Quest Oil 10QSB 2007 Q3 Quarterly report (small business)

U. S. SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-QSB

[ X ]

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

For the quarterly period ended December 31, 2006

[ ]	TRANSITION REPORT UNDER SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from ___________ to _____________

Commission File Number: 33-90355

QUEST OIL CORPORATION

Nevada	000-26619	90-0281227
(State or other jurisdiction	(Commission File Number)	(IRS Employer
of Incorporation)		Identification Number)
	2038 Corte Del Nogal, Suite 110
	Carlsbad, CA 92011
	(Address of principal executive offices)

	(760) 804-8844
	(Issuer’s Telephone Number)

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

Indicate by check mark whether the registrant is a shell company (as defined by Rule 12b-2 or the Exchange Act

Yes No X

APPLICABLE ONLY TO ISSUERS INVOLVED IN BANKRUPTCY

PROCEEDINGS DURING THE PRECEDING FIVE YEARS

Check whether the registrant filed all documents and reports required to be filed by Section 12, 13, or 15(d) of the Exchange Act of 1934 after the distribution of securities under a plan confirmed by a court. Yes ___ No ____

APPLICABLE ONLY TO CORPORATE ISSUERS

State the number of shares outstanding of each of the issuer’s classes of common equity, as of the latest practicable date:

As of February 19, 2006, 77,738,340 shares of our common stock were issued and outstanding.

Transitional Small Business Disclosure Format: No

PART I

ITEM 1. FINANCIAL STATEMENTS

Our financial statements and related explanatory notes can be found on the “F” Pages at the end of this Report.

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OR PLAN OF OPERATIONS

The following discussion and analysis should be read in conjunction with our audited consolidated financial statements and related notes included in this report. The statements contained in this report that are not historic in nature, particularly those that utilize terminology such as “may,” “will,” “should,” “expects,” “anticipates,” “estimates,” “believes,” or “plans” or comparable terminology are forward-looking statements based on current expectations and assumptions.

Various risks and uncertainties could cause actual results to differ materially from those expressed in forward-looking statements. Factors that could cause actual results to differ from expectations include, but are not limited to, those set forth under the section “Risk Factors” set forth in this report.

The forward-looking events discussed in this prospectus, the documents to which we refer you and other statements made from time to time by us or our representatives, may not occur, and actual events and results may differ materially and are subject to risks, uncertainties and assumptions about us. For these statements, we claim the protection of the “bespeaks caution” doctrine. All forward-looking statements in this document are based on information currently available to us as of the date of this report, and we assume no obligation to update any forward-looking statements. Forward-looking statements involve known and unknown risks, uncertainties and other factors that may cause the actual results to differ materially from any future results, performance or achievements expressed or implied by such forward-looking statements.

General

We are an independent exploration stage oil and natural gas company that explores for, acquires and develops oil and natural gas properties. Currently, our operations are currently focused in the United States and on the Canadian oil and gas fields of Alberta. We are also exploring other various global opportunities.

Corporate History

We were originally incorporated in the State of Nevada on January 19, 1999 under the name of Luna Technologies, Inc. We have changed our name several times as follows: Luna Medical Technologies, Inc. (May 31, 1999), Lanwerx Entertainment, Inc. (May 19, 2003), GameState Entertainment, Inc. (September 24, 2003) and Quest Oil Corporation (September 7, 2004). In 2004, we formed Quest Canada Corp., a wholly owned Canadian subsidiary, which was created to serve as a holding company for our anticipated oil and gas projects in Alberta. In August 2005, we acquired Wallstin Petroleum LLC. In 2005, Petrostar Oil Services Inc. was created for the purpose of servicing the oil and gas properties in Texas.

Recent Developments

On June 30, 2006, our board of directors approved the dismissal of the firm of MacKay LLP as our certifying accountant. The dismissal was not due to any disagreements between ourselves and MacKay LLP. The reports on our financial statements for either of the past two years provided by MacKay LLP did not contain an adverse opinion or disclaimer of opinion, and were not modified as to uncertainty, audit scope, or accounting principles.

On June 30, 2006, we formally retained the firm of Malone & Bailey, PC to audit our financial statements for the year ended March 31, 2006. At no time prior to our retention of Malone & Bailey, PC, did we, or anyone on our behalf, consult with Malone & Bailey, PC regarding the application of accounting principles to a specific completed or contemplated transaction, or the type of audit opinion that might be rendered on our financial statements.

On July 14, 2006, Mr. Chris Phillips resigned from his position on our board of directors.

On July 15, 2006, we engaged The Baum Law Firm, P.C. as special securities counsel.

On September 12, 2006, we entered into an Assignment of Oil and Gas Lease with Mr. W.A. Walker. The Assignment provides us with a 100% working interest and an 87.5% net royalty interest in the oil, gas and mineral rights in the Kansas Shinkle property, which consists of five oil and gas zones located in the Kansas Cherokee Basin. In connection with the Assignment, we entered into a Purchase and Sale Agreement and a Consulting Agreement with Mr. W.A. Walker. Under the Consulting Agreement, we retained the services of Mr. W.A. Walker who will assist Quest with operations for the next 12 months.

On September 13, 2006, Mr. Joseph F. Wallen resigned from his positions as our Chief Financial Officer and Director. Mr. Wallen’s resignation was not because of any disagreements with the Corporation on matters relating to its operations, policies or practices. Mr. Wallen will continue to focus on the Company's operations and assume the post of Operations Director.

On September 14, 2006, our board of directors appointed Mr. Phil Scott, CFA to act as our Chief Financial Officer.

On December 1, 2006 Quest Oil Corporation (“Quest”) entered into a binding Letter of Intent (the “LOI”) with Endeavor Energy Corporation (“Endeavor”). Pursuant to the terms of the LOI, Endeavor will acquire from Quest a non-exclusive license of the seismic data obtained from the Acadia North 3D Seismic Data Acquisition Project covering 10 square miles over our main Canadian project Acadia North (the “Acadia Project”). The licensing fee is Two Hundred and Fifty Thousand Dollars ($250,000 US). Endeavor will pay all costs associated with interpreting the data which will be for internal use only. Quest will retain ownership of all results of the interpretation and internal documents that pertain to the seismic area surveyed.

In addition to the non-exclusive licensing fee, Endeavor will acquire the right to drill and explore the lands associated with the Acadia Project. All Canadian properties currently owned by Quest will remain in Quests name, Endeavor will become operator and abide by the CAPL operators guidelines, subject to amendments or modifications that are acceptable to both Quest and Endeavor. Endeavor will be responsible for bearing the costs associated with these properties.

Quest will receive the right to participate in future operations derived from the existing lands owned and or controlled by Quest and any lands acquired, farmed out and/or joint ventured or where Endeavor’s officers, directors, or affiliates receive an economic benefit from the properties covered within the 3D seismic area and 1 mile outside of the surveyed area.

On February 13, 2007 we received a demand letter for the amount of $6,048,000 plus accrued interest and costs from Howard Gorman at Macleod Dixon indicating that a group of Secured Lenders pursuant to the September 30, 2005 Debenture and Guarantee and Indemnity agreements had appointed the Double U Fund to act as an agent on behalf of the Secured Lenders, and that Macleod Dixon are the solicitors of the Double U Fund. The creditors also alleged that preferential transfers and other fraud took place between Quest and its employees and other insiders. We believe that these allegations have no merit. Quest is in the process of responding to the demand, which we believe is incorrect in the amount of the indebtedness. The outstanding balance at December 31, 2006 was $4,799,999 plus accrued interest.

Results of Operations

For the nine months ended December 31, 2006, we had a net loss of $1,948,341 compared to a net loss of $10,692,130 for the previous period ended December 31, 2005. This decrease in loss is primarily a result of the significant decrease in the expenses associated with the derivative expense, both derivative interest and change in value of derivatives. In addition, our operating loss increased slightly from $2,586,797 to $3,055,899. In addition, we had limited revenues of $485,675.

For the three months ended December 31, 2006, we had a net loss of $825,940 compared to a net profit of $2,029,121 for the previous period ended December 31, 2005. This decrease in profitability is a direct result of derivative expense income and a significant decrease in operating and general and administrative expenses. In addition, we had limited oil and gas sales of $269,768.

Liquidity and Capital Resources

At December 31, 2006, we had cash of $335,787 compared to $1,558,146 at March 31, 2006.

On October 6, 2005, we entered into a convertible note financing transaction with 25 accredited investors pursuant to which the investors agreed to loan us an aggregate principal amount of $8 million. The notes are released in two tranches of which $6 million was received at closing and the balance of $2 million will be released to us upon the successful effectiveness of a Registration Statement. At their election, the investors are also entitled to invest up to an additional $2 million. Each investor received a Zero Coupon Note equal to 5% of total amount invested by each investor. We issued to the investors, senior secured convertible notes, zero coupon convertible notes and common stock purchase warrants.

The senior secured convertible notes issued at the initial closing are due October 6, 2007, and bear interest, in arrears, at a rate per annum equal to ten percent (10%), payable annually on October 1 of each year commencing October 1, 2006 at our option in (A) cash, (B) additional senior secured convertible promissory notes, or (C) in registered shares of our common stock. Interest is computed on the basis of a 360-day year of twelve (12) 30-day months.

Commencing on the fifth (5^th) month following the issuance of the senior secured convertible notes and continuing thereafter on the first (1^st) business day of each month we are required to pay an amount to each note holder equal to 1/20 ^th of the original principal amount of the senior secured convertible notes plus any accrued but unpaid interest. Payment may be made at our option in cash or registered shares of our common stock. If we elect to make payments in registered shares of our common stock, the number of shares issued to the note holder shall be discounted to 87.5% of the average of the closing bid price of our common stock for the ten (10) trading days immediately preceding the payment date. Payment may be made in registered shares of our common stock only if: (A) the Registration Statement providing for the resale of the shares of common stock issuable upon conversion of the senior convertible notes is effective and has been effective, without lapse or suspension of any kind, for a period of twenty (20) consecutive calendar days, (B) trading in our common stock has not been suspended by the Securities and Exchange Commission or the OTC Bulletin Board (or other exchange or market on which our common stock is trading), (C) we are in material compliance with the terms and conditions of the senior secured convertible notes and other financing documents, and (D) the issuance of shares of common stock to each note holder does not violate the note holder’s 4.9% or 9.9% ownership cap restrictions.

The senior secured convertible notes are convertible at any time, at the option of the note holders, into such number of fully paid and non-assessable shares of our common stock as is determined by dividing (x) that portion of the outstanding principal balance plus any accrued but unpaid interest under the notes at the date that the note holder elects to convert by (y) the conversion price of $0.40 which is subject to adjustment.

We may cause the conversion of the senior secured convertible notes if, at any time following the effective date of the Registration Statement which registers the shares underlying the notes, the closing bid price exceeds $0.80 for a period of 10 consecutive trading days and the average daily trading volume for such 10 consecutive trading day period exceeds 250,000 shares of common stock subject to certain conditions. Upon mandatory conversion, the principal amount of the senior secured convertible notes plus all accrued and unpaid interest shall convert into a number of fully paid and nonassessable shares of common stock equal to the quotient of (i) the principal amount of the notes plus all accrued and unpaid interest outstanding on the mandatory conversion date divided by (ii) the conversion price in effect on the mandatory conversion date.

So long as the Registration Statement is effective, in the event that the closing bid price of the common stock is greater than $0.40 and less than $1.25, the maximum number of shares of common stock that may be issued upon conversion of the notes shall not exceed the greater of (1) 25% of the aggregate trading volume for the prior 15 days or (2) 20% of the original principal amount of the notes.

Prepayment of the senior secured convertible notes may be required at the option of the note holder subject to certain conditions. In addition, so long as ten (10%) of the original principal amount of the notes are outstanding, we can require prepayment of the notes by paying in cash, all or portion of the outstanding principal amount of the notes together with all accrued and unpaid interest thereon with 30 days prior written notice to the note holder at a price equal to 125% of the aggregate principal amount of the notes plus any accrued but unpaid interest.

The senior secured convertible notes are secured by a security agreement that we and our subsidiaries entered into with the investors. The security agreement grants the investors a secured interest in all of the collateral, as defined in the agreement, of the company and its subsidiaries until such time as our obligations under the senior secured convertible notes have been meet. In addition to the security agreement, Quest Canada Corp., our wholly owned Canadian subsidiary has entered into a guarantee and indemnity agreement with the investors, whereby Quest Canada has guaranteed payment of the notes and agreed to indemnify the investors against losses arising from our failure to meet the obligations of the notes. Quest Canada has also entered into a pledge and debenture agreement with the investors whereby Quest Canada has pledged $15 million in favor of the investors as a continuing collateral security for the payment and fulfillment of the notes. We and our wholly owned subsidiary, Wallstin Petroleum, LLC have entered into a deed of trust, security agreement, financing statement and assignment of rents and leases with the investors whereby some of our Texas properties, rents, royalties and proceeds have been conveyed to the trustee as collateral security for the notes.

The zero coupon convertible notes are also due on October 6, 2007 and have terms which are substantially similar to the senior secured convertible notes. However, the zero coupon convertible notes do not bear interest.

Also in connection with the transactions, we issued to each of the note holders, and to the Placement Agent, four types of warrants to acquire shares of our common stock, which are classified as “Series A,” “Series B,” “Series C” and “Placement Agent Series A,” “Placement Agent Series B,” “Placement Agent Series C,” and “Placement Agent Series D” Warrants. As discussed below, all warrants have substantially similar terms and conditions except for the exercise prices, the expiration dates and the absence of a call provision.

We issued to each of the note holders and to the Placement Agent, “Series A” warrants entitling the investors and the Placement Agent to acquire an aggregate of 27,500,000 shares of our common stock at an exercise price of $0.80 per share. The warrants issued to the investors have a “cashless exercise” provision which may be utilized by the holder only if one year has elapsed since the date of issuance of the warrant and a Registration Statement registering the common stock underlying the warrant is not in effect as required. The warrants issued to the Placement Agent have a “cashless exercise” provision which may be utilized by the holder without restriction. Subject to certain conditions, including the effectiveness of a Registration Statement providing for the resale of the common stock underlying the warrants, we may call the Series A warrants at any time so long as the value of our common stock is greater than $1.60 for a period of 10 consecutive days immediately prior to the call notice and the average daily trading volume during the 10 day call notice period exceeds 250,000 shares of common stock. The Series A warrants issued to the note holders are exercisable for a period of three years. The Placement Agent Series A warrants are exercisable for a period of five years.

We issued to each of the note holders and to the Placement Agent, “Series B” warrants entitling the investors and the Placement Agent to acquire an aggregate of 13,750,000 shares of our common stock at an exercise price of $0.46 per share. The warrants issued to the investors have a “cashless exercise” provision which may be utilized by the holder only if one year has elapsed since the date of issuance of the warrant and a Registration Statement registering the common stock underlying the warrant is not in effect as required. The warrants issued to the Placement Agent have a “cashless exercise” provision which may be utilized by the holder without restriction. Subject to certain conditions, including the effectiveness of a Registration Statement providing for the resale of the common stock underlying the warrants, we may call the Series B warrants at any time so long as the value of our common stock is greater than $0.56 for a period of 10 consecutive days immediately prior to the call notice and the average daily trading volume during the 10 day call notice period exceeds 250,000 shares of common stock. The Series B warrants issued to the note holders are exercisable for a period of two (2) years following the effective date of the Registration Statement providing for the resale of the shares of common stock underlying the warrants and the shares of common stock issuable upon conversion of the notes. The Placement Agent Series B warrants are exercisable for a period of five years.

We issued to each of the note holders and to the Placement Agent, “Series C” warrants which entitle the investors and the Placement Agent to acquire an aggregate of 13,750,000 shares of our common stock at an exercise price of $0.56 per share. The warrants issued to the investors have a “cashless exercise” provision which may be utilized by the holder only if one year has elapsed since the date of issuance of the warrant and a Registration Statement registering the common stock underlying the warrant is not in effect as required. The warrants issued to the Placement Agent have a “cashless exercise” provision which may be utilized by the holder without restriction. The Series C warrants issued to the note holders are exercisable for a period of seven years. There is no call provision in the Series C warrants. However, the Series C warrants are only exercisable for the number of shares of common stock that has been issued to the warrant holder pursuant to the warrant holder’s exercise of its Series B Warrant. The Placement Agent Series C warrants are exercisable for a period of seven years.

We issued to the Placement Agent, Placement Agent “Series D” warrants which entitle the Placement Agent to acquire an aggregate of 2,500,000 shares of our common stock at an exercise price of $0.40 per share with a “cashless exercise” provision which may be utilized by the holder without restriction. The Placement Agent Series D warrants are exercisable for a period of five years.

Assuming the total principal amount of each senior secured note and each zero coupon note held by each of the selling security holders is converted into common stock at a conversion price of $0.40 and all the converted shares are sold in this offering, the outstanding shares will be increased by 20,400,000. Assuming all warrants held by the selling security holders are exercised and all shares underlying the warrants are sold in this offering, the outstanding shares will be increased by an additional 57,500,000.

Our expectations are based on certain assumptions concerning the anticipated costs associated with any new projects. These assumptions concern future events and circumstances that our officers believe to be significant to our operations and upon which our working capital requirements will depend. Some assumptions will invariably not materialize and some unanticipated events and circumstances occurring subsequent to the date of this prospectus.

Although we believe that we are able to operate without additional financing, in order to expand operations, we may continue to seek additional capital over the next 12 months from the additional sale of our securities. The amount and timing of our future capital requirements will depend upon many factors, including the level of funding received by us, anticipated private placements of our common stock, the level of funding obtained through other financing sources, and the timing of such funding. In the event we are unable to raise additional capital, we will be unable to expand operations as desired.

We intend to retain any future earnings to retire any existing debt, finance the expansion of our business and any necessary capital expenditures, and for general corporate purposes.

We are required to make monthly principal and interest payments under the terms of our Senior Secured Convertible Promissory Notes. Because a Registration Statement registering the shares underlying the notes is not effective, we are required to make the monthly payments in cash instead of registered shares of our common stock. However, due to our current cash position, we do not intend to make any additional principal and interest payments in cash to the investors. Making the payments in cash would impair our ability to operate on a day-to-day basis. Should a Registration Statement become effective, we will be able to make any delinquent and future principal and interest payments under the terms of the notes to the investors in the form of registered shares of our common stock.

The fact that we did not make the June through December 2006 principal and interest payments in cash to our investors means that we are currently in default under the terms of the Notes. Such a default may provide the basis for the investors to force the liquidation of our assets. In the case of the liquidation of our assets, our common shareholders will likely lose all of their investment in our common stock.

Equipment

Equipment is recorded at historical cost. The straight line method with a half-year convention is used for depreciation. Asset life in years is a follows:

Computer equipment		5 years
Furniture and equipment		7 years
Well service equipment		7 years
Vehicles		5 years

Foreign Currency Transactions

Monetary assets and liabilities are translated at balance sheet date exchange rates; other assets and liabilities have been translated at the rates prevailing at the date of the transaction. Revenue and expense items, except for amortization, are translated at the average rate of exchange for the year. Amortization is converted using rates prevailing at dates of acquisition. Gains and losses from foreign currency translation are included in the statement of operations. All figures presented are in US dollars.

Critical Accounting Policies

Oil and Gas Activities

We follow the full cost method of accounting for our oil and gas activities; accordingly, all costs associated with the acquisition, exploration, and development of oil and gas properties are capitalized within the appropriate cost center. Any internal costs that are capitalized are limited to those costs that can be directly identified with acquisition, exploration, and development activities undertaken by us for our own account, and do not include any costs related to production, general corporate overhead, or similar activities.

All capitalized costs within a cost center are depleted on the units-of-production method based on estimated proved reserves attributable to the oil and gas properties we own.

For each cost center, capitalized costs less accumulated depletion and related deferred income taxes, may not exceed the cost center ceiling. The cost center ceiling is equal to the sum of: (a) the present value of estimated future net revenues from proved oil and gas reserves, less estimated future expenditures to be incurred in developing the proved reserves computed using a 10 percent discount factor; (b) the cost of properties not being amortized; (c) the lower of cost or fair market value of unproven properties included in the costs being amortized; and (d) income tax effects related to the differences between the book and tax basis of the properties. Any excess is charged to expense during the period in which the excess occurs.

Sales of oil and gas properties, whether or not being amortized currently, are accounted for as adjustments of capitalized costs, with no gain or loss recognized, unless such adjustments would significantly alter the relationship between capitalized costs and proved reserves of oil and gas attributable to a cost center. Abandonments of oil and gas properties are accounted for as adjustments of capitalized costs, and are amortized and subject to the cost center ceiling limitation.

Future site restoration and abandonment costs of our petroleum and natural gas properties are provided for when a reasonable estimate can be made. The estimated provision is reduced by expected equipment salvage values at the time of the abandonment. The resulting net estimated provision, if any, is charged against earnings over the remaining life our proved reserves on a unit-of production basis. Actual expenditures are applied against the accumulated provision account.

Derivative Financial Instruments

The Company does not use derivative instruments to hedge exposures to cash flow, market, or foreign currency risks.

We review the terms of convertible debt and equity instruments issued to determine whether there are embedded derivative instruments, including embedded conversion options that are required to be bifurcated and accounted for separately as a derivative financial instrument. In circumstances where the convertible instrument contains more than one embedded derivative instrument, including the conversion option, that is required to be bifurcated, the bifurcated derivative instruments are accounted for as a single, compound derivative instrument. Also, in connection with the sale of convertible debt and equity instruments, the Company may issue freestanding options or warrants that may, depending on their terms, be accounted for as derivative instrument liabilities, rather than as equity. The Company may also issue options or warrants to non-employees in connection with consulting or other services they provide.

Certain instruments, including convertible debt and equity instruments and the freestanding options and warrants issued in connection with those convertible instruments, may be subject to registration rights agreements, which impose penalties for failure to register the underlying common stock by a defined date. These potential cash penalties may require the Company to account for the debt or equity instruments or the freestanding options and warrants as derivative financial instrument liabilities, rather than as equity. In addition, when the ability to physical or net-share settle the conversion option or the exercise of the freestanding options or warrants is deemed to be not within the control of the company, the embedded conversion option or freestanding options or warrants may be required to be accounted for as a derivative financial instrument liability.

Derivative financial instruments are initially measured at their fair value. For derivative financial instruments that are accounted for as liabilities, the derivative instrument is initially recorded at its fair value and is then re-valued at each reporting date, with changes in the fair value reported as charges or credits to income. For option-based derivative financial instruments, the Company uses the lattice pricing model to value the derivative instruments. To the extent that the initial fair values of the freestanding and/or bifurcated derivative instrument liabilities exceed the total proceeds received, an immediate charge to income is recognized, in order to initially record the derivative instrument liabilities at their fair value.

The discount from the face value of the convertible debt or equity instruments resulting from allocating some or all of the proceeds to the derivative instruments, together with the stated interest on the instrument, is amortized over the life of the instrument through periodic charges to income, usually using the effective interest method. When the instrument is convertible preferred stock, the dividends payable are recognized as they accrue and, together with the periodic amortization of the discount, are charged directly to retained earnings.

The classification of derivative instruments, including whether such instruments should be recorded as liabilities or as equity, is re-assessed periodically, including at the end of each reporting period. If re-classification is required, the fair value of the derivative instrument, as of the determination date, is re-classified. Any previous charges or credits to income for changes in the fair value of the derivative instrument are not reversed. Derivative instrument liabilities are classified in the balance sheet as current or non-current based on whether or not net-cash settlement of the derivative instrument could be required within 12 months of the balance sheet date.

Additional Accounting Disclosures

On July 17, 2006, our board of directors determined that the previously-issued interim financial statements for the three months ended June 30, 2005, September 30, 2005 and December 31, 2005 should not be relied upon because the financial statements do not properly reflect non-cash transactions. These transactions include derivatives related to convertible debt. We have reported the amended the September 2005 financials results within the 10-QSB filed for the period ended September 30, 2006 and have reported amended December 2005 financial results within this 10-QSB. We intend to file amended Quarterly Reports on Form 10-QSB for the periods ended June 30, 2005, March 31, 2006 and June 30, 2006 to restate the affected financial statements previously filed with the Securities and Exchange Commission. This filing includes all cumulative transactions from the derivatives and details of the restatement are included in notes to the financial statements.

Our management team has recently changed. We are changing our internal controls to require that all non-cash transactions are reviewed quarterly. We will determine whether additional disclosure relating to the non-cash transactions is required at the end of each fiscal quarter.

Stock Based Compensation

The Company has elected to value stock based compensation granted at the fair value as determined using the Black-Scholes option valuation model.

Employees

We currently have three employees among the parent and all subsidiary companies. We intend to hire additional personnel and our employees will be entitled to paid vacation, paid sick days, and personal days off depending on job classification, length of service, and other factors. Our policy will be to recognize the cost of compensated absences when actually paid to employees.

We have not entered into a collective bargaining agreement with any union. We have not experienced any work stoppages and consider the relations with the individuals working for us to be good.

ITEM 3. CONTROLS AND PROCEDURES

As required by Rule 13a-15 under the Securities Exchange Act of 1934 (“Exchange Act”) we carried out an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures as of September 30, 2006, being the date of our most recently completed fiscal quarter. This evaluation was carried out under the supervision and with the participation of our Chief Executive Officer and Chief Financial Officer. Based upon that evaluation, they concluded that our disclosure controls and procedures were not effective to ensure that information required to be disclosed in our Exchange Act reports is recorded, processed, summarized, and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms, and that such information is accumulated and communicated to them to allow timely decisions regarding required disclosure. The disclosure controls and procedures were not effective due to late filing and significant adjustments proposed by our auditors that were recorded related to non-cash debt and equity transactions. We are in the process of implementing procedures to properly account for and disclose the non-cash transactions.

PART II

ITEM 1. LEGAL PROCEEDINGS

On April 4, 2006, our board authorized the retention of the law firm of Zimmerman, Axelrad, Meyer, Stern & Wise, P.C. of Houston, Texas to represent the company as litigation counsel. Zimmerman, on behalf of the company, filed a Petition and Application For Temporary Restraining Order, Temporary Injunction and Permanent Injunction, and Request for Order for Deposition to Investigate Claims against our former Chief Operating Officer, William Huntington Stinson, Nana Asomani-Arko and Norman S. Neidell in the 11 ^th Judicial District in the District Court of Harris County, Texas. The litigation arose from a dispute with our former Chief Operations Officer, William Huntington Stinson, concerning his alleged appointment as a Director, President, and Chief Executive Officer of the company.

On Thursday, April 6, 2006, our request for a Temporary Restraining Order was heard and denied by the Court. At the time that the denial for a Temporary Restraining Order was issued, the Presiding Judge set the hearing for our Temporary Injunction request for Monday, April 10, 2006. On the morning of April 10, 2006, after denying a Motion and Request for Continuance filed by Mr. Stinson, Judge Mark Davidson commenced the Temporary Injunction hearing. During the middle of Mr. Stinson’s examination, Mr. Stinson’s counsel initiated settlement discussions.

On the afternoon of April 10, 2006, a settlement was reached and read into the court record. As a condition for our dismissing the lawsuit, Mr. Stinson agreed, in part, as follows: (i) that Mr. Stinson did not dispute the authority of our board of directors that was appointed in our March 31, 2006 board resolution (which was reported in Section 5.02 of our Current Report on Form 8-K filed on April 7, 2006); (ii) that Mr. Stinson would assist in transferring control of company monies he had control of (and which were “frozen”) into a company account that he was not a signatory; and (iii) that as of the date of the settlement, Mr. Stinson did not claim to be a member of our board of directors or an officer of the company.

As a part of the settlement, we agreed to: (i) hold a meeting, attended by two members of our board of directors to discuss a proposal made by Mr. Stinson regarding the possibility of him continuing to provide services to the company; (ii) subject to our financial claims against Messrs. Stinson and Neidell, pay Messrs. Stinson and Neidell or their assigns, certain monies they claimed they were owed in connection to their service as our Chief Operating Officer and outside consultant, respectively.

On April 21, 2006, pursuant to the terms of the settlement agreement with Mr. Stinson, we appeared at 9:00 a.m. at our Houston, Texas office for the scheduled meeting with Mr. Stinson which had been confirmed by Mr. Stinson’s former counsel. Mr. Stinson failed to appear for the meeting. On April 24, 2006, our board of directors resolved that because: (i) we had in good faith attempted to comply with the terms of the settlement agreement with Mr. Stinson; (ii) Mr. Stinson failed to attend the meeting; (iii) there were significant costs associated with making additional attempts to meet with Mr. Stinson; and (iv) the members of the Board of Directors were disinterested in doing any business with Mr. Stinson, we would not make any further attempts to deal directly with Mr. Stinson relative to complying with this term of the settlement agreement.

On April 18, 2006, the Company filed a non-suit in the above lawsuit, dismissing the case against all defendants.

On April 24, 2006, we received a compensation demand from Mr. Stinson claiming wages owed from August 2005 through April 2006. On April 12, 2006, we receive a compensation demand from N.S. Neidell & Associates claiming that we owed him compensation for his services. We do not believe that either Mr. Stinson or Mr. Neidell are legally entitled to the compensation they claim.

In October, 2006, Sed-Strat GeoScience Consultant, Inc. filed a petition against Quest Oil Corporation in the County Court at Law No.3, Fort Bend County, Texas. The dispute arose from an alleged unpaid invoice in the amount of $12,131.76 due March 27, 2006 for geological consulting services provided by Sed-Strat. On October 23, 2006, we filed an answer denying liability. We are currently investigating the validity of this claim.

On January 22, 2007, Cisco Pump, Inc. filed a petition against Quest Oil Corporation in the 91^st District Court of Eastland County, Texas. The dispute arose from an alleged unpaid invoice in the amount of $21,715.19 due September 29, 2006 for services provided by Cisco Pump, Inc. As of the date of this filing, we are not required to, and have not filed an answer. We are currently investigating the validity of this claim.

ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

On July 3, 2006, we issued 370,000 shares registered on Form S-8 to various outside consultants pursuant to various consulting agreement.

On August 1, 2006, we issued 100,000 shares registered on Form S-8 pursuant to a settlement agreement in connection with a previous consulting agreement.

On August 29, 2006, we issued 250,000 shares registered on Form S-8 to an outside consultant pursuant to a consulting agreement.

On August 29, 2006, we issued 83,333 shares registered on Form S-8 to an employee pursuant to an employment agreement.

On August 31, 2006, we issued 50,000 shares registered on Form S-8 to an outside consultant pursuant to a consulting agreement.

On September 5, 2006, we issued 180,000 shares registered on Form S-8 to an outside consultant pursuant to a consulting agreement.

On September 6, 2006, we issued 50,000 shares registered on Form S-8 to an outside consultant pursuant to a consulting agreement.

On September 7, 2006, we issued 136,362 restricted shares to our directors pursuant to the 2006 Directors Annual Compensation Program.

On September 18, 2006, we issued 500,000 restricted shares pursuant to a purchase and sale agreement to the seller and 200,000 shares registered on Form S-8 pursuant to a consulting agreement to an outside consultant.

On September 18, 2006, we issued 30,769 shares registered on Form S-8 to an outside consultant pursuant to a consulting agreement.

On September 29, 2006, we issued 64,286 shares registered on Form S-8 to an outside consultant pursuant to a consulting agreement.

On October 3, 2006, we issued 264,705 shares registered on Form S-8 to an outside consultant pursuant to a consulting agreement.

On October 5, 2006, we issued 500,000 shares registered on Form S-8 to an outside consultant pursuant to a consulting agreement.

On October 6, 2006, we issued 840,960 shares registered on Form S-8 to an outside consultant pursuant to a consulting agreement.

On October 9, 2006, we issued 192,307 shares registered on Form S-8 to an employee pursuant to an employment agreement.

On October 13, 2006, we issued 1,285,714 shares registered on Form S-8 to an outside consultant pursuant to a consulting agreement.

On October 17, 2006, we issued 238,638 restricted shares to our directors pursuant to the 2006 Directors Annual Compensation Program.

ITEM 3. DEFAULT UPON SENIOR SECURITIES

We are required to make monthly principal and interest payments under the terms of our Senior Secured Convertible Promissory Notes beginning February 7, 2006. If a Registration Statement registering the shares underlying the Notes is not effective, we are required to make the monthly payments in cash instead of registered shares of our common stock. Because a Registration Statement is not yet effective, we made the first four payments for the months of February, March, April and May, 2006 in cash.

However, due to our current cash position, as of June 7, 2006 we have not made any further payments and are currently in default under the terms of these Notes. Making the payments in cash would impair our ability to operate on a day-to-day basis. Should a Registration Statement become effective, we will be able to make any delinquent and future principal and interest payments under the terms of these Notes to the investors in the form of registered shares of our common stock. The fact that we have not made the June through December, 2006 principal and interest payments to our investors in cash means that we are in default under the terms of these Notes. Such a default may provide the basis for the investors to force the liquidation of our assets. In the case of the liquidation of our assets, our common shareholders will likely lose all of their investment in our common stock.

Pursuant to the Senior Secured Convertible Promissory Notes, our Registration Statement was required to be effective as of April 7, 2006. In the event the Registration Statement is not effective as of the above date, we are in default under the Notes and the interest rate on these Notes increases from 10% to 15%. Although we have filed our Registration Statement with the Securities and Exchange Commission, as of the date of this report it has not been declared effective. Accordingly, as of April 7, 2006 we are in default under the Senior Secured Convertible Promissory Notes and the interest rate on these Notes has increased from 10% to 15%. When our Registration Statement is declared effective, this event of default will be cured and the interest rate will decrease to 10%.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

None.

ITEM 5. OTHER INFORMATION

None.

ITEM 6. EXHIBITS

Exhibit No.		Description

3.1.1		Articles of Incorporation. (Attached as an exhibit to our General Form For Registration of Securities on Form 10-SB filed with the SEC on July 7, 1999 and incorporated herein by reference).

3.1.2		Certificate of Amendment to the Articles of Incorporation (Attached as an exhibit to our Current Report on Form 8-K filed with the SEC on October 29, 2004 and incorporated herein by reference).

3.2		Bylaws. (Attached as an exhibit to our General Form For Registration of Securities on Form 10-SB filed with the SEC on July 7, 1999 and incorporated herein by reference.).

4.1		2004 Stock Incentive Plan (Attached as an exhibit to our Registration Statement on Form S-8 filed on August 5, 2004 and incorporated herein by reference).

10.1		September 12, 2006 Assignment of Oil and Gas Lease between Quest Oil Corporation and W.A. Walker. (Attached as an exhibit to our Current Report on Form 8-K filed with the SEC on October 17, 2006 and incorporated herein by reference).

10.2		September 12, 2006 Consulting Agreement between Quest Oil Corporation and W.A. Walker. (Attached as an exhibit to our Current Report on Form 8-K filed with the SEC on October 17, 2006 and incorporated herein by reference).

10.3		2006 Directors Annual Compensation Program. (Attached as an exhibit to our Current Report on Form 8-K filed with the SEC on May 4, 2006 and incorporated herein by reference).

14.1		Code of Business Conduct and Ethics. (Attached as an exhibit to our Current Report on Form 8-K filed with the SEC on May 4, 2006 and incorporated herein by reference).

31.1		Certification of James B. Panther, II pursuant to Rule 13a-14(a).

31.2		Certification of Phillip C. Scott pursuant to Rule 13a-14(a).

32.1		Certification of James B. Panther, II pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

32.2		Certification of Phillip C. Scott pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

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.

QUEST OIL CORPORATION

/s/ Phillip C. Scott
By: Phillip C. Scott
Its: Chief Financial Officer

Pursuant to the requirements of the Securities Exchange Act of 1934, as amended, this report has been signed below by the following persons on behalf of the registrant and in the capacities indicated.

Signatures	Title	Date

/s/ James B. Panther, II	President, Chief Executive Officer, Director	February 20, 2006
James B. Panther, II

/s/ Phillip C. Scott	Chief Financial Officer	February 20, 2006
Phillip C. Scott

------INDEX------

Consolidated Balance Sheets

Consolidated Statements of Operations

Consolidated Statements of Cash Flows

Notes to Consolidated Financial Statements

Quest Oil Corporation
CONSOLIDATED BALANCE SHEETS
(Unaudited)

	December 31,	March 31,
	2006	2006

ASSETS
Current Assets:
Cash and cash equivalents	335,787	1,558,146
Accounts receivable, net	21,276	21,501
Prepaid expenses	82,810	53,293
Total Current Assets	439,873	1,632,940

Oil and Gas Properties, using the full
cost method of accounting
Proved properties	2,565,095	2,468,449
Unproved properties	899,782	898,315
Less: Accumulated depletion	(1,807,822)	(1,683,654)
Total Oil and Gas Properties	1,657,055	1,683,110

Property and Equipment:
Operating equipment	215,640	204,498
Less: Accumulated depreciation	(41,408)	(16,293)
Total Property and Equipment	174,232	188,205

Deferred financing costs	2,855,946	3,459,713

Total Assets	5,127,106	6,963,968

LIABILITIES AND SHAREHOLDERS' EQUITY
Current Liabilities:
Accounts payable	282,917	85,298
Accrued expenses	689,729	478,379
Derivative liabilities	60,630	3,028,767
Notes payable	318,589	182,305
Total Current Liabilities	1,351,865	3,774,749

Asset retirement obligation	21,000	21,000
Total Liabilities	1,372,865	3,795,749

Shareholders' Equity:
Preferred stock - $.001 par value,
50,000,000 shares authorized, none issued
and outstanding
Common stock - $.001 par value,
450,000,000 shares authorized, 77,738,340
and 68,773,099 shares issued and
outstanding, respectively	77,738	68,773
Additional paid-in capital	24,429,561	21,918,215
Accumulated deficit	(20,704,502)	(18,756,116)
Accumulated other comprehensive income
(loss)	(48,601)	(62,653)
Total Shareholders' Equity	3,754,196	3,168,219

Total Liabilities and Shareholders' Equity	5,127,106	6,963,968

See accompanying notes to consolidated financial statements.

F-1

Quest Oil Corporation
CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME
(Unaudited)

	For the Three Months ended		For the Nine Months ended
	December 31,		December 31,
	2006	2005	2006	2005
		(restated)		(restated)

Revenues - oil and gas	269,768	1,126,859	485,675	1,126,859

Operating Expenses:
Lease Operating	29,080	735,131	319,217	735,131
General and administrative	527,707	915,132	3,053,341	2,966,426
Research and development	-	-	18,609	-
Depreciation, depletion
and amortization	37,861	11,029	150,407	12,099
Total Operating Expenses	594,648	1,661,292	3,541,574	3,713,656

Gain(Loss) from Operations	(324,880)	(534,433)	(3,055,899)	(2,586,797)

Other Income/(Expense)
Interest income	690	45	2,031	45
Interest expense	(542,256)	(618,965)	(1,902,164)	(4,564,768)
Net change in the fair
value of derivatives	40,506	3,182,474	2,968,137	(3,557,768)
Other Income (expense)	-		39,554	-
Gain (Loss) on forgiveness
of debt	-	-	-	17,158
Total Other Income
(Expense)	(501,060)	2,563,554	1,107,558	(8,105,333)

Net Profit (Loss)	(825,940)	2,029,121	(1,948,341)	(10,692,130)

Other comprehensive income
(loss) - foreign exchange
translation	(58,771)	14,676	14,052	47,738

Total comprehensive profit (loss)	(884,710)	2,043,797	(1,934,289)	(10,644,392)

Net Loss per Common Share:
Basic	(0.01)	0.03	(0.03)	(0.22)
Diluted	(0.01)	0.03	(0.03)	(0.22)

Weighted average common
shares outstanding:
Basic	77,278,133	63,780,152	74,146,524	47,760,944
Diluted	77,278,133	65,086,410	74,146,524	47,760,944

See accompanying notes to consolidated financial statements.

F-2

Quest Oil Corporation
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)

	For the nine months ended
	December 31,
	2006	2005
		(restated)
Cash Flows From Operating Activities

Net Loss	$(1,948,341)	$(10,692,130)
Adjustments To Reconcile Net Loss to
Net Cash
Used By Operating Activities:
Debt forgiveness	-	(17,158)
Gain/(Loss) on sale of Assets	12,909	-
Amortization of debt discount	1,900,737	3,807,668
Depletion, depreciation and
Amortization	150,407	9,099
Net change in the fair value of
derivatives	(2,968,137)	3,557,769
Allowance for Doubtful Accounts	-	5,000
Stock based compensation and stock
option expense	2,257,072	1,855,250

Change in assets and liabilities:
(Increase)/Decrease in Accounts
Receivable	225	(442,162)
(Increase)/Decrease in Prepaid
Expenses	(29,386)	(9,588)
Increase/(Decrease) in Accounts
Payable	57,155	629,390
Net Cash Used by Operating Activities	(567,359)	(1,296,863)

Cash Flows From Investing Activities:
Purchase of Property and Equipment	(11,000)	(159,074)
Payment for purchase of Wallstin, net
of cash acquired	-	4,581
Purchase of oil and gas interest	(10,799)	(2,288,686)
Net Cash Used by Investing Activities	(21,799)	(2,443,179)

Cash Flows From Financing Activities:
Proceeds from financing agreements,
net	-	6,430,085
Principal payments on notes payable	(631,512)
Proceeds from sale of stock	-	1,185,650
Net Cash Provided By Financing
Activities	(631,512)	7,615,735

Effect of exchange rates on cash	(1,688)	-

Net Increase/(Decrease) in Cash	(1,222,359)	3,875,693

Cash At The Beginning of Period	1,558,146	3,197
Cash At the End Of Period	335,787	3,878,890

Supplemental Disclosure of Cash Flow
Information:
Net Cash Paid During the Year for
Interest	-	-
Income Taxes	-	-

Non Cash Transactions Common Shares for assets acquired
Shares Issued for Property Common Shares Issued for Conversion of Debt Common Shares Issued for Accounts Payable

See accompanying notes to consolidated financial statements.

F-3

QUEST OIL CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

NOTE 1 - BASIS OF PRESENTATION

The accompanying unaudited interim financial statements of Quest Oil Corporation (“Quest”), have been prepared in accordance with accounting principles generally accepted in the United States of America and the rules of the Securities and Exchange Commission (“SEC”), and should be read in conjunction with the audited financial statements and notes thereto contained in Quest’s latest annual report filed with the SEC on Form 10-KSB. In the opinion of management, all adjustments, consisting of normal recurring adjustments, necessary for a fair presentation of financial position and the results of operations for the interim periods presented have been reflected herein. The results of operations for interim periods are not necessarily indicative of the results to be expected for the full year. Notes to the financial statements which would substantially duplicate the disclosure contained in the audited financial statements for fiscal year 2005, as reported in the 10-KSB, have been omitted.

NOTE 2 - RESTATEMENT

Quest restated its quarterly financial statements from amounts previously reported from June 30, 2005 through June 30, 2006. Quest has determined that the May, 2005 financing contained derivative financial instruments and were not accounted for properly. In addition, several equity issuances from July, 2005 through June 30, 2006 were not accounted for properly, as well as adjustments made during the year-end audit that affected expenses during the interim periods. This note discloses the effects of the derivative financial instruments and equity issuances and provides information on subsequent changes.

The effect of the non-cash changes related to accounting for these derivative financial instruments, equity issuances, and Wallstin purchase corrections on the statement of operations for the three and nine months ended December 31, 2006 was an increase in the Company's net profit (loss) attributable to common shareholders of $3,424,960 and ($7,360,204), respectively. Basic earnings (loss) attributable to common shareholders per share for the three and nine month period ended December 31, 2006 changed by $0.05 and ($0.15) per share, respectively.

Following is a summary of the restatement adjustments:

SUMMARY STATEMENT OF OPERATIONS

	For the Three Months ended				For the Nine Months ended
	December 31, 2005				December 31, 2005

	Original	Adjustment		Restated	Original	Adjustment		Restated

Total Operating
Expenses	1,665,008	(3,716)	(a)	1,661,292	3,007,447	706,209	(a)	3,713,656

Other
Income/(Expense)
Interest expense	(857,735)	238,770	(b)	(618,965)	(1,451,383)	(3,113,385)	(b)	(4,564,768)
Net change in fair
value of derivatives -	-	3,182,474	(b)	3,182,474	-	(3,557,768)	(b)	(3,557,768)
Gain on forgiveness
of debt	-	-		-	-	17,158	(c)	17,158
Total Other Income
(Expense)	(857,735)	3,421,244		2,563,509	(1,451,383)	(6,653,995)		(8,105,378)

Net Profit (Loss)	(1,381,163)	3,424,960		2,043,797	(3,284,188)	(7,360,204)		(10,644,392)

Net Loss per Common
Share:
Basic	(0.02)			0.03	(0.07)			(0.22)
Diluted	(0.02)			0.03	(0.07)			(0.22)

(a)	To record increases in stock-based compensation associated with the Wallstin purchase and share issuances previously recorded incorrectly.
(b)	To record the net change in fair value of derivatives associated with the May, 2005 financing and the change in the estimated fair value of the warrants and embedded derivatives.
(c)	Adjustments based on the purchase of Wallstin.

NOTE 3 - EQUITY ISSUANCES

During the nine months ended December 31, 2006, Quest issued common shares as follows:

·	3,482,873 common shares with a value of $535,825 as payment for services.

·	2,276,351 common shares with a value of $455,270 for the conversion of outstanding debt totaling $113,189 and additional expenses of $342,081.

·	500,000 common shares with a value of $82,500 for property.

·	75,000 common shares for stock issuance payable with a value of $25,875.

During the nine months ended December 31, 2006, Quest issued warrants as follows:

·	150,000 warrants to consultants for services valued at $28,775. The warrants vested immediately and are exercisable for five years at $0.22 per share.

9,000,000 options to officers for services valued at $1,525,775. At December 31, 2006, 6,111,110 warrants had vested and Quest recorded expense of $1,036,020 for the period. The remaining 2,888,890 options vest evenly over the following 208 days. The options are exercisable for five years at $0.22 per share.

4,000,000 warrants to directors and officers for services valued at $767,334. At December 31, 2006, 1,433,333 warrants had vested and Quest recorded expense of $274,961 for the period and 1,411,111 warrants valued at $270,698 were forfeited. The remaining 1,155,556 warrants vest evenly over the following 208 days. The warrants are exercisable for five years at $0.22 per share.

The warrants were valued using the Black-Scholes valuation model. Variables used in the Black-Scholes option-pricing model include (1) discount rates of 4.9%, (2) expected option life is the actual remaining life of the options as of each period end, (3) expected volatility of 180% and (4) zero expected dividends.

NOTE 4 - CONVERTIBLE DEBENTURES AND DERIVIATIVE LIABILITY

On May 23, 2005, Quest closed a $750,000 financing for net proceeds of $647,423 by issuing twelve-month convertible notes with a face value of $787,500, bearing simple interest at 10% annually, payable upon conversion of the notes, quarterly commencing July 1, 2005,and on the maturity date of May 23, 2006. The note holders had the right to convert the principal plus accrued interest into our common stock at a price equal to the lesser of $0.30 or seventy percent of the average of the three lowest closing bid prices for the 30 days preceding a conversion. The conversion price is subject to adjustment in the event shares are issued for consideration less than the exercise price, or certain other corporate events. The notes can be redeemed by Quest, subject to certain conditions, by payment of 150% of the principal and accrued interest. The investors and the placement agent received four separate classes of warrants in connection with the convertible notes:

- Class A warrants allow the holders and placement agent to purchase up to 6,629,295 common shares at a price of $0.25 per share with a “cashless exercise” provision. The Class A warrants issued to the note holders are exercisable for a period of fifteen months and the Class A warrants issued to the placement agent are exercisable for a period of two years

- Class B warrants allow the holders and placement agent to purchase up to 6,629,295 common shares at a price of $0.1503 per share with a “cashless exercise” provision. The Class B warrants issued to the note holders are exercisable for a period of five years and the Class B warrants issued to the placement agent are exercisable for a period of two years

- Class C warrants allow the holders and placement agent to purchase up to 6,629,295 common shares at a price of $0.6533 per share with a “cashless exercise” provision. The Class C warrants issued to the note holders are exercisable for a period of five years and the Class C warrants issued to the placement agent are exercisable for a period of two years

- Placement agent warrants allow the placement agent to purchase up to 602,663 common shares at a price of $0.30 per share with a “cashless exercise” provision for a period of twelve months.

The notes were converted into 7,353,756 common shares from July 5, through September 2, 2005. In addition, during the period August 17 through October 25, 2005 the holders of the warrants exercised all but 4,016,572 Class A warrants, 806,380 Class B warrants, and 6,025,449 Class C warrants.

As a result, we have determined that the conversion feature of the senior secured convertible notes and the warrants issued with the senior secured convertible notes are embedded derivative instruments pursuant to SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities, as amended. Under the provisions of EITF Issue No. 00−19, Accounting for Derivative Financial Instruments Indexed to, and Potentially Settled in, a Company's Own Stock, the accounting treatment of these derivative financial instruments requires that Quest record the derivatives at their fair values as of the inception date of the note agreements and at fair value as of each subsequent balance sheet date as a liability. Any change in fair value is recorded as non−operating, non−cash income or expense at each balance sheet date. Quest estimates fair value using a lattice valuation model. The lattice model values the computed embedded derivative based on a probability weighted discounted cash flow model. The primary determinants of the economic value of the derivative under the lattice model are (1) the price of Quest’s stock, (2) the volatility of Quest’s common stock price, (3) the likelihood that Quest will be required to pay registration delay payments, (4) the likelihood that an event of default or a change in control will occur and (5) the likelihood that Quest common stock will be listed on an exchange. These estimates directly affect the reported amounts of the derivative instrument liabilities. At March 31, 2006, Quest estimated the fair value of the derivative liability at $3,028,767. At December 31, 2006, Quest estimated fair value of the derivative liability at $60,630.

For the nine months ended December 31, 2006 and 2005, Quest recognized the net change in the fair value of derivatives as other income (expense) of $2,968,137 and (3,557,768), respectively.

A summary of the notes payable is as follows:

	December 31, 2006	March 31, 2006
Gross proceeds from notes	$ 6,000,000	$ 6,000,000
Less: Discount	(6,000,000)	(6,000,000)
Less: Principle payments	(1,200,000)	(600,000)
Wallstin notes payable	21,723	21,723
Add: Amortization of discounts	1,496,866	760,582
Carrying value of notes on December 31, 2006	$ 318,589	$ 182,305

NOTE 5 - DEFAULT ON SENIOR SECURITIES AND GOING CONCERN

However, due to our current cash position, we have not made any further payments and are currently in default under the terms of these Notes. Making the payments in cash would impair our ability to operate on a day-to-day basis. Should a Registration Statement become effective, we will be able to make any delinquent and future principal and interest payments under the terms of these Notes to the investors in the form of registered shares of our common stock. The fact that we have not made the June through December, 2006 principal and interest payments to our investors in cash means that we are in default under the terms of these Notes. Such a default may provide the basis for the investors to force the liquidation of our assets. In the case of the liquidation of our assets, our common shareholders will likely lose all of their investment in our common stock.

Pursuant to the Senior Secured Convertible Promissory Notes, our Registration Statement was required to be effective as of April 7, 2006. Because the Registration Statement is not effective, we are in default under the Notes and the interest rate on these Notes increases from 10% to 15%. Although we have filed our Registration Statement with the Securities and Exchange Commission, as of the date of this report it has not been declared effective. Accordingly, as of April 7, 2006 we are in default under the Senior Secured Convertible Promissory Notes and the interest rate on these Notes has increased from 10% to 15%. When our Registration Statement is declared effective, this event of default will be cured and the interest rate will decrease to 10%.

We have no other commitments from officers, directors or affiliates to provide funding. If we are unable to obtain debt and/or equity financing upon terms that we deem sufficiently favorable, or at all, it would have a materially adverse impact upon our ability to pursue our business strategy and maintain our current operations. As a result, it may require us to delay, curtail or scale back some or all of our operations.

Quest Oil (QOIL) 10QSB2007 Q3 Quarterly report (small business)