UNITED
STATES


SECURITIES
AND EXCHANGE COMMISSION


Washington,
D.C.  20549





FORM
10-Q





(Mark
One)


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





For the
quarterly period ended January 31, 2010





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





For the
transition period from _______ to _______





Commission
File Number:   333-141480





KENTUCKY
USA ENERGY, INC.


(Exact
name of small business issuer as specified in its charter)





Delaware
              20-5750488(State
      of incorporation)
              (IRS
      Employer Identification No.)





321
Somerset Road, Suite 1


London,
KY 40741


(Address
of principal executive offices)





(606)
878-5987


(Issuer’s
telephone number)





(Former
name, former address and former fiscal year, if changed since last
report)





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





Indicate by check mark whether the
registrant has submitted electronically and posted on its corporate Web site, if
any, every Interactive Data File required to be submitted and posted pursuant to
Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12
months (or for such shorter period that the registrant was required to submit
and post such files).   Yes ̈No ̈





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





Large
      accelerated
      filer          ̈
                
                Accelerated
      filer  ̈
                
                Non-accelerated
      filer  ̈
                
                Smaller
      reporting company þ(Do
      not check if a smaller
                  Reporting
      company)




Indicate
by check mark whether the registrant is a shell company (as defined in Rule
12b-2 of the Exchange Act).  Yes  ̈ No
x




There
were 36,927,092 shares of the issuer’s common stock outstanding as of March 17,
2010.





PART
I – FINANCIAL INFORMATION





ITEM
1.  FINANCIAL STATEMENTS







KENTUCKY
USA ENERGY, INC.


Condensed
Consolidated Balance Sheets





January31,2010
                
                
                October31,2009ASSETSCurrent
      AssetsCash
      and cash equivalents
                
                $
                477,487
                
                
                $
                59,105Prepaid
      expenses
                
                
                23,492
                
                
                
                37,006Total
      current assets
                
                
                500,979
                
                
                
                96,111Other
      AssetsLoan
      fees, net of accumulated amortization of $235,987 and
    $509,511
                
                
                549,595
                
                
                
                640,694Investment
      in natural gas properties using full cost method, net of depletion of
      $2,800 and $0
                
                
                8,124,542
                
                
                
                7,708,811Total
      other assets
                
                
                8,674,137
                
                
                
                8,349,505Other
      property and equipment, net of accumulated depreciation of $53,181 and
      $42,258
                
                
                462,727
                
                
                
                450,650Total
      assets
                
                $
                9,637,843
                
                
                $
                8,896,266LIABILITIES
      AND STOCKHOLDERS' EQUITY (DEFICIT)Current
      LiabilitiesAccounts
      payable
                
                $
                112,038
                
                
                $
                343,890Accrued
      interest
                
                
                491,799
                
                
                
                522,303Accrued
      liabilities
                
                
                7,996
                
                
                
                7,763Stock
      liability
                
                
                156,775
                
                
                
                149,125Derivative
      liability
                
                
                770,686
                
                
                
                1,015,971Notes
      payable, due within one year
                
                
                7,500,000
                
                
                
                6,300,000Capital
      lease obligations, due within one year
                
                
                94,847
                
                
                
                94,847Total
      current liabilities
                
                
                9,134,141
                
                
                
                8,433,899Long-term
      DebtConvertible
      debt, net of discounts of $1,319,446 and $1,527,779
                
                
                1,180,554
                
                
                
                972,220Capital
      lease obligations, less amounts due within one year
                
                
                80,807
                
                
                
                110,083Total
      long-term debt
                
                
                1,261,361
                
                
                
                1,082,303Total
      liabilities
                
                
                10,395,502
                
                
                
                9,516,202Stockholders'
      Equity (Deficit)Preferred
      stock (20,000,000 shares authorized, none issued)Common
      stock, ($0.0001 par value; 300,000,000 shares authorized; 36,927,092
      and 36,927,092 shares issued and outstanding)
                
                
                3,692
                
                
                
                3,692Additional
      paid-in capital
                
                
                4,298,928
                
                
                
                4,298,928Accumulated
      (Deficit)
                
                
                (5,060,279
                )
                
                
                (4,922,556
                )Total
      stockholders' (deficit)
                
                
                (757,659
                )
                
                
                (619,936
                )Total
      liabilities and stockholders'  deficit
                
                $
                9,637,843
                
                
                $
                8,896,266




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




2


KENTUCKY
USA ENERGY, INC.


Consolidated
Statements of Operations





For the Three Months
                
                
                For the Three MonthsEnded
                
                
                EndedJanuary31,2010
                
                
                January31,2009RevenuesGas
      revenues
                
                $
                32,360
                
                
                $
                -Costs
      and expensesProduction
      costs and taxes
                
                
                29,836
                
                
                
                -Depletion
      expense
                
                
                2,800
                
                
                
                -Amortization of loan fees
                
                
                91,099
                
                
                
                91,099General and administrative
                
                
                37,001
                
                
                
                42,622Compensation expense (including $21,741 and  $230,500 of
      share-based compensation)
                
                
                107,059
                
                
                
                347,698Legal and accounting
                
                
                76,023
                
                
                
                36,907Total
      costs and expenses
                
                
                343,818
                
                
                
                518,326(Loss)
      from operations
                
                
                (311,458
                )
                
                
                (518,326
                )Other
      income (expense)Changes
      in fair value of derivative liability
                
                
                245,285
                
                
                
                (66,285
                )Interest
      (expense)
                
                
                (71,550
                )
                
                
                (74,137
                )(Loss)
      before income taxes
                
                
                (137,723
                )
                
                
                (658,747
                )Income
      taxes
                
                
                -
                
                
                
                -Net
      (Loss)
                
                $
                (137,723
                )
                
                $
                (658,747
                )Net
      loss per shareBasic
      and diluted:Operations
                
                $
                (0.00
                )
                
                $
                (0.02
                )Total
                
                $
                (0.00
                )
                
                $
                (0.02
                )





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


3


KENTUCKY
USA ENERGY, INC.


Statement
of Changes in Stockholders’ Deficit


For the
period ended January 31, 2010





DeficitCommon
                
                
                
                
                
                Additional
                
                
                Accumulated
                
                
                TotalStock
                
                
                Common
                
                
                Paid -in
                
                
                During Exploration
                
                
                Stockholders’Shares
                
                
                Stock
                
                
                Capital
                
                
                Stage
                
                
                (Deficit)Balance
      at October 31, 2009
                
                
                36,927,092
                
                
                $
                3,692
                
                
                $
                4,298,928
                
                
                $
                (4,922,556
                )
                
                $
                (619,936
                )Net
      loss for the period
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                (137,723
                )
                
                
                (137,723
                )Balance
      at January 31, 2010
                
                
                36,927,092
                
                
                $
                3,692
                
                
                $
                4,298,928
                
                
                $
                (5,060,279
                )
                
                $
                (757,659
                )





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


4


KENTUCKY
USA ENERGY, INC.


Condensed
Consolidated Statements of Cash Flows





For the Three Months
                
                
                For the Three MonthsEnded
                
                
                EndedJanuary 31, 2010
                
                
                January 31, 2009Net
      loss
                
                $
                (137,723
                )
                
                $
                (658,747
                )Adjustments
      to reconcile net loss to net cash flows from operating
      activitiesGain
      on market valuation of derivative liabilities
                
                
                (245,285
                )
                
                
                66,284Amortization
      of loan fees
                
                
                299,433
                
                
                
                -Depreciation
                
                
                10,923
                
                
                
                8,129Depletion
                
                
                2,800
                
                
                
                -(Increase)decrease
      in assets and increase (decrease) in liabilitiesPrepaid
      expenses
                
                
                13,514
                
                
                
                10,170Accounts
      payable and accrued liabilities
                
                
                (231,619
                )
                
                
                96,812Stock
      liability
                
                
                7,650
                
                
                
                230,500Accrued
      interest
                
                
                (30,504
                )
                
                
                -Total
      adjustments to reconcile net loss to net cash from operating
      activities
                
                
                (173,088
                )
                
                
                411,895Net
      cash flows from operating activities
                
                
                (310,811
                )
                
                
                (246,852
                )Cash
      flows from investing activitiesPurchase
      of other property and equipment
                
                
                (23,000
                )
                
                
                (16,064
                )Investment
      in oil & gas properties
                
                
                (418,531
                )
                
                
                (537,716
                )Total
      cash flows from investing activities
                
                
                (441,531
                )
                
                
                (553,780
                )Cash
      flows from financing activitiesProceeds
      from borrowings
                
                
                1,200,000
                
                
                
                -Payments
      on capital lease obligations
                
                
                (29,276
                )
                
                
                (14,637
                )Total
      cash flows from financing activities
                
                
                1,170,724
                
                
                
                (14,637
                )Net
      change in cash
                
                
                418,382
                
                
                
                (815,269
                )Cash
      and cash equivalents, beginning of period
                
                
                59,105
                
                
                
                899,037Cash
      and cash equivalents, end of period
                
                $
                477,487
                
                
                $
                83,768Supplemental
      Disclosures of Cash Flow informationCash
      paid for interest
                
                $
                66,783
                
                
                $
                50,833





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


5


Kentucky
USA Energy, Inc.


Notes to
Condensed Financial Statements


(Unaudited)





(1)  Basis of
Presentation





The
accompanying unaudited condensed consolidated financial statements of Kentucky
USA Energy, Inc. (“the Company”) have been prepared in accordance with generally
accepted accounting principles (“GAAP”) for interim financial information and
with the instructions to Form 10-Q and Article 10 of Regulation S-X.
Accordingly, they do not include all of the information and footnotes required
by GAAP for complete financial statements.  In the opinion of
management, all adjustments consisting of normal recurring adjustments
considered necessary for fair presentation have been
included.  Operating results for the three months ended January 31,
2010 are not necessarily indicative of the results that may be expected for the
year ended October 31, 2010.





Thefinancial statements do not
include any adjustments that could be required if the Company were unable to
refinance debt or continue as a going concern.  The Company has
incurred substantial losses, which have strained its financial resources, and,
at January 31, 2010, the Company’s liabilities exceed its assets.  The
Company is currently in default on the senior credit facility with NSES, LLC
(“NSES”) and the NSES loan may be called. Additionally, the Company is behind
schedule on drilling as specified in the K & D farm-out, and currently does
not have the funds to complete these drillings over the expected life of the K
& D Assignments and will require additional funds to do so.  In
the event the Company cannot raise the necessary funds or does not drill the
required 12 wells per year, the Company might lose the rights to the K & D
Properties.  Thus, if the Company is unable to raise sufficient
additional capital through debt and equity offerings or K & D successfully
forecloses under the terms of the farm-out, liquidity problems will cause the
Company to curtail operations, liquidate or sell assets or entities, or pursue
other actions that could adversely affect future operations.  These
factors have raised doubt about the Company’s ability to continue as a going
concern.  For these reasons our auditors state in their report on our
audited financial statements for the year ended October 31, 2009 that they have
a substantial doubt we will be able to continue as a going concern.





To
mitigate the effects of the above problems, management plans to work with NSES
on its technical default and is looking at options for raising additional
capital. Management continues to work with K&D’s principals, and the
principals have continued to assist the Company in implementing its plans.
Additionally, the Company entered into additional agreements with a K&D
principal in January, 2010. Management has maintained good relations with the
principals and does not believe the Company’s failure to adhere to the specified
schedule will lead to a material loss to the Company.





Certain
amounts in prior periods have been reclassified to conform to the report
classifications of the quarter ended January 31, 2010 with no effect on
previously reported net income or stockholders’ equity.




6




Kentucky
USA Energy, Inc.


Notes to
Condensed Financial Statements


(Unaudited)





(2)  Earnings per
Share





In
accordance with the Financial Accounting Standards Board (“FASB”) Accounting
Standards Codification (“ASC”) 260-10, Earnings Per Share, basic
income per share is based on 36,927,092 weighted average shares outstanding for
the quarter ended January31,
2010. Diluted earnings per common share are computed by dividing income
available to common shareholders by the weighted average number of shares of
common stock outstanding during the period increased to include the number of
additional shares of common stock that would have been outstanding if the
dilutive potential shares of common stock had been issued.  Because
the Company has incurred losses from inception, all potentially dilutive
securities are anti-dilutive for all periods presented.





(3)  Recent
Accounting Pronouncements





In May
2009, the FASB issued Statement No. 165, Subsequent Events, which was
primarily codified into ASC Topic 855 (“Topic 855”). Topic 855 establishes
general standards of accounting for and disclosures of events that occur after
the balance sheet date but before financial statements are issued or are
available to be issued. In particular, this Statement requires the following:
(a) the period after the balance sheet date during which management of a
reporting entity should evaluate events or transactions that may occur for
potential recognition or disclosure in the financial statements, (b) the
circumstances under which an entity should recognize events or transactions
occurring after the balance sheet date in its financial statements, and (c) the
disclosures an entity should make about events or transactions that occurred
after the balance sheet date. In accordance with this Statement, an entity
should apply the requirements to interim or annual financial periods ending
after June 15, 2009. Topic 855 was updated by FASB Accounting Standards Update
(“ASU”) 2010-09. Further discussion of related accounting treatment is noted
below.





Effective
July 1, 2009, the Company adopted the FASB ASC 105-10, Generally Accepted Accounting
Principles – Overall which establishes the FASB Accounting Standards
Codification (the “Codification”) as the source of authoritative
accounting principlesrecognized by the FASB
to be applied by nongovernmental entities in the preparation of financial
statements in conformity with U.S. GAAP.  Rules and interpretive releases
of the SEC under authority of federal securities laws are also sources of
authoritative U.S. GAAP for SEC registrants.  All guidance contained in the
Codification carries an equal level of authority.  The Codification
superseded all existing non-SEC accounting and reporting standards and all other
non-grandfathered, non-SEC accounting literature not included in the Positions
or Emerging Issues Task Force (“EITF”) Abstracts.  Instead, it will issue
ASUs. The FASB will not consider ASUs as authoritative in their own right.
ASUs will serve only to update the Codification, provide background information
about the guidance and provide the bases of conclusions on the change(s) in the
Codification.  References made to FASB guidance throughout this document
have been updated for the Codification.




7




Kentucky
USA Energy, Inc.


Notes to
Condensed Financial Statements


(Unaudited)





(3)  Recent
accounting pronouncements (continued)





On
December 31, 2008, the SEC published the final rules and interpretations
updating its oil and gas reporting requirements. In January 2010, the FASB
released ASU 2010-03, Extractive Activities – Oil and
Gas (“Topic 932”): Oil
and Gas Reserve Estimation andDisclosures aligning U.S.
GAAP standards with the SEC’s new rules. Many of the revisions are updates to
definitions in the existing oil and gas rules to make them consistent with the
petroleum resource management system, which is a widely accepted standard for
the management of petroleum resources that was developed by several industry
organizations. Key revisions include: (a) changes to the pricing used to
estimate reserves utilizing a 12-month average price rather than a single day
spot price which eliminates the ability to utilize subsequent prices to the end
of a reporting period when the full cost ceiling was exceeded and subsequent
pricing exceeds pricing at the end of a reporting period, (b) the ability to
include nontraditional resources in reserves, (c) the use of new technology for
determining reserves, and (d) permitting disclosure of probable and possible
reserves. The SEC will require companies to comply with the amended disclosure
requirements for registration statements filed after January 1, 2010, and for
annual reports on Form 10-K for fiscal years ending on or after December 15,
2009. The ASC is effective for annual periods ending on or after December 31,
2009. The Company does not believe the changes to Topic 932 will have a
material impact on our results of operations or financial position.





On
February 24, 2010, the FASB issued ASU 2010-09, effective immediately, which
amended ASC Topic 855, Subsequent Events. The
amendments were made to address concerns about conflicts with SEC guidance and
other practice issues. Among the provisions of the amendment, the FASB defined a
new type of entity, termed an “SEC filer,” which is an entity required to file
or furnish its financial statements with the SEC. Entities other than
registrants whose financial statements are included in SEC filings (e.g.,
businesses or real estate operations acquired or to be acquired, equity method
investees, and entities whose securities collateralize registered securities)
are not SEC filers. While an SEC filer is still required by GAAP to evaluate
subsequent events through the date its financial statements are issued, it is no
longer required to disclose in the financial statements that it has done so or
the date through which subsequent events have been evaluated. The Company does
not believe the changes have a material impact on our results or financial
position.




8




Kentucky
USA Energy, Inc.


Notes to
Condensed Financial Statements


(Unaudited)





(4)  Natural Gas
Properties





The
following table sets forth information concerning costs related to the Company’s
natural gas property acquisitions, exploration and development
activities:





January31,2010
                  
                  
                  October31,2009Property
      acquisitions:Development
      costs
                  
                  $
                  6,404,814
                  
                  
                  $
                  5,989,038Leasehold
      acquisitions
                  
                  
                  1,719,728
                  
                  
                  
                  1,719,728Investment
      in natural gas properties
                  
                  $
                  8,124,542
                  
                  
                  $
                  7,708,811




Interest
of $405,542 and $71,550 was capitalized to natural gas properties during the
quarters ending January 31, 2010 and January 31, 2009 ,
respectively.





(5)  Credit
Facilities





On May
29, 2008 the Company closed a $2,500,000 securities purchase agreement with a
private investor.  Under the agreement, the Company authorized a
senior convertible note which is convertible into the Company’s common Stock,
par value $0.0001 per share. The note bears interest based on a 360-day year
with the first interest payment due August 29, 2008. As amended, the note is
interest only until the first principal payment, which is due May 29,
2010.  The note is secured by a lien on substantially all of the
Company’s natural gas properties.  The note has no financial covenants
and the Company is in compliance with all non-financial
covenants.  The Company incurred closing costs of approximately
$651,000 which are being amortized over the term of the note.





On June
25, 2008 the Company closed a $10,000,000 senior credit facility with NSES 12,
LLC.  Under the facility, the Company may borrow up to
$10,000,000.  The Company has borrowed $6,850,000 as of January 31,
2010. The loan under the facility with NSES 12, LLC, bears interest at 12% per
year.  Interest only is payable during the term of the loan and the
principal balance of the loan is due thirty-six months from closing. The
facility is secured by a lien on substantially all of the Company’s natural gas
properties.  The facility has affirmative and negative covenants. The
Company is not in compliance of the loan convenants at January 31, 2010 and
accordingly the loan is classified as currently due. The loan proceeds were used
for the development of certain oil and gas properties. The Company incurred
closing costs associated with the loan of approximately $499,000, which are
being amortized over the term of the loan.




9




Kentucky
USA Energy, Inc.


Notes to
Condensed Financial Statements


(Unaudited)





(6) Derivative Liabilities,
Beneficial Conversion Feature, Convertible Debt, and
Warrants





In June
2008, the Company entered into financings involving derivative investments. The
derivative features provided credit enhancement and enabled the Company to
access funds on terms that would otherwise not have been available. None of the
derivativeinstruments
held by the Company at October 31, 2009 or January 31, 2010 are designated as
hedges.





The
Company's derivative instruments include equity contracts consisting of warrant
liabilities that the Company will satisfy by issuing a variable number of
shares, and conversion features attaching to the Company's debt.





Balances
related to the contracts and included on the balance sheets at October 31, 2009
and January 31, 2010, are as follows:





January31,2010
                        
                        
                        October31,2009Conversion
      features
                        
                        $
                        444,298
                        
                        
                        $
                        585,182Warrant
      liabilities
                        
                        
                        326,388
                        
                        
                        
                        430,789Derivative
      Liability
                        
                        $
                        770,686
                        
                        
                        $
                        1,015,971





Gains
recognized for the quarters ended January 31, 2010 and 2009, to adjust the above
derivative liabilities to fair value are included on the statements of
operations under the caption "Changes in fair value of derivative liability,"
among items of other income and expense. The gains and (losses) are composed of
changes to the liabilities as follows:





January31,2010
                        
                        
                        January31,2009Conversion
      features
                        
                        $
                        140,884
                        
                        
                        $
                        (24,772
                        )Warrant
      liabilities
                        
                        
                        104,401
                        
                        
                        
                        (41,513
                        )Gain
      (Loss)
                        
                        $
                        245,285
                        
                        
                        $
                        (66,285
                        )





(7) Fair Value
Measurements




SFAS No. 157,
Fair Value Measurements and Disclosures, primarily codified under Topic
820, established a three-tier fair value hierarchy, which prioritizes the
inputs used in measuring fair value. These tiers include: Level 1, defined
as observable inputs such as quoted prices in
active markets; Level 2, defined as inputs other than quoted prices in
active markets that are either directly or indirectly observable; and
Level 3, defined as unobservable inputs in which little or no market data
exists, therefore requiring an entity to
developits own
assumptions. As ofJanuary
31, 2010,our stock
warrant liability lack Level 1
and 2 inputs and are thus required to be measured at fair value on a
Level 3 basis.




10




Kentucky
USA Energy, Inc.


Notes to
Condensed Financial Statements


(Unaudited)





(7) Fair Value Measurements
(continued)




The fair
value of stock warrant liabilities is the estimated present value at grant date
using the Black-Scholes option-pricing model with the following weighted average
assumptions for October 31, 2009 and 2010: expected volatility of 158% and 158%
respectively, a risk-free interest rate of 4.00% respectively; and an expected
option life remaining from 2.5 to 5 years respectively.





(8) Exploration
Stage





Since its
inception, the Company has devoted substantially all of its efforts to acquiring
operating assets, business planning, raising capital, drilling and exploration.
However, on October 23, 2009, the Company completed preparation and connected
into the pipeline system operated by Seminole Energy Services. With connection,
the Company now has a viable method of delivery of its natural gas product, and
sales began in the first quarter of fiscal year 2010. Accordingly, the Company
is considered to have left the exploration stage.




11





ITEM
2.  MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS.





Statement Regarding Forward-Looking
Information





This
report contains forward-looking statements. All statements other than statements
of historical facts included in this Quarterly Report on Form 10-Q, including
without limitation, statements in this Management’s Discussion and Analysis of
Financial Condition and Results of Operations regarding our financial position,
estimated working capital, business strategy, the plans and objectives of our
management for future operations and those statements preceded by, followed by
or that otherwise include the words “believe”, “expects”, “anticipates”,
“intends”, “estimates”, “projects”, “target”, “goal”, “plans”, “objective”,
“should”, or similar expressions or variations on such expressions are
forward-looking statements. We can give no assurances that the assumptions upon
which the forward-looking statements are based will prove to be correct. Because
forward-looking statements are subject to risks and uncertainties, actual
results may differ materially from those expressed or implied by the
forward-looking statements. There are a number of risks, uncertainties and other
important factors that could cause our actual results to differ materially from
the forward-looking statements, including, but not limited to, the availability
and pricing of additional capital to finance operations, including the drilling
of our initial gas wells, longer term drilling programs and additional leasehold
acquisitions, the viability of the shale gas fields in the Illinois Basin in
western Kentucky, our ability to build and maintain a successful operations
infrastructure and to effectively drill and develop producing wells, the
successful negotiation and execution of cost-effective third-party gas drilling,
processing and distribution agreements, the continued commitment of drill rig
operators and future economic conditions and the volatility and decreases in
energy prices.




Except
as otherwise required by the federal securities laws, we disclaim any
obligations or undertaking to publicly release any updates or revisions to any
forward-looking statement contained in this Quarterly Report on Form 10-Q to
reflect any change in our expectations with regard thereto or any change in
events, conditions or circumstances on which any such statement is
based.





Background





Kentucky
USA Energy, Inc. (the “Company” or “we”) was incorporated in the State of
Delaware on September 29, 2006 under the name Las Rocas Mining Corp.  On
October 26, 2007, the Company changed its name to Kentucky USA Energy, Inc. to
facilitate the merger discussions with KY USA Energy, Inc. (“KY
USA”).  On May 2, 2008, the Company, KY Acquisition Corp., a
wholly-owned subsidiary of the Company (“Acquisition Sub”), and KY USA entered
into an Agreement and Plan of Merger and Reorganization (the “Merger
Agreement”), which closed on May 2, 2008.  Pursuant to the terms of
the Merger Agreement, Acquisition Sub merged with and into KY USA, which became
a wholly-owned subsidiary of the Company (the “Merger”).




12




KY USA was incorporated in the Commonwealth of Kentucky on
October 5, 2007 to acquire, explore and develop oil and gas resource properties,
with a primary focus initially on shale gas in the Illinois Basin in western
Kentucky. KY USA has secured a 75% net revenue interest, less a 6% overriding
royalty interest owned by NSES, LLC., from K&D Energy in a leasehold in
Western Kentucky covering approximately 3,000 acres targeting gas extraction
from the New Albany Shale (the “K&D Leasehold”). We have identified
approximately 40-50 drilling locations on the K&D Leasehold.  Our
net recoverable “proved developed producing reserves1” on the
K&D Leasehold as of October 31, 2009, are estimated at 1.825 billion cubic
feet of gas (“Bcf”)2, while
“proved undeveloped primary reserves3” are
estimated at 23.725 Bcf, for a total proved developed and undeveloped reserves
of 25.550 Bcf.  The K&D Leasehold is directly adjacent to
third-party producing wells.





Well
Development Status




Following
the closing of the Offering (discussed below), we began drilling activities at
our initial well locations.  We have continued these drilling efforts
using the net proceeds from our Initial Loan and Installment Loans under the
Credit Facility (discussed below).





We have
drilled 17 initial wells to date to total depths (“TD”) from 2,340 to 3,460 feet
in the New Albany shale formation on our K&D Leasehold. These wells
have been logged, cased with 4 1⁄2" production casing and cemented, and in all but
four cases the wells have been perforated, fractured and tested.  We
utilize nitrogen fracturing of the shale formation to create open spaces for the
gas to escape and have not, to this point, encountered any water in our
formations.




We have
recently staked out locations for the drilling of a number of additional wells
on our K&D Leasehold. We have identified these drilling prospects through
recent data analysis and we expect to begin drilling these additional wells
during the next few months, as permitting is approved.




We have
entered into a contract with an independent drilling company based in western
Kentucky for the drilling of an initial 20 wells. This company has committed to
drill an additional 20 wells once the first 20 wells have been
completed.




The
Sale of our Natural Gas





On
October 19, 20094, we
entered into a base contract for the purchase and sale of natural gas (the “Base
Contract”) with Seminole Energy Services, L.L.C. (“Seminole”), one of the
largest natural gas distributors in the Oklahoma, Kansas and Texas panhandle
region.  Pursuant to the terms of the Base Contract, Seminole has
agreed to purchase from us up to a maximum of 2,500 mBTU’S (million British
thermal units) per day out of the production of gas from our wells on our
leasehold properties located in the western Kentucky region.


1   According
to Securities and Exchange Commission (“SEC”) definitions, “proved developed
reserves” are those that are expected to be recovered from existing wells with
existing equipment and operating methods.


2   As
determined by Robinson Engineering & Oil Co., Inc., an independent petroleum
engineering firm in a report to us dated  January 26,
2010.


3  
According to SEC definitions, “proved undeveloped reserves” are those that are
expected to be recovered from new wells on undrilled acreage, or from existing
wells where a relatively major expenditure is required.


4   As more fully discussed in our Form 8-K
filed with the SEC on October 23, 2009.




13




We will
sell our gas to Seminole following treatment of the gas at Seminole’s gathering
and treatment facilities located in Christian and Muhlenberg Counties,
Kentucky.  This facility is jointly owned by Seminole and Daugherty
Petroleum, Inc., and is managed by Seminole. We have constructed approximately
67,000 feet of gathering line to connect our wells to Seminole’s gathering and
treatment facility.  We completed this system of lines and the
interconnection to Seminole’s gathering facility in October 2009.  Fourteen
(14) of our wells are now connected to this
system.





Seminole
will pay us the Gas Daily Texas Zone SL daily midpoint spot price for the
gas that it purchases from us.  We and Seminole have agreed to net any
payments due us under the Base Contract against fees due Seminole under that
certain Gas Gathering & Treatment Agreement between the Company and Seminole
(and its related parties) dated August 6, 20095.





On
October 27, 2009, we began the production and delivery of natural gas to
Seminole’s treatment facilities, with actual sales beginning in November
2009.





The sale
of our gas to Seminole since our tie-in to the Seminole gathering and processing
facility has been minimal, however, and the flow of our gas into the Seminole
facility has been intermittent, due to a bottleneck at the Seminole facility
created as a result of the increased gas volume flowing from our wells into the
facility. Because of the potential increased sales volume expected from our
wells, Seminole has been adding new equipment to its facilities to increase
efficiencies and improve Seminole’s ability to accept our natural gas into its
facility. During the final wrap-up stages of completing the facility upgrade, we
are working with Seminole to balance the system and maximize our production and
delivery of our gas to the facility. We expect to increase the rate of its
production and delivery of our gas during the current fiscal quarter following
completion of the facility upgrade.





Thomasson Farm-Out and 7921 Energy
Joint Venture





On August
24, 2009, KY USA entered into a farm-out agreement with Thomasson Petroleum
Enterprises, Inc. (“TPE”) to acquire from TPE certain drilling rights on
farm-out acreage in Todd, Muhlenberg and Christian counties in western Kentucky
adjacent to the Company’s existing K&D Leasehold.  Under the terms
of the agreement with TPE, KY USA acquired the right to drill up to 40 wells on
the subject leases to explore for oil and gas in, above and below the New Albany
Shale. KY USA must drill ten (10) wells in each year of the agreement to be
eligible to drill an additional ten wells in the following year, up to a maximum
of 40 wells over four years. TPE will retain a 25% net revenue interest in the
wells that KY USA drills into the Albany shale on the TPE acreage and an 18.75%
net revenue interest in any oil “twin wells” drilled above the top of the Albany
shale.


5  As
more fully discussed in our Form 8-K filed with the SEC on August 17,
2009.




14




KY USA
recently entered into a joint venture (“JV”) agreement with 7921 Energy LLC
(“7921”) to develop natural gas and oil prospects in, above and below the New
Albany Shale formation on the TPE acreage. The wells to be drilled under the JV
agreement will utilize the Company’s field gathering system that is currently
connected to the Olive Grove Treatment Facility.  Under the terms of
the JV agreement, 7921 will have the right to participate with KY USA in
drilling and developing up to 40 wells on the newly acquired TPE farm-out
acreage. Phase 1 under this JV agreement will consist of drilling and completing
ten (10) wells. Under the terms of the JV, 7921 will earn a 50% working interest
in each of the first ten wells, which translates to a 37.5% net revenue interest
(assuming each well is funded by 7921 and drilled to completion), in exchange
for providing KY USA with $1,675,000 in working capital to drill and complete
the Phase 1 wells. The 50% working interest is reduced by a 6% overriding
royalty interest owned by NSES, LLC. 7921 will also retain the option to
participate with KY USA in the drilling of the up to 30 additional wells on the
TPE acreage. To date the Company has not received the indicated payment, and no
transactions are reflected on the Company’s financial
statements as a result of this agreement.




Thomasson - Hardison Lease
Farm-Out





Effective
January 21, 2010, KY USA entered into a farm-out agreement with TPE (the
“TPE/Hardison Farm-Out Agreement”) to acquire from TPE certain drilling rights
on TPE’s leasehold acreage under the Linda Hardison lease in Todd County in
western Kentucky adjacent to our existing K&D Leasehold. Under the
terms of the TPE/Hardison Farm-Out Agreement, KY USA acquired the right to drill
wells below the top of the Devonian (Black) shale formation on the Hardison
leasehold.  We are required to pay TPE $20,000 for each well location
and we have paid TPE an initial $20,000 for the first well that we will be
drilling, the Hardison #1 well.





We have
completed drilling the first well on the Hardison acreage, tha Hardison #1, and
reached total depth at 2,412 feet. The well has been evaluated and determined to
be commercially viable - the Hardison #1 well’s drilling log confirms that there
is approximately 155 feet of black shale formation encountered in this
well.  We have begun the completion process on the Hardison #1 well
and 4 1⁄2” production casing has been run into the well. We have also scheduled
perforation and fracing of this well.





If the
Hardison #1 well proves to be a producing well, we will have the right to
continue to develop this leasehold by drilling a minimum of one well per year
until the leasehold is completely developed.  We will receive our
assigned rights under the TPE/Hardison Farm-Out Agreement once we have completed
the first producing well and have met certain other terms under the farm-out
agreement.  Under the assignment, we shall be entitled to a
seventy-five percent (75%) net revenue working interest, less a 6% overriding
royalty interest in each producing well that we develop on this
leasehold.  To drill under this agreement, TPE is requiring that we
remain in compliance with the terms and conditions of the TPE Farm-Out
Agreement.





Results of Operations for
the Three Month Periods Ended January 31, 2010 and 2009





We are
still in our exploration stage and have generated minimal revenue to
date.





We
generated $32,360 in revenues for the three month period ended January 31, 2010
compared to no revenues for the three month period ended January 31,
2009.  This change was the result of our beginning to sell our initial
well production to Seminole under the Base Contract.




15




All
productive and non-productive costs incurred in connection with the acquisitions
of, exploration for and development of our gas reserves are capitalized using
the full cost method of accounting.  These costs include lease
acquisitions, geological and geophysical work, and the costs of drilling,
completing and equipping our gas wells.  For the three month periods
ended January 31, 2010 and 2009, we incurred such capitalized costs of $405,542
and $71,550, respectively.  The increase from 2009 to 2010 was the
result of loan fees capitalized related to additional borrowing used to
facilitate additional drilling. We incurred currently expensed production costs
and taxes related to our well production in the three month period ended January
31, 2010 of $29,836 compared to no costs in this category for the three month
period ended January 31, 2009, as a result of our having begun the initial sales
of our gas to Seminole in the three month period ended January 31,
2010.




We
incurred general and administrative expenses of $37,001 and $42,622 for the
three month periods ended January 31, 2010 and 2009, respectively. These
expenses consisted of costs incurred in connection with the start-up and day to
day operation of our business.




Amortization
of loan fees for the three month periods ended January 31, 2010 and January 31,
2009 totaled $91,099 in each such period.  These costs are related to
the Note and the Loan (discussed below).




Legal and
professional expenses increased to $76,203 for the three month period ended
January 31, 2010 from $36,907 for the three month period ended January 31, 2009.
The increase in these expenses primarily resulted from the costs relating to
increased activity in legal fees associated with contracts being drawn
up.




Our
interest expense for the three month periods ended January 31, 2010 and 2009,
was $71,550 and $74,137 respectively. This cost is attributable to interest due
and paid on the Note and the Loan, as well as non-cash amortization of the note
discount. During the three month period ended January 31, 2010, we recognized a
net gain on a derivative liability relating to the Note in the amount of
$245,285, due to a revaluation of the derivative liability to market at January
31, 2010.





Liquidity and Capital
Resources





Our cash
and cash equivalents balance as of January 31, 2010 was $477,487.




On
May 9, 2008, KY USA borrowed $100,000 from one individual as a bridge loan
to be used for working capital purposes. In addition, upon the closing of the
Merger, this lender received warrants to purchase 200,000 shares of our Common
Stock, such warrants having an initial exercise price of $1.00 per share and
expiring five years after issuance.




16




On May
29, 2008 we closed a private offering (the “Offering”) of an 8% senior secured
convertible note (the “Note”) and warrants (the “Warrants”) to purchase
2,500,000 shares of the Company’s common stock, $0.0001 par value per share (the
“Common Stock”), to one institutional investor (the “Investor”) for aggregate
gross proceeds of $2.5 million, as more fully described in our Form 8-K filed
with the SEC on June 4, 2008.  We have used the net proceeds of the
Offering of approximately $1,857,600 (after expenses of the Offering) to repay
bridge loans made to KY USA, to begin drilling our initial wells, and for
general working capital purposes. The initial installment payment date on the
Note was extended from May 29, 2009 to May 29, 2010.





On June
27, 2008, KY USA, entered into a credit agreement (the “Credit Agreement”) with
NSES 12, LLC (the “Lender”), a funding vehicle of New Stream Capital, pursuant
to which KY USA may borrow up to $10,000,000 in the aggregate, under certain
conditions (the “Loan”). Under the Loan, KY USA initially borrowed $2,500,000
(the “Initial Loan”), and may borrow up to an additional aggregate
amount of $7,500,000 in installments of a minimum of $2,500,000 (or such lesser
amounts as the Lender may approve) each (each, an “Installment Loan”), solely at
the discretion of the Lender.  The proceeds of the Initial Loan, net
after expenses of the transaction, including a $200,000 credit facility fee paid
to the Lender and a $200,000 consulting fee paid to one consultant at closing,
were used by KY USA for ongoing working capital purposes, including the
costs and expenses relating to the drilling of our initial wells in the New
Albany shale on the K&D Leasehold.  The term note evidencing the
Loan was issued pursuant to the exemption from the registration requirements of
the federal securities laws provided by Section 4(2) of the Securities Act. No
sales commissions were paid in connection with the Initial Loan.





On
February 12, 2009, we received the first Installment Loan in an amount of $2.5
million, on August 14, 2009, we received a second Installment Loan of $600,000
and on December 11, 2009, we received an additional Installment Loan of $1.2
million.  To date, we have received $6,850,000 under the Credit
Facility.





The
Credit Agreement requires that KY USA comply with financial covenants relating
to, among other things, collateral and current ratio coverage. As of January 31,
2010, KY USA was not in compliance with the 1.0 to 1.0 current ratio requirement
of the Credit Agreement.  This breach of the current ratio covenant
contained in the Credit Agreement constitutes an event of default under the
Credit Agreement. The breach would permit the Lender under the Credit Agreement
to declare all amounts borrowed thereunder to be immediately due and
payable.  We intend to request from the Lender a waiver of this
current ratio covenant, but we cannot assure you that we will be successful in
obtaining such waiver.  Additionally, even if we obtain a waiver from
the Lender, we may not be able to satisfy these or other covenants in the future
or be able to pursue our strategies within the constraints of these
covenants.  These circumstances could materially and adversely impair
our liquidity and, among other factors, raise substantial doubt regarding our
ability to continue as a going concern.





On July
22, 2009, KY USA entered into the JV agreement with 7921 pursuant to which 7921
agreed to provide KY USA with $1,675,000 in working capital for the Phase 1
drilling of the first 10 wells on the TPE acreage.  These funds may
not be used for any other purpose and are to be disbursed to KY USA on a well by
well basis prior to the drilling of a particular well.  Under terms of
the agreement, an initial payment of $50,000 was to be provided to us by
September 30, 2009. To date the Company has not received the indicated payment,
and no transactions are reflected on the Company’s books as a result of this
agreement.




17




Including
the net proceeds from the Offering, the Credit Facility and the 7921 JV
agreement, we believe that we have sufficient funds to conduct our operations
for approximately the next three to six months, if the notes are not
called.





If we are
not successful in generating sufficient liquidity from KY USA operations or in
raising sufficient capital resources on terms acceptable to us, our business,
results of operations, liquidity and financial condition could suffer
materially.





We
presently do not have any available credit, bank financing or other external
sources of liquidity, other than the net proceeds from the Offering, the New
Stream Credit Facility and 7921 JV agreement. Due to our brief history and
historical operating losses, our operations have not been a source of liquidity.
We will need to obtain additional capital in order to expand operations and
become profitable. In order to obtain capital, we may need to sell additional
shares of our common stock or borrow funds from private lenders. There can be no
assurance that we will be successful in obtaining additional funding in amounts
or on terms acceptable to us, if at all.





Critical Accounting
Policies





The
Company prepares its Consolidated Financial Statements in conformity with
accounting principles generally accepted in the United States of America, which
requires the Company to make estimates and assumptions that affect the reported
amounts of assets and liabilities and disclosures of contingent assets and
liabilities at the date of the financial statements and the reported amounts of
revenues and expenses during the year. Actual results could differ from those
estimates. The Company considers the following policies to be the most critical
in understanding the judgments that are involved in preparing the Company’s
financial statements and the uncertainties that could impact the Company’s
results of operations, financial condition and cash flows.





Full Cost Method of
Accounting





The Company follows the full cost
method of accounting for oil and gas property acquisition, exploration and
development activities. Under this method, all productive and non-productive
costs incurred in connection with the acquisition of, exploration for and
development of oil and gas reserves for each cost center are capitalized.
Capitalized costs include lease acquisitions, geological and geophysical work,
day rate rentals and the costs of drilling, completing and equipping oil and gas
wells. Costs, however, associated with production and general corporate
activities are expensed in the period incurred. Interest costs related to
unproved properties and properties under development are also capitalized to oil
and gas properties. Gains or losses are recognized only upon sales or
dispositions of significant amounts of oil and gas reserves representing an
entire cost center. Proceeds from all other sales or dispositions are treated as
reductions to capitalized costs. The capitalized oil and gas property, less
accumulated depreciation, depletion and amortization and related deferred income
taxes, if any, are generally limited to an amount (the ceiling limitation) equal
to the sum of: (a) the present value of estimated future net revenues computed
by applying current prices in effect as of the balance sheet date (with
consideration of price changes only to the extent provided by contractual
arrangements) to estimated future production of proved oil and gas reserves,
less estimated future expenditures (based on current costs) to be incurred in
developing and producing the reserves using a discount factor of 10% and
assuming continuation of existing economic conditions; and (b) the cost of
investments in unevaluated properties excluded from the costs being amortized.
No ceiling write-downs have been recorded to date.




18




Oil and Gas
Reserves





The Company’s proved gas reserves as of
October 31, 2009 were developed from information provided by Glenn Robinson –
Robinson Engineering. Projecting the effects of commodity prices on production,
and timing of development expenditures includes many factors beyond the
Company’s control. The future estimates of net cash flows from the Company’s
proved reserves and their present value are based upon various assumptions about
future production levels, prices, and costs that may prove to be incorrect over
time. Any significant variance from assumptions could result in the actual
future net cash flows being materially different from the
estimates.





Derivative
Instruments





We value
derivativeinstruments in accordance
with the interpretative guidance of ASC Topic 815 and associated pronouncements
related to the classification and measurement of warrants and instruments with
embedded conversion features. We make certain assumptions and estimates to value
our derivative liabilities. Factors affecting these liabilities and values
include changes in the stock price and other assumptions.





Off-Balance Sheet
Arrangements





We have
no off-balance sheet arrangements.





ITEM
4T.  CONTROLS AND PROCEDURES





EVALUATION
OF DISCLOSURE CONTROLS AND PROCEDURES





Under the
supervision and with the participation of our management, including our
principal executive officer and principal financial officer, we have conducted
an evaluation of 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
Securities and Exchange Act of 1934, as of the end of the period covered by this
report. Based on this evaluation, our principal executive officer and principal
financial officer concluded as of the evaluation date that, due to the
insufficiency of the depth and breadth of our accounting function, our
disclosure controls and procedures were not adequate and effective to ensure
that our management is alerted to material information required to be included
in our periodic filings with the SEC. We are in the process of improving our
processes and procedures to ensure full, accurate and timely disclosure in the
current fiscal year, with the expectation of establishing effective disclosure
controls and procedures as soon as reasonably practicable.




19





Additionally,
there were no significant changes in our internal controls or in other factors
that could significantly affect these controls subsequent to the evaluation
date. We have not identified any significant deficiencies or material weaknesses
in our internal controls, and therefore there were no corrective actions
taken.




PART
II – OTHER INFORMATION





ITEM
6. EXHIBITS.





Exhibit No.
                  
                  Description10.1
                  
                  Farm-Out
      Agreement by and between Thomasson Petroleum Enterprises, Inc. and KY USA
      Energy, Inc. dated January 21, 2010 (1)31.1
                  
                  Certification
      of Principal Executive Officer pursuant to Section 302 the Sarbanes-Oxley
      Act of 200231.2
                  
                  Certification
      of Principal Financial Officer pursuant to Section 302 the Sarbanes-Oxley
      Act of 200232.1
                  
                  Certification
      of Chief Executive Officer 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 Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted
      pursuant to Section 906 of the Sarbanes-Oxley Act of
  2002*


*
This certification is being furnished and shall not be deemed “filed” with the
SEC for purposes of Section 18 of the Exchange Act, or otherwise subject to the
liability of that section, and shall not be deemed to be incorporated by
reference into any filing under the Securities Act or the Exchange Act, except
to the extent that the Registrant specifically incorporates it by
reference.





(1)
            Filed
      with the Securities and Exchange Commission (the “SEC”) on February 16,
      2010 as an exhibit to the Registrant’s Annual Report (SEC File No.
      333-141480) on Form 10-K, which exhibit is incorporated herein by
      reference




20


SIGNATURES





In
accordance with the requirements of the Securities Exchange Act of 1934, the
Registrant has caused this report to be signed on its behalf by the undersigned,
thereunto duly authorized.




Date:  March
      17, 2010
                Kentucky
      USA Energy, Inc.By:
                /s/Steven D. EversoleName: 
      Steven D. EversoleTitle:   
      Principal Executive OfficerBy:
                /s/ Charles M. StiversName:  Charles
      M. Stivers
                  Title:    Principal
      Financial Officer




21