blug_10q93011.htm

Item 1.	Financial Statements (Unaudited)
			Page

	Balance Sheets – September 30, 2011 and December 31, 2010		1

	Statements of Operations -
		Three and Nine months ended September 30, 2011 and 2010 and
		From December 11, 2007 (Inception) to September 30, 2011	2

	Statements of Shareholders’ Equity (Deficit)		3

	Statements of Cash Flows –
		Nine months ended September 30, 2011 and 2010 and
		From December 11, 2007 (Inception) to September 30, 2011	4

	Notes to the Condensed Financial Statements		5

Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations		12

Item 3.	Quantitative and Qualitative Disclosures About Market Risk
	– Not Applicable		15

Item 4.	Controls and Procedures		15

PART II – OTHER INFORMATION

Item 1.	Legal Proceedings		16

Item 1A.	Risk Factors		16

Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds		16

Item 3.	Defaults Upon Senior Securities		17

Item 4.	Reserved		17

Item 5.	Other Information		17

Item 6.	Exhibits		17

SIGNATURES			17

	September 30, 2011			December 31, 2010
ASSETS
Current assets:
Cash	$	-		$	-
Other receivable		39,811			-
Total current assets		39,811			-

Oil and gas properties - undeveloped		1,984,383			1,984,383

Other assets:
Investment in Quad Energy		15,000			-
Total other assets		15,000			-

Total assets	$	2,039,194		$	1,984,383


LIABILITIES AND SHAREHOLDERS' EQUITY (DEFICIT)
Current liabilities:
Accounts payable and accrued liabilities	$	775,935		$	-
Notes payable		20,000			-
Convertible notes payable, net		286,271			-
Derivative liability		141,742			-
Accrued interest		225,545			-
Total current liabilities		1,449,493			-

Long-term note payable		3,500,000			-
Total liabilities		4,949,493			-

COMMITMENTS AND CONTENGENCIES
Shareholders' equity (deficit):
Common stock par value $.005, 100,000,000 shares authorized,
70,866,638 and 0 issued and outstanding, respectively		354,333			-
Additional paid-in-capital		(1,586,561	)		1,984,383
Deficit accumulated during the development stage		(1,678,071	)		-
Total shareholders' equity (deficit)		(2,910,299	)		1,984,383
Total liabilities and shareholders' equity (deficit)	$	2,039,194		$	1,984,383

BLUGRASS ENERGY INC.

(A Development Stage Company)

STATEMENTS OF OPERATIONS

(Unaudited)

	Three Months Ended			Three Months Ended		Nine Months Ended			Nine Months Ended		December 11, 2007 (Inception) to
	September 30, 2011			September 30, 2010		September 30, 2011			September 30, 2010		September 30, 2011

Operating expenses:
Land development costs	$	-		$	-	$	176,130		$	-	$	176,130
Professional fees		39,943			-		291,722			-		291,722
General and administrative expenses		192,192			-		497,399			-		497,399
Total operating expenses		232,135			-		965,251			-		965,251

Other expense:
Loss on investment in Quad Energy		(10,000	)		-		(485,000	)		-		(485,000	)
Interest expense		(111,005	)		-		(227,820	)		-		(227,820	)
Total other expense		(121,005	)		-		(712,820	)		-		(712,820	)
Net Loss		(353,140	)		-		(1,678,071	)		-		(1,678,071	)

Per share information:
Basic and diluted loss per common share	$	(0.00	)	$	-	$	(0.03	)	$	-

Weighted average shares outstanding		70,866,638			-		56,639,796			-

(See accompanying notes to the financial statements)

BLUGRASS ENERGY INC.

(A Development Stage Company)

STATEMENT OF SHAREHOLDERS' DEFICIT

December 11, 2007 (Inception) through

September 30, 2011

	Common Stock				Additional			Deficit Accumulated During Development			Total Stockholders'
	Shares		Amount		Paid-in-Capital			Stage			Equity (Deficit)


Balance at December 11, 2007		-	$	-	$	1,984,383		$	-		$	1,984,383
Balance at December 31, 2010		-		-		1,984,383			-			1,984,383
Recapitalization - February 23, 2011		69,254,294		346,272		(3,873,848	)		-			(3,527,576	)
Conversion of debentures		528,344		2,641		31,159						33,800
Common stock issued for services March 31, 2011		180,000		900		26,100			-			27,000
Stock compensation expense - March 31, 2011		-		-		24,123			-			24,123
Net loss		-		-		-			(523,844	)		(523,844	)
Balances at March 31, 2011		69,962,638		349,813		(1,808,083	)		(523,844	)		(1,982,114	)
Stock issued for compensation - Fullerton - April 5, 2011		64,000		320		9,280			-			9,600
Common stock and warrants issued		840,000		4,200		46,200			-			50,400
Stock compensation expense - June 30, 2011		-		-		83,021			-			83,021
Net loss		-		-		-			(801,087	)		(801,087	)
Balances at June 30, 2011		70,866,638		354,333		(1,669,582	)		(1,324,931	)		(2,640,180	)
Stock compensation expense - September 30, 2011		-		-		83,021			-			83,021
Net loss		-		-		-			(353,140	)		(353,140	)
Balances at September 30, 2011		70,866,638	$	354,333	$	(1,586,561	)	$	(1,678,071	)	$	(2,910,299	)

(See accompanying notes to the financial statements)

						December 11, 2007
	Nine months ended			Nine months ended		(Inception) to
	September 30, 2011			September 30, 2010		September 30, 2011

Cash Flows used in Operating Activities
Net loss	$	(1,678,071	)	$	-	$	(1,678,071	)
Adjustments to reconcile net loss to net cash used in operating activities:
Debt discount amortization		86,097			-		86,097
Impairment of assets		485,000			-		485,000
Common stock issued for services		36,600			-		36,600
Stock compensation		190,165			-		190,165
Changes in working capital:
Accounts payable		514,683			-		514,683
Other receivable		(39,811	)		-		(39,811	)
Accrued interest payable		139,937			-		139,937
Net cash used in operating activities		(265,400	)		-		(265,400	)

Cash Flows from financing activities:
Proceeds from issuance of short term notes		20,000			-		20,000
Proceeds from convertible promissory notes		195,000			-		195,000
Proceeds from issuance of common stock and warrants		50,400			-		50,400
Net cash provided by financing activities		265,400			-		265,400

Net increase in cash and cash equivalents		-			-		-
Cash and cash equivalents at the beginning of the period		-			-		-
Cash and cash equivalents at the end of the period	$	-		$	-	$	-

Supplemental Disclosure of Cash Flow Information:
Cash paid for interest expense	$	-		$	-	$	-
Cash paid for income taxes	$	-		$	-	$	-
Debt and interest converted to equity	$	33,800		$	-	$	33,800

Blugrass Energy Inc. (the “Company” or “Blugrass”) was incorporated under the laws of the State of Nevada on May 19, 2006, as Coastal Media Inc. The Company was originally formed to engage in the business of manufacturing, marketing, distributing and selling its marine DVDs. On September 11, 2008, the Company amended its Articles of Incorporation to change its name from "Coastal Media Inc." to "Blugrass Energy Inc.", to reflect the change in direction of the Company’s business to the Oil and Gas Industry. As a result of the name change, the Company’s trading symbol was changed to “BLUG”.

On February 23, 2011, Petro Grande, LLC (“Petro Grande”) consummated a transaction with Blugrass whereby Petro Grande acquired a controlling interest in Blugrass. This transaction effected a change of control and Blugrass’ management team was replaced with Petro Grande’s management team. Upon the reverse merger recapitalization on February 23, 2011 the inception date of the Company changed to December 11, 2007, the date of the acquisition of the lease by Petro Grande, LLC. As a result of the reverse merger recapitalization, Blugrass’ new management team has implemented a new business strategy (discussed in detail in the section on Management’s Discussion and Analysis below).

Use of Estimates – The preparation of financial statements in conformity with generally accepted accounting principles in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of sales and expenses during the reporting periods. Key estimates in the accompanying financial statements include, among others, revenue recognition, allowances for doubtful accounts, valuation of long-lived assets, and deferred income tax asset valuation allowances.

Oil and Gas Properties – We follow the successful efforts method of accounting for oil and gas producing activities. Unsuccessful exploration drilling costs are expensed and can have a significant effect on reported operating results. Successful exploration drilling costs and all development costs are capitalized and systematically charged to expense using the units of production method based on proved developed oil and gas reserves as estimated by our engineers and reviewed by independent engineers. Costs incurred for exploratory wells that find reserves that cannot yet be classified as proved are capitalized if (a) the well has found a sufficient quantity of reserves to justify its completion as a producing well and (b) there is sufficient progress being made in assessing the reserves and the economic and operating viability of the project. Proven property leasehold costs are amortized to expense using the units of production method based on total proved reserves. Properties are assessed for impairment as circumstances warrant and impairments to value are charged to expense. The successful efforts method inherently relies upon the estimation of proved reserves, which includes proved developed and proved undeveloped volumes.

Proved reserves are defined by the SEC as those volumes of crude oil, condensate, natural gas liquids and natural gas that geological and engineering data demonstrate with reasonable certainty are recoverable in future years from known reservoirs under existing economic and operating conditions. Proved developed reserves are volumes expected to be recovered through existing wells with existing equipment and operating methods. Although engineers are knowledgeable of and follow the guidelines for reserves established by the SEC, including the rule revisions designed to modernize the oil and gas company reserves reporting requirements, the estimation of reserves requires engineers to make a significant number of assumptions based on professional judgment. Reserve estimates are updated periodically and consider recent production levels and other technical information. Estimated reserves are often subject to future revisions, which could be substantial, based on the availability of additional information, including: reservoir performance, new geological and geophysical data, additional drilling, technological advancements, price and cost changes and other economic factors. Changes in oil and gas prices can lead to a decision to start-up or shut-in production, which can lead to revisions to reserve quantities. It is difficult to predict what reserve revisions may be required in future periods.

Depletion rates are determined based on reserve quantity estimates and the capitalized costs of producing properties. As the estimated reserves are adjusted, the depletion expense for a property will change, assuming no change in production volumes or capitalized costs. While total depletion expense for the life of a property is limited to the property’s total cost, proved reserve revisions result in a change in timing when depletion expense is recognized. Downward revisions of proved reserves result in an acceleration of depletion expense, while upward revisions tend to lower the rate of depletion expense recognition. Estimated reserves are used as the basis for calculating the expected future cash flows from a property, which are used to determine whether that property may be impaired. Reserves are also used to estimate the supplemental disclosure of the standardized measure of discounted future net cash flows relating to oil and gas producing activities and reserve quantities. Changes in the estimated reserves are considered a change in estimate for accounting purposes and are reflected on a prospective basis.

Income Taxes – The Company estimates its current tax position together with its future tax consequences attributable to temporary differences resulting from differing treatment of items, such as depreciation and other reserves for tax and accounting purposes. These temporary differences result in deferred tax assets and liabilities. Management must then assess the likelihood that its deferred tax assets will be recovered from future taxable income, prior year carryback, or future reversals of existing taxable temporary differences. To the extent management believes that recovery is unlikely, management establishes a valuation allowance against these deferred tax assets. Significant judgment is required in determining the Company’s provision for income taxes, its deferred tax assets and liabilities, and any valuation allowance recorded against its deferred tax assets. At September 30, 2011 and December 31, 2010, the Company has recorded a full valuation allowance against its net deferred tax assets due to the uncertainty these assets will be used in the future.

On February 23, 2011, the Company was acquired by Petro Grande, which contributed a significant oil and gas working interest lease covering acreage located in Crockett County, Texas from Petro Grande as consideration in exchange for 52,294,336 shares of the Company’s restricted common stock plus a promissory note in the amount of $3.5 million. On the closing date of the PG Transaction, a change in control of the Company occurred and the senior management and directors of Blugrass resigned and were replaced by Petro Grande’s management team. Although Blugrass is the surviving legal entity; the contributed Petro Grande working interest lease remained the financial reporting entity and the merger was treated as a reverse recapitalization as, prior to the PG transaction, Blugrass was a public holding company with limited assets or operations and, upon completion of the PG transaction, Petro Grande shareholders emerged with a controlling 77% interest in the merged Company.

The PG Transaction was initially valued by Petro Grande management at approximately $8.7 million and, as such, the Company recorded an increase to the value of undeveloped leasehold costs of Blugrass of approximately $6.7 million. After reviewing the PG Transaction, the Securities and Exchange Commission’s Division of Corporate Finance recommended that the consideration provided in the transaction should be valued at its historical cost as is consistent with a reverse recapitalization. As a result, management has reduced the amount recorded as “Oil and gas properties – undeveloped” and additional paid in capital as of September 30, 2011 balance sheet, to $1,984,383.

The oil and gas lease contributed as consideration as part of the PG Transaction (the Soto Lease defined below) includes an option to participate as a working interest partner in drilling programs sponsored on an additional 9,850 acres (currently held by Petro Grande) located in close proximity to the oil and gas lease properties contributed. This acreage also benefits from 3D seismic imaging.

On February 23, 2011, upon the reverse merger recapitalization the Company acquired an asset purchase agreement with Quad Energy Corp. (“Quad Energy”) for the sale of 100% of the Company’s rights, title and interest to certain properties located in and around the Cave Pool Unit (Marks and Garner Productions) in Eddy County, New Mexico (the “Eddy County Properties”). The Eddy County Properties consist of leasehold interests in approximately 2,800 acres and all existing equipment used to produce oil and natural gas located on the Eddy County Properties. As consideration for the transaction the Company was to receive 5,000,000 shares of Quad Energy’s common stock, valued at $.10 per share. The transaction closed on January 25, 2011 pre-recapitalization, and the Company recorded an investment in Quad Energy in the amount of $500,000. During the nine months ended September 30, 2011, the value of the investment in Quad Energy had decreased and the Company recorded a loss on the statement of operations of $485,000 as the Company considers the loss other than temporary.

On February 23, 2011, in conjunction with the PG Transaction, the Company acquired a 4,808 acre undeveloped lease located in the Permian Basin in Crockett County, Texas (the “Soto Lease”). Acquisition of the Soto Lease, representing an 87.5% working interest in the underlying acreage, includes full access to Petro Grande’s complete three-dimensional (3D) seismic imaging of the land under lease. The lease expiration date is July 12, 2013 with a 2011 lease obligation to drill one Strawn formation well and one Ellenburger formation well by December 31, 2011. The Company’s plans to drill by December 31, 2011, are contingent upon management raising additional funding to finance drilling costs. This lease has a continuous drilling clause of 120 days provided the drilling obligations previously described are satisfied.

The Company’s financial statements for the nine-month period ended September 30, 2011 have been prepared on a going concern basis, which contemplates the realization of assets and the settlement of liabilities and commitments in the normal course of business. The Company reported a net loss of $1,678,071 for the nine-month period ended September 30, 2011, and an accumulated deficit during the development stage of $1,678,071 as of September 30, 2011. At September 30, 2011, the Company had a working capital deficit of $1,409,682 and the Company had no revenues from its activities during the nine-month period ended September 30, 2011.

In conjunction with the PG Transaction, the Company issued a note payable in the amount of $3.5 million (the “PG Note Payable”) on February 23, 2011. The PG Note Payable accrues interest at a rate of 6.5% per annum beginning on February 23, 2011 with accrued interest payable in semi-annual installments beginning on October 1, 2011. Past due principal and accrued interest accrue interest at a rate of 10% per annum. The balance of the PG Note Payable along with any accrued and unpaid interest is due on February 22, 2013. The PG Note Payable is secured by a first priority interest in the Company’s Soto Lease.

Holders of the April 2011 Convertible Promissory Note have the right to convert all or any part of the outstanding principal and accrued interest to shares of common stock of the Company beginning 180 days after April 8, 2011. The April 2011 Convertible Promissory Note is convertible at a per share price equal to 60% of the average of the lowest 5 closing bid prices of the Company’s common stock as listed on the Over-the-Counter Bulletin Board over the 10 trading days immediately prior to conversion. In the event of a default, the minimum amount due is 150% of outstanding principal and unpaid interest, and the April 2011 Convertible Promissory Note accrues interest at a rate of 22% per annum until paid or converted.

On May 19, 2011 the Company issued a Convertible Promissory Note totaling $42,500 to a third party (the “May 2011 Convertible Promissory Note”). The May 2011 Convertible Promissory Note accrues interest at a rate of 8% per annum. The principal balance and accrued interest under the May 2011 Convertible Promissory Note is due on January 12, 2012. Holders of the May 2011 Convertible Promissory Note have the right to convert all or any part of the outstanding principal and accrued interest to shares of common stock of the Company beginning 180 days after May 19, 2011. The May 2011 Convertible Promissory Note is convertible at a per share price equal to 60% of the average of the lowest 5 closing bid prices of the Company’s common stock as listed on the Over-the-Counter Bulletin Board over the 10 trading days immediately prior to conversion. In the event of a default, the minimum amount due is 150% of outstanding principal and unpaid interest, and the May 2011 Convertible Promissory Note accrues interest at a rate of 22% per annum until paid or converted.

On July 12, 2011, the Company issued a Convertible Promissory Note (the “July 2011 Convertible Promissory Note”) in the amount of $35,000. The balance of the July 2011 Convertible Promissory Note is payable in full on April 17, 2012. The July 2011 Convertible Promissory Note accrues interest at a rate of 8.0% per annum. Holders of the July 2011 Convertible Promissory Note have the right to convert all or any part of the outstanding principal and accrued interest to shares of common stock of the Company beginning 180 days after July 12, 2011. The July 2011 Convertible Promissory Note is convertible at a per share price equal to 55% of the average of the lowest 3 closing bid prices of the Company’s common stock as listed on the Over-the-Counter Bulletin Board over the 10 trading days immediately prior to conversion. In the event of a default, the minimum amount due is 150% of outstanding principal and unpaid interest, which accrues interest at a rate of 22% per annum until paid or converted.

On August 11, 2011, the Company issued a Convertible Promissory Note (the “August 2011 Convertible Promissory Note”) in the amount of $42,500. The balance of the August 2011 Convertible Promissory Note is payable in full on May 15, 2012. The August 2011 Convertible Promissory Note accrues interest at a rate of 8.0% per annum. Holders of the August 2011 Convertible Promissory Note have the right to convert all or any part of the outstanding principal and accrued interest to shares of common stock of the Company beginning 180 days after August 15, 2011. The August 2011 Convertible Promissory Note is convertible at a per share price equal to 55% of the average of the lowest 3 closing bid prices of the Company’s common stock as listed on the Over-the-Counter Bulletin Board over the 10 trading days immediately prior to conversion. In the event of a default, the minimum amount due is 150% of outstanding principal and unpaid interest, which accrues interest at a rate of 22% per annum until paid or converted.

The Company determined that the conversion features in the April, May, July, and August 2011 Convertible Promissory Notes (collectively, the “Convertible Promissory Notes”) should be accounted for as a convertible note derivative liability. The conversion features are treated as a derivative and recorded at their fair value. Accordingly, the Company recorded a derivative liability and debt discount for each of the notes in the amount of $141,742. During the nine months ended September 30, 2011 a charge to debt discount in the amount of $66,347 was expensed through interest expense. At September 30, 2011 the debt discount was $75,395. The Company will continue to reevaluate the derivative liability in future reporting periods and adjust the derivative liability as necessary. This derivative will continue to be marked to market in accordance with FASB ASC 815.

			Ending	Stated	Default			Effective
		Debt	Balance	Interest	Interest	Current		Interest
Date of Issuance	Principal	Discount	@ 9/30/11	Rate	Rate	Rate		Rate
11/17/2008	50,000	-	50,000	6.0%	18.0%	18.0%	(1)	72.55%
12/9/2008	33,333	-	33,333	6.0%	18.0%	18.0%	(1)	88.00%
12/9/2008	33,333	-	33,333	6.0%	18.0%	18.0%	(1)	88.00%
1/29/2009	50,000	-	50,000	6.0%	18.0%	18.0%	(1)	88.00%
4/8/2011	75,000	16,667	58,333	8.0%	22.0%	8.0%		74.67%
5/19/2011	42,500	12,592	29,908	8.0%	22.0%	8.0%		74.67%
7/12/2011	35,000	19,090	15,910	8.0%	22.0%	8.0%		89.82%
8/11/2011	42,500	27,046	15,454	8.0%	22.0%	8.0%		89.82%
Total	361,666	75,395	286,271
(1) Currently in default.

The Company's financial instruments, including cash, other receivable, accounts payable, and accrued liabilities approximated fair value due to the short-term nature of those instruments. The carrying value of notes payable and convertible notes payable approximates fair value as these instruments bear market rates of interest. None of these instruments are held for trading purposes.

On February 23, 2011, in conjunction with the PG Transaction, the Company issued to Petro Grande 52,294,336 shares of its restricted common stock, or approximately 77% of its restricted common stock outstanding at that time. Upon closing of the PG Transaction, Petro Grande held a controlling interest in the Company. These shares are included in the recapitalization line on the Statement of Shareholders’ Equity (Deficit).

On February 23, 2011, the Company awarded options to purchase 2,400,000 shares of the Company’s common stock (the “Option Grants”). The Option Grants include options to purchase 1,000,000 shares of the Company’s common stock to each of the Chief Executive Officer and the Chief Financial Officer, plus an option to purchase 400,000 shares of the Company’s common stock to an advisor. Each of the Option Grants provides the option holder the right to purchase shares of the Company’s common stock at an exercise price of $0.25 per share, subject to vesting requirements. Options to purchase 1,200,000 shares of the Company’s common stock vest on February 23, 2012. Beginning on February 23, 2012, options to purchase the remaining 1,200,000 shares of the Company’s common stock vest pro rata on a monthly basis over the succeeding twelve months; accordingly, the Option Grants will vest in full on February 23, 2013. For the nine months ended September 30, 2011 the Company recorded stock related compensation expense of $190,165 in connection with the Option Grants.

As a result of the reverse split, the number of authorized shares of the Company’s common stock has been reduced, from 500,000,000 shares to 100,000,000 shares. Also as a result of the reverse split, each five shares of the Company’s common stock issued and outstanding on the Effective Date represented one share of the Company’s common stock. Fractional shares existing as a result of the reverse split were rounded up to the nearest whole share.

On June 29, 2011, the Company issued 840,000 shares of common stock and 840,000 warrants. As consideration the Company received net cash proceeds of $50,400. The fair value of the 840,000 warrants at the date of issuance was $.04 per warrant. During the nine months ended September 30, 2011, the Company issued 180,000 shares of restricted common stock in lieu of cash payment for services to a related party.

This Quarterly Report on Form 10-Q contains forward-looking statements. Any statements contained herein that are not statements of historical fact may be deemed to be forward-looking statements within the meaning of Section 21E of the Securities Exchange Act. The words “believes,” “anticipates,” “plans,” “seeks,” “expects,” “intends” and similar expressions identify some of the forward-looking statements. Forward-looking statements are not guarantees of performance or future results and involve risks, uncertainties and assumptions. The factors discussed elsewhere in this Form 10-Q could also cause actual results to differ materially from those indicated by the Company’s forward-looking statements. The Company undertakes no obligation to publicly update or revise any forward-looking statements.

Blugrass Energy Inc. is a publicly held Nevada corporation listed on the OTC under the symbol BLUG.PK. The Company was incorporated under the laws of the State of Nevada on May 19, 2006 as Coastal Media Inc. On September 11, 2008, the Company amended its Articles of Incorporation to change its name to Blugrass Energy Inc. Upon the reverse merger recapitalization on February 23, 2011, the new inception date is December 11. 2007.

Strategic initiatives for the Company are defined and driven by a carefully selected management team and business partners that have long, proven records of successes in their specialized disciplines. We are of the belief that the extensive experience and past successes of the professionals on our team are the best indicators of future success. This strategy requires the following principal elements.

Commitment to Advanced Seismic Technology. The Company committed to a 3D seismic data acquisition program, plus advanced processing of the 3D seismic data, as 3D is the most sophisticated technology available for analyzing the formations, faults, integrating land culture, etc. The distinct advantage of 3D seismic surveys over 2D surveys is that 3D provides a continuity of subsurface rocks and fluids (including hydrocarbons), the ability to extract new information from data, and a common focus for integration of reservoir data from all sources. This technology -- both the 3D data and the processing of that data -- significantly reduces risk in the drilling program. This heavy front-end commitment provides current state-of-the-art technology that, in turn, contributes significantly to lowering project risk and identifying potential targets with a much higher degree of accuracy.

Results of the 3D Analysis. The Company’s 3D analysis was performed by our outsourced Geoscientist and trusted member of our advisory team, whose experience spans more than 35 years. He has a high level of expertise with the geology of the Permian and Val Verde Basins, where the Company holds a mineral rights lease, and his expertise extends to the Strawn and Ellenburger Formations which are located beneath the Company’s leased acreage. The results of his analysis were used to generate structural maps and seismic attributes for the Strawn and Ellenburger reservoirs, and comparable structural maps for the shallower Canyon Sands formation also located beneath the Company’s leased acreage. Premised upon the 3D seismic interpretations, the Company believes that there is significant natural gas in its current acreage position.

Acreage Acquisition. Blugrass holds a lease covering 4,808 acres in Crockett County, located in West Texas, for the purpose of drilling and developing. The Company is required to drill an Ellenburger formation natural gas well and a Strawn formation natural gas well, each on the Company’s Soto Lease acreage in Crockett County, Texas by December 31, 2011. The Company is in discussion with the lessor to extend the lease obligations.

Drilling Targets and HBP Acreage. Drilling targets are carefully evaluated by the Blugrass management and advisory team. A number of considerations are factored into each decision and incorporated into the overall drilling plan. These include the seismic results and analysis of possible well locations, the potential reserves at a specific target, the ease or difficulty of building on specific terrain and the associated cost of the location construction (incorporated into the total drilling expenditures), the overall risk associated with a specific target based on geology and depth of the well, and other known factors that may impact success in the immediate geographic area. Since successful commercial wells hold production acreage, known as HBP (Held by Production) acreage for long-term production for working and royalty interest owners, the overall drilling plan includes the careful selection of drilling locations to maximize HBP acreage within the contracted lease terms. The drilling plan also incorporates the state’s spacing and other requirements while trying to maximize the desired HBP acreage.

The principal target formations in the Permian and Val Verde Basins are the Strawn formation at approximately 12,500 feet total depth, and the Ellenburger formation at approximately 14,000 feet total depth. These formations are known to contain natural gas in relatively large quantities, based on previous wells drilled either in adjacent properties or in close proximity to the Company’s acreage position.

Premised upon the 3D seismic interpretations, the Company has also identified numerous drilling targets in the Canyon Sands formation at a shallower depth of approximately 6,500 feet. Regionally, the Company’s land position is on trend with numerous giant, multipay gas fields which include the Gomez Field, the Brown Bassett, the JM Field, and others.

Advanced Drilling Technology. Blugrass has selected air drilling technology that uses an air hammer for drilling. This technology has the advantage of being more economical, as well as time-effective. Air hammers drill straight holes because their drilling power comes from high frequency percussion rather than from high rotation and pulldown, and because the air hammer piston impacts directly on the bit rather than through a drill string, which can bend over long hole depths. This technology minimizes hole deviations and doglegs, and the speed of the process, coupled with open hole completions, results in significant savings in total drilling costs.

Continuous Monitoring, Cost Controls, and Auditing. Since control activities are a vital part of making business processes work effectively, Blugrass uses the extensive internal audit and contract compliance experience of its Financial Advisor in reviewing bid processes, contract compliance with operators, contractors, and vendors including expenditure and revenue audits and reviewing gas measurement controls and contract terms that eventually determine the gas volumes that go into gas settlement statements.

We incurred operating expenses of $965,251 for the nine months ended September 30, 2011. There were no expenses incurred for the same nine months ended post-recapitalization (described in Acquisitions and Dispositions section). The operating expenses were primarily related to general and administrative expenses of $497,399, and professional fees of $291,722. In addition, the Company recorded land development costs of $176,130, which related to a reserve booked to the Soto Lease related to a lien on that property (described in Oil & Gas Properties section) during the nine months ended September 30, 2011.

We incurred operating expenses of $232,135 for the three-months ended September 30, 2011. There were no expenses incurred for the same three months ended post-recapitalization 2010 (described in Reverse Merger Note in the financial statement section). The operating expenses were primarily related to general and administrative expenses of $192,192. In addition, the Company incurred $39,943 in professional fees. There were no expenses incurred during the three months ended September 30, 2010 pre-acquisition as noted in acquisitions and dispositions above. During the three months ended September 30, 2011, we recognized a net loss of $353,140.

At September 30, 2011, we had total assets of $2,039,194, consisting primarily of $1,984,383 in undeveloped leases (the Soto Lease) acquired in conjunction with the PG Transaction as well as an investment in Quad Energy valued at $15,000. At September 30, 2011, we had total current liabilities of $1,449,493, consisting of accounts payable and accrued liabilities totaling $775,935, accrued interest totaling $225,545 and $286,271 of convertible promissory notes outstanding.

As of September 30, 2011, as required by Rule 13a-15(b) of the Exchange Act, new management, including our Chief Executive and Accounting Officer, evaluated the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) as of the end of the period covered by this Form 10-Q. Our disclosure controls and procedures are designed to provide reasonable assurance that the information required to be disclosed by us in reports that we file under the Exchange Act is accumulated and communicated to our management, including our Chief Executive and Accounting Officer, as appropriate, to allow timely decisions regarding required disclosure and is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the SEC. Based upon the evaluation, our Chief Executive and Accounting Officer concluded that our disclosure controls and procedures were effective as of September 30, 2011 at the reasonable assurance level.

As a result of our change in management subsequent to year end, the Company’s new management performed an evaluation of the Company’s internal controls over financial reporting for the six-month period ended December 31, 2010, and such controls were determined to be ineffective at the reasonable assurance level, as disclosed in the Company’s 10-KT filing for that period. During the nine months ended September 30, 2011, the Company’s new management team, including the Company’s Chief Executive and Accounting Officer, developed and implemented new internal controls over financial reporting which replaced the existing internal controls over financial reporting and evaluated the effectiveness of the design and operation of the Company’s new internal controls over financial reporting in accordance with the Sarbanes-Oxley Act of 2002 Section 404. Accordingly, new management determined the design and operation of the Company’s newly implemented internal controls over financial reporting were effective.

We are subject to various risks and uncertainties in the course of our business. In addition to the factors discussed elsewhere in this report, you should carefully consider the risks and uncertainties described under Item 1A. Risk Factors filed in our Transition Report on Form 10-KT for the year ended December 31, 2010. There have been no material changes from the risk factors previously disclosed in that Form 10-KT.

In a series of transactions commencing February 24, 2011 and ending September 30, 2011, the Company issued an aggregate of 528,344 shares of its common stock to the holders of convertible promissory notes, upon conversion of all or part of the principal amount of such notes. The shares of common stock issued upon conversion were not registered under the Securities Act of 1933. The issuance of these shares was exempt from registration pursuant to Section 4(2) of the Securities Act of 1933. The Company made this determination based on the representations of each note holder that it is an “accredited investor,” as defined in Regulation D of the Securities Act.

On February 24, 2011, the Company issued an aggregate of 180,000 shares of its common stock to an executive officer of the Company, in lieu of the payment of accrued salary. Such shares of common stock were not registered under the Securities Act of 1933. The issuance of these shares was exempt from registration pursuant to Section 4(2) of the Securities Act of 1933. The Company made this determination based on the executive officer’s tenure with the Company and his knowledge and experience in financial and business matters.

On April 13, 2011, the Company issued an aggregate of 64,000 shares of its common stock to a provider of professional services to the Company, in lieu of the payment of cash for such services. The issuance of these shares was exempt from registration pursuant to Section 4(2) of the Securities Act of 1933. The Company made this determination based on the individual’s long-standing business relationship with the Company and his knowledge and experience in financial and business matters. Appropriate legends have been affixed to all shares of the Company’s common stock issued in the transaction.


Nevada		20-4952339
(State or other jurisdiction of		(IRS Employer Identification No.)
incorporation or organization)

	Large accelerated filer [_]	Accelerated Filer [_]

	Non-accelerated filer [_]	Smaller reporting company [X]

	By:	/s/ Abram Janz
		Abram Janz, Chief Executive Officer


	By:	/s/ Abram Janz
		Abram Janz, Chief Accounting Officer