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 April 30, 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:   000-53728





KENTUCKY
USA ENERGY, INC.


(Exact
name of registrant as specified in its charter)





Delaware
              20-5750488(State
      or other jurisdiction of incorporation
              (IRS
      Employer Identification No.)or
      organization)


321
Somerset Road, Suite 1


London,
KY 40741


(Address
of principal executive offices)





(606)
878-5987


(Registrant’s
telephone number)





N/A


(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 June 21,
2010.











PART
I – FINANCIAL INFORMATION





ITEM
1.  FINANCIAL STATEMENTS





1





KENTUCKY
USA ENERGY, INC.




Condensed
Consolidated Balance Sheets


April 30, 2010Unaudited
                        
                        
                        October31,2009ASSETSCurrent
      AssetsCash
      and cash equivalents
                        
                        $
                        109,212
                        
                        
                        $
                        59,105Accounts
      receivable
                        
                        
                        12,232
                        
                        
                        
                        -Prepaid
      expenses
                        
                        
                        10,282
                        
                        
                        
                        37,006Total
      Current Assets
                        
                        
                        131,726
                        
                        
                        
                        96,111Other
      AssetsLoan
      fees, net of accumulated amortization of $691,709 and
    $509,511
                        
                        
                        458,496
                        
                        
                        
                        640,694Investment
      in natural gas properties, using full cost method, net of depletion of
      $5,600 and $0
                        
                        
                        8,712,295
                        
                        
                        
                        7,708,811Total
      Other Assets
                        
                        
                        9,170,791
                        
                        
                        
                        8,349,505Other
      property and equipment, net of accumulated depreciation of $64,142 and
      $42,258
                        
                        
                        453,990
                        
                        
                        
                        450,650Total
      Assets
                        
                        $
                        9,756,507
                        
                        
                        $
                        8,896,266LIABILITIES
      AND STOCKHOLDERS' EQUITY (DEFICIT)Current
      LiabilitiesAccounts
      payable
                        
                        $
                        164,912
                        
                        
                        $
                        343,890Accrued
      interest
                        
                        
                        707,310
                        
                        
                        
                        522,303Accrued
      liabilities
                        
                        
                        9,308
                        
                        
                        
                        7,763Stock
      liability
                        
                        
                        164,275
                        
                        
                        
                        149,125Derivative
      liability - warrants
                        
                        
                        95,499
                        
                        
                        
                        1,015,971Notes
      payable
                        
                        
                        7,500,000
                        
                        
                        
                        6,300,000Capital
      lease obligations
                        
                        
                        94,847
                        
                        
                        
                        94,847Total
      Current Liabilities
                        
                        
                        8,736,151
                        
                        
                        
                        8,433,899Long-term
      DebtConvertible
      debt, net of discounts of $1,111,113 and $1,527,780
                        
                        
                        1,388,887
                        
                        
                        
                        972,220Capital
      lease obligations
                        
                        
                        66,169
                        
                        
                        
                        110,083Total
      Long-term Debt
                        
                        
                        1,455,056
                        
                        
                        
                        1,082,303Total
      Liabilities
                        
                        
                        10,191,207
                        
                        
                        
                        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)
                        
                        
                        (4,737,320
                        )
                        
                        
                        (4,922,556
                        )Total
      Stockholders' (Deficit)
                        
                        
                        (434,700
                        )
                        
                        
                        (619,936
                        )Total
      Liabilities and Stockholders' Equity (Deficit)
                        
                        $
                        9,756,507
                        
                        
                        $
                        8,896,266




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





2




KENTUCKY
USA ENERGY, INC.
 Condensed
Consolidated Statements of Operations


Three Months
                
                
                Three Months
                
                
                Six Months
                
                
                Six MonthsEnded
                
                
                Ended
                
                
                Ended
                
                
                EndedApril 30, 2010
                
                
                April 30, 2009
                
                
                April 30, 2010
                
                
                April 30, 2009Unaudited
                
                
                Unaudited
                
                
                Unaudited
                
                
                UnauditedRevenues
                
                $
                61,278
                
                
                $
                -
                
                
                $
                93,638
                
                
                $
                -General
      and Administrative ExpensesProduction
      costs and taxes
                
                
                44,829
                
                
                
                
                
                
                
                74,665Depreciation
      and depletion
                
                
                13,761
                
                
                
                
                
                
                
                27,484Amortization
      of loan fees
                
                
                91,099
                
                
                
                91,099
                
                
                
                182,198
                
                
                
                182,198General
      and administrative
                
                
                26,413
                
                
                
                23,704
                
                
                
                52,491
                
                
                
                66,327Compensation
      expense (including $19,250, $226,500, $40,991 and $457,000 of share-based
      compensation)
                
                
                105,200
                
                
                
                322,500
                
                
                
                212,259
                
                
                
                670,198Legal
      and accounting
                
                
                58,009
                
                
                
                63,855
                
                
                
                134,032
                
                
                
                100,762Total
      costs and expenses
                
                
                339,311
                
                
                
                501,158
                
                
                
                683,129
                
                
                
                1,019,485(Loss)
      from operations
                
                
                (278,033
                )
                
                
                (501,158
                )
                
                
                (589,491
                )
                
                
                (1,019,485
                )Other
      Income (expense)Changes
      in fair value of derivative liability
                
                
                675,187
                
                
                
                327,427
                
                
                
                920,472
                
                
                
                261,143Interest
      expense
                
                
                (74,194
                )
                
                
                (205,169
                )
                
                
                (145,745
                )
                
                
                (279,305
                )Net
      income (loss) before income taxes
                
                
                322,960
                
                
                
                (378,900
                )
                
                
                185,236
                
                
                
                (1,037,647
                )Income
      taxes
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                -Net
      income (loss)
                
                $
                322,960
                
                
                $
                (378,900
                )
                
                $
                185,236
                
                
                $
                (1,037,647
                )Net
      income (loss) per shareBasic
      and diluted
                
                $
                0.01
                
                
                $
                (0.01
                )
                
                $
                -
                
                
                $
                (0.03
                )





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





3


KENTUCKY
USA ENERGY, INC.
 Condensed
Consolidated Statement of Changes in Stockholders’ Deficit
 For the
period ended April 30, 2010




TotalCommon
                
                
                
                
                
                Additional
                
                
                
                
                
                Stockholders’Stock
                
                
                Common
                
                
                Paid -in
                
                
                Accumulated
                
                
                EquityShares
                
                
                Stock
                
                
                Capital
                
                
                Deficit
                
                
                (Deficit)Balance
      at October 31, 2009
                
                
                36,927,092
                
                
                $
                3,692
                
                
                $
                4,298,928
                
                
                $
                (4,922,556
                )
                
                $
                (619,936
                )Net
      income for the period
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                185,236
                
                
                
                185,236Balance
      at April 30, 2010
                
                
                36,927,092
                
                
                $
                3,692
                
                
                $
                4,298,928
                
                
                $
                (4,737,320
                )
                
                $
                (434,700
                )





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





4




KENTUCKY
USA ENERGY, INC.
  Condensed
Consolidated Statements of Cash Flows





Six Months
                    
                    
                    Six MonthsEnded
                    
                    
                    EndedApril 30, 2010
                    
                    
                    April 30, 2009Unaudited
                    
                    
                    UnauditedNet
      income (loss)
                    
                    $
                    185,236
                    
                    
                    $
                    (1,037,647
                    )Adjustments
      to reconcile net income (loss) to net cash flows from operating
      activitiesGains
      on market valuation of derivative liabilities
                    
                    
                    (920,472
                    )
                    
                    
                    (261,143
                    )Discount
      on convertible debt
                    
                    
                    416,667
                    
                    
                    
                    416,667Amortization
      of loan fees
                    
                    
                    182,198
                    
                    
                    
                    182,198Depreciation
                    
                    
                    21,884
                    
                    
                    
                    16,432Accounts
      receivable
                    
                    
                    (12,232
                    )Depletion
                    
                    
                    5,600
                    
                    
                    
                    -(Increase)
      decrease in assets and increase (decrease) in liabilitiesPrepaid
      expenses
                    
                    
                    26,725
                    
                    
                    
                    10,115Accounts
      payable and accrued liabilities
                    
                    
                    (177,433
                    )
                    
                    
                    121,065Stock
      liability
                    
                    
                    15,150
                    
                    
                    
                    457,000Accrued
      interest
                    
                    
                    185,007
                    
                    
                    
                    -Total
      adjustments to reconcile net income (loss) to net cashflows from
      operating activities
                    
                    
                    (256,906
                    )
                    
                    
                    942,334Net
      cash flows from operating activities
                    
                    
                    (71,670
                    )
                    
                    
                    (95,313
                    )Cash
      flows from investing activitiesPurchase
      of other property and equipment
                    
                    
                    (25,225
                    )
                    
                    
                    (80,621
                    )Investment
      in oil & gas properties
                    
                    
                    (1,009,084
                    )
                    
                    
                    (2,400,709
                    )Net
      cash flows from investing activities
                    
                    
                    (1,034,309
                    )
                    
                    
                    (2,481,330
                    )Cash
      flows from financing activitiesProceeds
      from borrowings
                    
                    
                    1,200,000
                    
                    
                    
                    2,500,000Payments
      of capital lease obligation
                    
                    
                    (43,914
                    )
                    
                    
                    (43,913
                    )Total
      cash flows from financing activities
                    
                    
                    1,156,086
                    
                    
                    
                    2,456,087Net
      (decrease) increase in cash
                    
                    
                    50,107
                    
                    
                    
                    (120,556
                    )Cash
      and cash equivalents, beginning of period
                    
                    
                    59,105
                    
                    
                    
                    899,037Cash
      and cash equivalents, end of period
                    
                    $
                    109,212
                    
                    
                    $
                    778,481Supplemental
      Disclosures of Cash Flow informationCash paid for interest
                    
                    $
                    137,566
                    
                    
                    $
                    215,833




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
accounting principles generally accepted in the United States of America (“US
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 US 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 and six months ended
April 30, 2010 are not necessarily indicative of the results that may be
expected for the year ended October 31, 2010.





The
Company has incurred substantial losses, which have strained its financial
resources. At April 30, 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. Additional funds will be
required 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. The Company entered into additional agreements with a K&D principal
in April, 2010, and Management continues to work with K&D’s principals, and
the principals have continued to assist the Company in implementing its
plans.





Certain
amounts in prior periods have been reclassified to conform to the report
classifications of the quarter ended April 30, 2010 with no effect on previously
reported net income or stockholders’ equity.





(2)  Earnings per
Share





In
accordance with of Financial Accounting Standards (“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 April
30, 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
had incurred losses from inception, for 2009 periods presented all potentially
dilutive securities were anti-dilutive. For the three and six months ended April
30, 2010, the potential effects of the issuance of warrants and conversion of
debt were anti-dilutive.





(3)  Recent
Accounting Pronouncements





In
January 2010, the FASB issued ASU 2010-06, “Fair Value Measurements and
Disclosures (Topic 820): Improving Disclosures about Fair Value Measurements”.
This update requires more robust disclosures about valuation techniques and
inputs to fair value measurements. The update is effective for interim and
annual reporting periods beginning after December 15, 2009. The Company has
adopted the update. There was  no material effect on the Company’s
consolidated financial statements.





6




Kentucky
USA Energy, Inc.


Notes to
Condensed Financial Statements


(Unaudited)





(3)  Recent
Accounting Pronouncements (continued)





Effective
July 1, 2009, the Company adopted the FASB ASC 105-10, Generally Accepted
Accounting Principles – Overall whichestablishes the FASB Accounting Standards
Codification(the “Codification”) as the source of authoritative
accounting principles recognized 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. The Company adopted the policy effective
September 30, 2009. There was no material effect on the presentation of the
Company’s consolidated financial statements as a result of the adoption of ASC
105.





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 ASU 2010-09. This Topic was
amended by ASU 2010-09. See above for further discussion of the Company’s
treatment.





In
February, 2010, the FASB issued Accounting Standards Update (“ASU”) 2010-09,
effective immediately, which amended ASC Topic 855, Subsequent Events, discussed
above. The amendment was 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 with or furnish its financial statements to 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 U.S.
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 adopted the change and does not believe the changes have a material
impact on our results of operations or financial position.








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 and Disclosuresaligning 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 orafter
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
resulted in a material impact on our results of operations or financial
position.  In April 2010, the FASB issued ASU 2010-14, Accounting for
Extractive Activities-Oil & Gas: Amendments to Paragraph 932-10-S99-1. This
ASU amends terminology as defined in Topic
932-10-S99-1.





(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:





April 30, 2010
                  
                  
                  October 31, 2009Property
      acquisitions:Development
      cost
                  
                  $
                  6,992,567
                  
                  
                  $
                  5,989,083Leasehold
      acquisitions
                  
                  
                  1,719,728
                  
                  
                  
                  1,719,728Total
                  
                  $
                  8,712,295
                  
                  
                  $
                  7,708,811





Interest
of $420,434 and $446,906 was capitalized to natural gas properties during the
quarters ending April 30, 2010 and April 30, 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, 2011. 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 April 30,
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 loan convenants at April 30, 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.





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





In June
2008, the Company entered into financing 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 derivative  instruments held by the
Company at October 31, 2009 or April 30, 2010 are designed 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.





8





Kentucky
USA Energy, Inc.


Notes to
Condensed Financial Statements


(Unaudited)





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





Balances
related to the contracts and included on the balance sheets at April 30, 2010
and October 31, 2009 are as follows:





April 30, 2010
                  
                  
                  October 31, 2009Conversion
      features
                  
                  $
                  60,711
                  
                  
                  $
                  585,182Warrant
      liabilities
                  
                  
                  34,788
                  
                  
                  
                  430,789Derivative
      Liability
                  
                  $
                  95,499
                  
                  
                  $
                  1,015,971





Gains
recognized for the quarters ended April 30, 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 liability,” among items
of other income and expense.  The gains and (losses) are composed of
changes to the liabilities as follows:





April 30, 2010
                    
                    
                    April 30, 2009Conversion
      features
                    
                    $
                    251,572
                    
                    
                    $
                    205,485Warrant
      Liabilities
                    
                    
                    423,615
                    
                    
                    
                    121,942Gain
                    
                    $
                    675,187
                    
                    
                    $
                    327,427





(7) Fair Value
Measurements





Topic
820, Fair Value Measurements and Disclosures, establishes 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 develop its own
assumptions.  As of April 30, 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.





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 April 30, 2010: expected volatility of 158%
and 60% 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 then
left the exploration stage.





9





Kentucky
USA Energy, Inc.


Notes to
Condensed Financial Statements


(Unaudited)





(9) Subsequent
Events


On May
21, 2010, the Company received a letter from legal counsel representing K&D
Energy and each of the landowners/lessors (the “Lessors”) of the nine leases of
which the K&D Leasehold is comprised.  The letter claims the
Company is in default of its obligations under the Farm-Out
Agreement.  Specifically, the letter claims the Company is not paying
K&D Energy and the Lessors the correct amount of royalties due them on the
sale of gas pumped from the wells on the K&D Leasehold; the Company has not
drilledthe
minimum of 12 wells per year required under the Farm-Out Agreement and that,
therefore, the Company’s rights and interests under the Farm-Out Agreement,
except with respect to the wells that already have been drilled and completed,
are terminated; that if the proper amount of royalties is not paid with respect
to the wells that already have been drilled and completed, the Company will lose
all rights to and interests in those wells and the Farm-Out Agreement shall be
deemed terminated with respect to those wells; that the Company is in breach of
certain duties to repair damages on the leased properties caused by its drilling
efforts; and that, with respect to the design and construction of its pipeline
gathering system, the Company is in breach of certain local safety regulations
and certain state law requirements relating to the obtaining of required
licenses and permits and has failed to obtain certain right-of-way easement
agreements from certain of the Lessors.  The Company strongly denies
these allegations and will defend its rights under the Farm-Out Agreement
vigorously.  Management believes that the eventual resolution of this
matter will not have a material effect on the Company’s financial position or
the results of its operations.





10





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”).





11





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. Through the
execution of a Farm-Out Assignment Agreement with K&D Energy, a Kentucky
partnership (“K&D Energy”), as supplemented and corrected (the “Farm-out
Agreement”), 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




We have
drilled 18 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. Fifteen (15) of
these wells are on the K&D Leasehold, two (2) are on the Additional TPE
Acreage (defined below) and one (1) is on the Hardison Leasehold (defined
below).  These wells have been logged, cased with 4 1⁄2" production
casing and cemented, and all but three of the wells have been perforated and
fractured and all but five have been 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.




The chart
below shows the progress we have made at our initial wells, as of June 15,
2010.





Well Name
                    Drilling Order
                  
                  Spud-ded
                  
                  TD
                  
                  Logged
                  
                  Casing
                  
                  Cement
                  
                  Perf’ed
                  
                  Frac’ed
                  
                  4Pt
                    Test
                  
                  CR1
                  
                  Selling
                    Gas21.
                  
                  Francis
      Grace # 1
                  
                  X
                  
                  2626’
                  
                  X
                  
                  X
                  
                  X
                  
                  X
                  
                  X
                  
                  X
                  
                  X
                  
                  Yes2.
                  
                  Hunter
      Wells # 3
                  
                  X
                  
                  2509’
                  
                  X
                  
                  X
                  
                  X
                  
                  X
                  
                  X
                  
                  X
                  
                  
                  
                  2nd
      phase3.
                  
                  Hunter
      Wells # 2
                  
                  X
                  
                  2340’
                  
                  X
                  
                  X
                  
                  X3
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  3rd
      phase4.
                  
                  B.
      Johnston # 1
                  
                  X
                  
                  2387’
                  
                  X
                  
                  X
                  
                  X
                  
                  X
                  
                  X
                  
                  X
                  
                  X
                  
                  Yes5.
                  
                  Slinker
      # 1B
                  
                  X
                  
                  2340’
                  
                  X
                  
                  X
                  
                  X
                  
                  X
                  
                  X
                  
                  X
                  
                  X
                  
                  Yes6.
                  
                  Walker
      #1
                  
                  X
                  
                  2430’
                  
                  X
                  
                  X
                  
                  X
                  
                  X
                  
                  X
                  
                  X
                  
                  X
                  
                  2nd
      phase7.
                  
                  Hunter
      Wells #1
                  
                  X
                  
                  2431’
                  
                  X
                  
                  X
                  
                  X
                  
                  X
                  
                  X
                  
                  X
                  
                  X
                  
                  3rd
      phase8.
                  
                  Francis
      Grace #2
                  
                  X
                  
                  2395’
                  
                  X
                  
                  X
                  
                  X
                  
                  X
                  
                  X
                  
                  X
                  
                  X
                  
                  3rd
      phase9.
                  
                  J
      Johnston #24
                  
                  X
                  
                  3011’
                  
                  X
                  
                  X
                  
                  X
                  
                  X
                  
                  X
                  
                  X
                  
                  X10.
                  
                  Francis
      Grace #3
                  
                  X
                  
                  2578’
                  
                  X
                  
                  X
                  
                  X
                  
                  X
                  
                  X
                  
                  X
                  
                  X
                  
                  3rd
      phase11.
                  
                  Golden
      Eagle #1
                  
                  X
                  
                  2760’
                  
                  X
                  
                  X
                  
                  X
                  
                  X
                  
                  X
                  
                  X
                  
                  X
                  
                  Yes12.
                  
                  Hunter
      Wells #4
                  
                  X
                  
                  2721’
                  
                  X
                  
                  X
                  
                  X
                  
                  X
                  
                  X
                  
                  X
                  
                  
                  
                  3rd
      phase







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.





12





Well Name
                                          Drilling Order
                                        
                                        Spud-ded
                                        
                                        TD
                                        
                                        Logged
                                        
                                        Casing
                                        
                                        Cement
                                        
                                        Perf’ed
                                        
                                        Frac’ed
                                        
                                        4Pt
                                          Test
                                        
                                        CR1
                                        
                                        Selling
                                          Gas213.
                                        
                                        J
      Johnston #4
                                        
                                        X
                                        
                                        2500’
                                        
                                        X
                                        
                                        X
                                        
                                        X
                                        
                                        X
                                        
                                        X
                                        
                                        X
                                        
                                        X
                                        
                                        Yes14.
                                        
                                        B.
      Johnston #2
                                        
                                        X
                                        
                                        2640’
                                        
                                        X
                                        
                                        X
                                        
                                        X
                                        
                                        X
                                        
                                        X
                                        
                                        X
                                        
                                        X
                                        
                                        2nd
      phase15.
                                        
                                        Slinker
      #2
                                        
                                        X
                                        
                                        2618’
                                        
                                        X
                                        
                                        X
                                        
                                        X
                                        
                                        X
                                        
                                        X
                                        
                                        
                                        
                                        
                                        
                                        Yes16.
                                        
                                        Jackson
      #1
                                        
                                        X
                                        
                                        2664’
                                        
                                        X17.
                                        
                                        Swinney
      #1
                                        
                                        X
                                        
                                        3460’
                                        
                                        X18.
                                        
                                        Hardison
      #1
                                        
                                        X
                                        
                                        2528’
                                        
                                        X
                                        
                                        X
                                        
                                        X
                                        
                                        X
                                        
                                        X





1.
              Indicates
      that Completion Report has been completed and submitted to the state oil
      and gas authority.


2.
              A
      “Yes” indicates that gas is currently being sold to Seminole from these
      wells.  “2nd
      phase” and “3rd
      phase” indicates that the sale of gas from these wells will be phased in
      in two stages as certain required work on these wells is completed during
      the fiscal quarter ending July 31,
2010.


3.
            This
      well needs to be re-cemented prior to perfing and
  fracing.


4.
              In
      the J & J Johnston #2 well, commercial gas was encountered in the
      Clear Creek Lime which is 60 feet below the New Albany Shale
      formation.  This find was unexpected and will contribute to the
      production of this well.





We have
staked out locations for the drilling of a number of additional wells on our
K&D Leasehold, as listed in the chart below. We have identified these
drilling prospects through recent data analysis, and subject to amicable
resolution of the dispute with K&D ownership, we expect to begin drilling
these additional wells during the next few months, as permitting is
approved.




Well Name
                  
                  Drilling Permit GrantedWalker
      #2
                  
                  XJ
      & J Johnston #1Golden
      Eagle #2B.
      Johnston #3
                  
                  XHunter
      Wells #5Lacefield-Taylor
      #1
                  
                  XLacefield-Taylor
      #2Slinker
      #3B





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 the 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 the
K&D Leasehold.







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 and purification 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.  Fifteen (15) of our wells are now tied-in 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.  We are now selling gas to Seminole from six (6) of our wells
that are connected to the Seminole facility and we expect to begin selling gas
from an additional eight wells in two phase-ins during the fiscal quarter ending
July 31, 2010.  The remaining wells will be brought on line as soon as
funds become available to complete necessary pipeline and/or tie-in
work.





Due to
bottlenecks at the Seminole facility created as a result of the increased gas
volume flowing from our wells into the facility, the sale of our gas to Seminole
since our tie-in to the Seminole gathering and processing facility has been
minimal and the flow of our gas into the Seminole facility has been
intermittent.  Because of the potential increased sales volume
expected from our wells, Seminole has added new equipment to its facilities to
increase efficiencies and improve Seminole’s ability to accept and process our
natural gas. 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 production and delivery of our gas to Seminole during the next few
fiscal quarters as we bring additional wells online.





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 (the “Additional TPE Acreage”) in Todd, Muhlenberg and
Christian counties in western Kentucky adjacent to the Company’s existing
K&D Leasehold (the “TPE Farm-Out Agreement”).  Under the terms of
the TPE Farm-Out Agreement, KY USA acquired the right to drill up to 40 wells on
the Additional TPE Acreage 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 Additional
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




In August
2009, KY USA 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 Additional 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 Additional TPE
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
Additional TPE Acreage. Because 7921 has not yet made any payments to us under
the JV agreement, we have elected not to give accounting recognition to the
transaction as of April 30, 2010.  At this time, we cannot be sure
that 7921 will proceed with payments to us under the JV 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 (the “Hardison
Leasehold”) 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 have drilled, the Hardison #1 well.





We have
completed drilling the Hardison #1 well, 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.  The Hardison #1 well
has been perforated, fractured and completed, and is ready for tie-in to
Seminole’s facility.





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 TPE/Hardison
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 the Hardison
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 and Six Month Periods Ended April 30, 2010 and
2009





Revenues





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


15





We
generated $61,278 and $93,638 in revenues for the three and six month periods
ended April 30, 2010, respectively, compared to no revenues for the three and
six month periods ended April 30, 2009.  This change was the result of
our beginning to sell our initial well production to Seminole under the Base
Contract.




Costs
and Expenses




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 April 30, 2010 and 2009, we incurred such capitalized costs of $590,553
and $1,841,676, respectively.  For the six month periods ended April
30, 2010 and 2009, we incurred such total capitalized costs of $1,009,084 and
$2,696,768, respectively.  The decreases from 2009 to 2010 were the
result of decreases in costs and spending related to our drilling
program.  More specifically, the decrease from 2009 to 2010 was the
result of a decrease 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 and six month periods ended April 30, 2010 of $44,829
and $74,665, respectively, compared to no costs in this category for the three
and six month periods ended April 30, 2009, as a result of our having begun the
initial sales of our gas to Seminole in the six month period ended April 30,
2010.




We
incurred general and administrative expenses of $26,413 and $23,704 for the
three month periods ended April 30, 2010 and 2009, respectively, and $52,491 and
$66,327 for the six month periods ended April 30, 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 April 30, 2010 and April 30, 2009
totaled $91,099 in each such period, and $182,198 for each six month period
ended April 30, 2010 and 2009.  These costs are related to the Note
and the Loan (discussed below).




Compensation
expense decreased to $105,200 for the three month period ended April 30, 2010
from $322,500 for the three month period ended April 30, 2009, and decreased to
$212,259 for the six month period ended April 30, 2010 from $670,198 for the six
month period ended April 30, 2009.  These expenses relate to stock
option and warrant costs.




Legal and
professional expenses decreased to $58,009 for the three month period ended
April 30, 2010 from $63,855 for the three month period ended April 30, 2009, but
increased to $134,032 for the six month period ended April 30, 2010 from
$100,762 for the six month period ended April 30, 2009.




Our
interest expense for the three month periods ended April 30, 2010 and 2009 was
$74,194 and $205,169, respectively, while for the six month periods ended April
30, 2010 and 2009, these expenses totaled $145,745 and $279,305, 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. These decreases were due
to a reduction in the non-cash amortization for these
periods.


16





During
the three and six month periods ended April 30, 2010, we recognized a net gain
on a derivative liability relating to the Note in the amounts of $675,187 and
$920,472,
respectively, while these amounts for the three and six month periods ended
April 30, 2009 totaled $327,427 and $261,143, respectively.  These
gains were due to a revaluation of the derivative liability to market at the end
of each applicable period.





Net
Loss





Our net
income for the three and six months ended April 30, 2010 was $322,960 and
$185,236, respectively, compared to losses of $(378,900) and $(1,037,647),
respectively, for the three and six months ended April 30, 2009.  The
increases in income from 2009 to 2010 are mainly due to decreases in our
operating costs over these periods attributable to a decrease in compensation
expenses and adjustments to the estimated fair value of our derivative
liabilities.




Adjusted
EBITDA as a Non-GAAP Performance Measure
  In
evaluating our business, management believes earnings before interest,
amortization of financing costs, taxes, depreciation, depletion, amortization
and accretion of abandonment liabilities, unrealized gains and losses on
financial instruments, gains and losses on sales of assets and stock-based
compensation expense ("Adjusted EBITDA") is a key indicator of financial
operating performance and is a measure of our ability to generate cash for
operational activities and future capital expenditures.  Adjusted
EBITDA is not a GAAP measure of performance. We use this non-GAAP measure
primarily to compare our performance with other companies in our industry and as
a measure of our current liquidity.  We believe that this measure may
also be useful to investors for the same purposes and as an indication of our
ability to generate cash flow at a level that can sustain or support our
operations and capital investment program.  Investors should not
consider this measure in isolation or as a substitute for income from
operations, or cash flow from operations determined under GAAP, or any other
measure for determining operating performance that is calculated in accordance
with GAAP.  In addition, because Adjusted EBITDA is not a GAAP
measure, it may not necessarily be comparable to similarly titled measures that
may be disclosed by other companies.
  The
following is a reconciliation of our net loss in accordance with GAAP to our
Adjusted EBITDA for the three and six month periods ending April 30, 2010 and
2009:
  Three months ended
                                                
                                                
                                                Six months endedApril 30, 2010
                                                
                                                
                                                April 30, 2009
                                                
                                                
                                                April 30, 2010
                                                
                                                
                                                April 30, 2009Net
      Income (loss)
                                                
                                                $
                                                322,960
                                                
                                                
                                                $
                                                (378,900
                                                )
                                                
                                                $
                                                185,236
                                                
                                                
                                                $
                                                (1,037,647
                                                )Add
      Back:Interest
      expense, net
                                                
                                                
                                                74,194
                                                
                                                
                                                
                                                205,169
                                                
                                                
                                                
                                                145,745
                                                
                                                
                                                
                                                279,305Amortization
      of deferred financing costs
                                                
                                                
                                                91,099
                                                
                                                
                                                
                                                91,099
                                                
                                                
                                                
                                                182,198
                                                
                                                
                                                
                                                182,198Income
      tax expense
                                                
                                                
                                                -
                                                
                                                
                                                
                                                -
                                                
                                                
                                                
                                                -
                                                
                                                
                                                
                                                -Depreciation,
      depletion, accretion and impairment
                                                
                                                
                                                13,761
                                                
                                                
                                                
                                                -
                                                
                                                
                                                
                                                27,484
                                                
                                                
                                                
                                                -(Gain)
      loss on change in derivative value
                                                
                                                
                                                (675,187
                                                )
                                                
                                                
                                                (327,427
                                                )
                                                
                                                
                                                (920,472
                                                )
                                                
                                                
                                                (261,143
                                                )(Gain)/loss
      on sales of assets
                                                
                                                
                                                -
                                                
                                                
                                                
                                                -
                                                
                                                
                                                
                                                -
                                                
                                                
                                                
                                                -Stock
      based compensation
                                                
                                                
                                                19,250
                                                
                                                
                                                
                                                226,500
                                                
                                                
                                                
                                                40,991
                                                
                                                
                                                
                                                457,000Adjusted
      EBITDA
                                                
                                                $
                                                (153,923
                                                )
                                                
                                                $
                                                (183,559
                                                )
                                                
                                                $
                                                (338,818
                                                )
                                                
                                                $
                                                (380,287
                                                )


Liquidity and Capital
Resources





Our cash
and cash equivalents balance as of April 30, 2010 was $109,212 compared to
$59,105 at October 31, 2009.





On May
29, 2008 we closed a private offering of an 8% senior secured convertible note
(the “Note”) and warrants to purchase 2,500,000 shares of our common stock to
one institutional investor for aggregate gross proceeds of $2.5
million.  The Note has been amended to extend the initial installment
payment date from May 29, 2010 to May 29, 2011.





On June
25, 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. To date, we have borrowed $6,850,000 under the Credit
Agreement.  The Credit Agreement requires that KY USA comply with
financial covenants relating to, among other things, collateral and current
ratio coverage. As of April 30, 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. Additionally, because of our
limited available cash, we have been in default since March 1, 2010 on our
obligation under the Credit Agreement to pay the Lender interest on a monthly
basis.  Through June 1, 2010, the most recent interest payment date,
there was a total of $308,366.90 accrued and unpaid past due interest under the
Credit Agreement.  These defaults would permit the Lender under the
Credit Agreement to declare all amounts borrowed thereunder to be immediately
due and payable.  We have requested from the Lender a forbearance and
waiver of our Credit Agreement defaults, but we cannot assure you that we will
be successful in obtaining this.  Additionally, even if we obtain a
forbearance and waiver from the Lender, we may not be able to satisfy these or
other covenants and obligations in the future or be able to pursue our
strategies within the constraints of these covenants and
obligations.  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.  At this time, we do not
know whether KY USA will be able to borrow any additional funds under the Credit
Facility.


17





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.  To date, the
Company has not received any funds under the 7921 JV agreement and there can be
no assurance that we will receive any funds from 7921.





Currently,
we do not have sufficient capital to continue our drilling
program.  We have recently begun to generate revenues and cash flow
from the sale of our gas to Seminole and we are applying these funds towards our
ongoing working capital needs, including well maintenance and production and the
bringing of additional wells on line to Seminole’s processing and sales
facility.  We expect our revenues and cash flow to increase over the
next few quarters as we bring additional wells online.





We
presently do not have any available credit, bank financing or other external
sources of liquidity, other than the Credit Agreement. We will be able to
generate a certain amount of liquidity from KY USA operations to meet some of
our ongoing operational expenses but we will need to raise additional capital
to, among other things, restart our drilling program, complete pipeline tie-ins
for a number of our already drilled wells, cure our interest payment default
under the Credit Agreement and acquire additional exploration and production
acreage.  In order to obtain additional 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. If we are not able
to raise capital and restart our drilling program, our business, results of
operations, liquidity and financial condition will suffer
materially.





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.


18





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.





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
derivative instruments 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.


19





ITEM
4T.  CONTROLS AND PROCEDURES





EVALUATION
OF DISCLOSURE 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.





Changes
in Internal Controls over Financial Reporting





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
5. OTHER INFORMATION.





KY USA
has received a letter dated May 21, 2010 from legal counsel to K&D Energy
and each of the landowners/lessors (the “Lessors”) of the nine leases of which
the K&D Leasehold is comprised.  The letter claims that that KY
USA is in default of its obligations under the Farm-Out
Agreement.  Specifically, the letter claims that KY USA is not paying
K&D Energy and the Lessors the correct amount of royalties due them on the
sale of gas pumped from the wells on the K&D Leasehold; that KY USA has not
drilled the minimum of 12 wells per year required under the Farm-Out Agreement
and that, therefore, KY USA’s rights and interests under the Farm-Out Agreement,
except with respect to the wells that already have been drilled and completed,
are terminated; that if the proper amount of royalties is not paid with respect
to the wells that already have been drilled and completed, KY USA will lose all
rights to and interests in those wells and the Farm-Out Agreement shall be
deemed terminated with respect to those wells; that KY USA is in breach of
certain duties to repair damages on the leased properties caused by its drilling
efforts; and that, with respect to the design and construction of its pipeline
gathering system, KY USA is in breach of certain local safety regulations and
certain state law requirements relating to the obtaining of required licenses
and permits and has failed to obtain certain right-of-way easement agreements
from certain of the Lessors.  We and KY USA strongly deny these
allegations and will defend our rights under the Farm-Out Agreement
vigorously.  Additionally, we believe that case law in the State of
Kentucky supports our position that net revenue interest royalties should be
paid on the net amount of gas pumped from our wells after the removal of inert
materials and other impurities rather than on the gross amount of gas measured
at the well head prior to processing.


20





ITEM
6. EXHIBITS.





Exhibit No.
              
              Description31.1
              
              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.


21


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:  June
      21, 2010
                Kentucky
      USA Energy, Inc.By:
                /s/Steven D.
      EversoleName:
      Steven D. EversoleTitle:   Principal
      Executive OfficerBy:
                /s/ Charles M. StiversName:
      Charles M. StiversTitle:   Principal
      Financial Officer


22