U.S.
SECURITIES AND EXCHANGE COMMISSION


WASHINGTON,
D.C. 20549


FORM
10-K




(Mark
One)


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


For
Fiscal Year Ended: October 31, 2008


OR


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




For the
transition period from _______________ to _______________




Commission
file number:  333-141480




Kentucky
      USA Energy, Inc.(Exact
      name of registrant as specified in its
charter)





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





321
      Somerset Road, Suite 1, London, KY
                    
                    40741(Address
      of principal executive offices)
                    
                    (Postal
      Code)




Issuer's
telephone number:  (606)
8878-5987




Securities
registered under Section 12(b) of the Act:  None




Securities
registered under Section 12(g) of the Act:  None




Indicate
by check mark if the registrant is a well-known seasoned issuer, as defined in
Rule 405 of the Securities Act.


Yes ̈Nox




Indicate by check mark if the
registrant is not required to file reports pursuant to Section 13 or 15(d) of
the Exchange Act.  YesxNo ̈




Indicate by check mark whether the
registrant (1) has filed all reports required to be filed by Section 13 or 15(d)
of the Exchange Act during the past 12 months (or for such shorter period that
the registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days.  YesxNo ̈




Indicate
by check mark if disclosure of delinquent filers pursuant to Item 405 of
Regulation S-K is not contained herein, and will not be contained, to the best
of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K.   ̈




Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, or a smaller reporting company.  See the
definitions of the “large accelerated filer,” “accelerate 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 x


(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




As of
February 9, 2009, there were 36,607,092 shares of the registrant's common stock,
par value $0.0001, issued and outstanding.  Of these, 25,563,342
shares are held by non-affiliates of the registrant.  The market value
of securities held by non-affiliates is $15,338,005, based on the closing price
of $0.60 for the registrant’s common stock on February 10, 2009. Shares of
common stock held by each officer and director and by each shareowner affiliated
with a director have been excluded from this calculation because such persons
may be deemed to be affiliates. This determination of officer or affiliate
status is not necessarily a conclusive determination for other
purposes.




DOCUMENTS
INCORPORATED BY REFERENCE


Not
Applicable.







TABLE
OF CONTENTS
 Item Number and Caption
                                        
                                        PageForward-Looking
      Statements
                                        3PART
      I
                                        
                                        41.
                                        Business
                                        41A.
                                        Risk
      Factors
                                        142.
                                        Properties
                                        243.
                                        Legal
      Proceedings
                                        244.
                                        Submission
      Of Matters To A Vote Of Security Holders
                                        24PART
      II
                                        
                                        245.
                                        Market
      For Registrant’s Common Equity, Related Stockholder Matters And Issuer
      Purchases Of Equity Securities
                                        246.
                                        Selected
      Financial Data
                                        267.
                                        Management’s
      Discussion and Analysis of Financial Condition andResults
      of Operations
                                        268.
                                        Financial
      Statements and Supplemental Data
                                        329.
                                        Changes
      In And Disagreements With Accountants On Accounting, And Financial
      Disclosure
                                        329A.[T]
                                        Controls
      And Procedures
                                        329B.
                                        Other
      Information
                                        33PART
      III
                                        
                                        3410.
                                        Directors,
      Executive Officers, and Corporate Governance
                                        3411.
                                        Executive
      Compensation
                                        3612.
                                        Security
      Ownership Of Certain Beneficial Owners And ManagementAnd
      Related Stockholder Matters
                                        3713.
                                        Certain
      Relationships And Related Transactions and Director
      Independence
                                        4014.
                                        Principal
      Accountant Fees And Services
                                        40PART
      IV
                                        
                                        4115.
                                        Exhibits
      and Financial Statement Schedules
                                        41
  2
  FORWARD-LOOKING
STATEMENTS
 
 This
report contains forward-looking statements. All statements other than statements
of historical facts included in this Annual Report on Form 10-K, 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
and distribution agreements, the continued commitment of drill rig operators and
future economic conditions and volatility in energy prices.
 
 All
references in this Form 10-K to the “Company,” “Kentucky USA,” “we,” “us” or
“our” are to Kentucky USA Energy, Inc. and when context requires, our wholly
owned subsidiary, KY USA Energy, Inc. (“KY USA”).
  3
  PART
I
 
 ITEM
1.   BUSINESS
 
 History
and General Development of Our Business
 
 Kentucky
USA Energy, Inc. was incorporated in the State of Delaware on September 29, 2006
under the name Las Rocas Mining Corp.  Our principal business plan was
to acquire, explore and develop mineral properties and to ultimately seek
earnings by exploiting the mineral claims. We determined that we could not
continue with our original business operations because of a lack of financial
results and resources and, subsequently, we decided to abandon our mineral
property operations and to seek a possible business
combination.
 
 On
October 26, 2007, we changed our name to Kentucky USA Energy, Inc. to facilitate
the merger discussions with KY USA Energy, Inc. (“KY USA”). We also increased
our authorized capital stock to an aggregate of 320,000,000shares consisting
of300,000,000
shares of common stock, $0.0001 par value per share (the “Common
Stock”),  and 20,000,000 shares of preferred stock with preferences
and rights to be determined by our Board of Directors.  Additionally,
our Board of Directors approved a forward stock split in the form of a dividend
with a record date of November 13, 2007 and effective on or about November 19,
2007, as a result of which each share of Common Stock then issued and
outstanding converted into twelve shares of Common Stock.
 
 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. Since its
formation, KY USA has focused its business efforts on raising funds, acquiring
working and revenue interests in property leases, putting together an
experienced team of technical and business people and operations related to and
including the drilling of its initial wells.
 
 Our
ability to emerge from the exploration stage with respect to any planned
principal business activity is dependent upon our successful efforts to raise
additional equity financing and generate significant revenue through our
operations. There is no guarantee that our efforts will be sufficient to
accomplish any of the above objectives.
 
 Our
principal offices are located at 321 Somerset Road, London, Kentucky 40741, and
our telephone number is (606) 878-5987.  Our website address is www.kusaenergy.com.
 
 Merger
 
 On May 2,
2008, the Company, KY Acquisition Corp., a Kentucky corporation and 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, with KY USA being the surviving
corporation and becoming a wholly-owned subsidiary of the Company (the
“Merger”).
  4
  At the
closing of the Merger, each share of KY USA’s common stock issued and
outstanding immediately prior to the closing of the Merger was converted into
9,000 shares of our Common Stock. An aggregate of 18,000,000 shares of our
Common Stock were issued to the holders of KY USA’s common stock. In order to secure the
indemnification obligations of the KY USA stockholders pursuant to the Merger
Agreement, 5% of the shares of the Company’s Common Stock that KY USA’s
pre-Merger stockholders received in exchange for their shares of KY USA are
being held in escrow until May 2, 2010 (the “Indemnification
Escrow”).
 
 The
Company, KY USA and Acquisition Sub each provided pre-closing covenants and
closing conditions and customary representations and warranties in the Merger
Agreement. Customary indemnification provisions in the Merger Agreement protect
the parties from breaches of these representations and warranties. The Merger
Agreement provided for a post-closing adjustment in an aggregate amount of up to
2,000,000 additional shares of Common Stock issuable pro rata to KY USA’s
pre-Merger stockholders for any breach of the Merger Agreement by the Company
that is discovered during the two-year period following the closing of the
Merger. In order to secure the indemnification obligations of the KY USA
stockholders pursuant to the Merger Agreement, 5% of the shares of Common Stock
that KY USA’s pre-Merger stockholders received in the Merger in exchange for
their shares of KY USA are being held in escrow for two years. Additionally, in
connection with the Merger and pursuant to the Merger Agreement, 5,000,000
shares of the Company’s Common Stock are being held in escrow for issuance to
the Company’s investor relations consultants as payment for their services to be
rendered to the Company.
 
 Split-Off
 
 Immediately
following the closing of the Merger, under the terms of a Split-Off Agreement,
the Company transferred all of its pre-Merger operating assets and liabilities
to its wholly-owned subsidiary, Las Rocas Leaseco Corp., a Delaware corporation
(“Leaseco”). Thereafter, pursuant to the Split-Off Agreement, the Company
transferred all of the outstanding capital stock of Leaseco to Christopher
Greenwood, a former officer and director of the Company, in exchange for
cancellation of 24,000,000 shares of Common Stock held by Mr. Greenwood as well
as certain covenants and indemnifications (the “Split-Off”).
 
 Our
Natural Shale Gas Business
  We are a
exploration stage, independent energy company organized to exploit and develop
the plentiful gas resources of the Illinois Basin’s New Albany
Shale.  We have acquired a 75% net revenue interest in a leasehold of
approximately 3,000 acres in the Illinois Basin in western Kentucky, which
permits us to extract and sell natural gas from the New Albany Shale formation
in that location.
 
 We expect
to create stockholder value and generate long-term reserve and production growth
through drilling activities on our western Kentucky leasehold and through
further acquisitions of additional properties. We believe that our management’s
experience and expertise will enable us to successfully exploit our current
resources and to identify, evaluate, and develop future natural gas
projects.
  5
  Our
Properties
  On
October 4, 2007, KY USA entered into three Farm-Out Assignment Agreements,
subsequently supplemented and corrected (the “Assignments”), with K & D
Energy, pursuant to which for a cost of approximately $1.7 million, KY USA
secured a 100% working interest being a 75% net revenue interest in ten separate
mineral leases in Christian, Muhlenberg and Todd Counties in the Illinois Basin
in Western Kentucky covering approximately 3,000 acres1 (the
“Leasehold” or the “Properties”) targeting the New Albany
Shale.  Pursuant to the Assignments, KY USA is entitled to all working
rights to, and a 75% net revenue interest in, the hydrocarbons in the New Albany
Shale (Devonian), being a shale formation approximately 275 feet thick directly
beneath the Lower Mississippian formation, the depth below the surface being
from approximately 1,850 feet to 3,000 feet, on the Leasehold.  These
Assignments give us the right to drill wells on the Properties and extract from
these wells and sell the natural gas found in or below the New Albany Shale
formation running through the Properties.  Pursuant to the
Assignments, KY USA is required to drill 12 wells per year within the Properties
to maintain its rights under the Assignments.  We expect to meet this
drilling requirement.  We have identified approximately 40-50 drilling
locations on the Properties and we expect that the wells we drill will measure
from 2,300 to 3,000 feet deep.
 
 A map
showing the location of our initial wells that we have drilled on the Leasehold
and that we propose to drill is attached hereto as Exhibit 99.1 and is
incorporated into this report by reference.
 
 Proved
Reserves
  Our net
recoverable “proved developed producing reserves2” as of
October 31, 2008, as determined by Robinson Engineering & Oil Co., Inc., an
independent petroleum engineering firm (“Robinson Engineering”), in a report to
us dated February 26, 2009, are estimated at 1.825 billion cubic feet of gas
(“Bcf”), while “proved undeveloped primary reserves3” are
estimated at 23.725 Bcf, for a total proved developed and un-developed reserves
of 25.550 Bcf.  These October 31, 2008 estimates reflect a decrease of
1.107 Bcf from estimates as of October 31, 2007.  As calculated by
Robinson Engineering in its reserves report, the estimated net present value of
our total proved reserves as of October 31, 2008 (reflecting our 75% net revenue
interest) over a 20 year production period totaled $31,492,000, discounted at
10% per year.  These calculations assume, among other things, a price
of $6.78 per thousand cubic feet of gas (“Mcf”), the local market price as of
October 31, 2008, a Kentucky State severance tax of 5% and 70 producing wells on
the Leasehold.  These standardized estimates are not intended to
represent the current market value of our estimated natural gas
reserves.  For additional information regarding our reserves, please
see Note 13 to our consolidated financial statements as of and for the fiscal
year ended October 31, 2008.
  
 1.  The
Company had initially reported that its Leasehold covered approximately 2,092
acres.  We are now correcting that number to an estimated 3,000 acres,
to reflect the inclusion of the approximate acreage under one of our farm-out
assignments where title to a particular lease included in the assignment had
been in question and which had not previously been included in the gross acreage
total.  All title issues with respect to this property have been
resolved in our favor.
 2.   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.
 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.
  6
 
 The
Leasehold is directly adjacent to producing wells - our western Kentucky acreage
is located in the middle of a number of ongoing aggressive drilling projects
managed by several other energy companies. We have purchased the rights to drill
for and extract only the natural gas out of the New Albany shale formation on
the Properties.  Although there are operating oil wells on the Properties,
we do not have any rights to the oil under the Leasehold and we anticipate that
we will not pursue any oil rights, since we will be concentrating our efforts on
the natural gas found in the New Albany shale formation.
 
 Recent
Developments
  We have
drilled nine initial wells to date to total depths (“TD”) from 2,340 to 3,000
feet in the New Albany shale formation on our Leasehold. These wells have
been logged, cased with 4 1⁄2" production casing and cemented, and in all but
three cases the wells have been perforated, fractured and tested.  We
utilize nitrogen fracturing of the shale formation to create open spaces for the
gas to escape and have not, to this point, encountered any water in our
formations.
  We have
entered into a contract with an independent drilling company based in western
Kentucky for the drilling of an initial 20 wells. This company has committed to
drill an additional 20 wells once the first 20 wells have been
completed.
  The chart
below shows the progress we have made at our initial wells, as of March 2,
2009.
 
 Well Name
                                                
                                                Spudded
                                                
                                                TD
                                                
                                                Logged
                                                
                                                Casing
                                                
                                                Cement
                                                
                                                Perforation
                                                
                                                Fracturing
                                                
                                                TestingFrancis
      Grace # 1
                                                
                                                X
                                                
                                                2,626
                                                
                                                X
                                                
                                                X
                                                
                                                XHunter
      Wells # 3
                                                
                                                X
                                                
                                                2,509
                                                
                                                X
                                                
                                                X
                                                
                                                X
                                                
                                                X
                                                
                                                X
                                                
                                                XHunter
      Wells # 2
                                                
                                                X
                                                
                                                2,340
                                                
                                                X
                                                
                                                X
                                                
                                                XBilly
      Johnston # 1
                                                
                                                X
                                                
                                                2,387
                                                
                                                X
                                                
                                                X
                                                
                                                X
                                                
                                                X
                                                
                                                X
                                                
                                                XSlinker
      #1B
                                                
                                                X
                                                
                                                2,340
                                                
                                                X
                                                
                                                X
                                                
                                                X
                                                
                                                X
                                                
                                                X
                                                
                                                XJ
      & J Johnston # 1
                                                
                                                DelayedWalker
      #1
                                                
                                                X
                                                
                                                2,430
                                                
                                                X
                                                
                                                X
                                                
                                                X
                                                
                                                X
                                                
                                                X
                                                
                                                XHunter
      Wells # 1
                                                
                                                X
                                                
                                                2,431
                                                
                                                X
                                                
                                                X
                                                
                                                X
                                                
                                                X
                                                
                                                X
                                                
                                                XFrancis
      Grace # 2
                                                
                                                X
                                                
                                                2,395
                                                
                                                X
                                                
                                                X
                                                
                                                X
                                                
                                                X
                                                
                                                X
                                                
                                                XJ
      & J Johnston # 24
                                                
                                                X
                                                
                                                3,000
                                                
                                                X
                                                
                                                X
                                                
                                                X
                                                
                                                X
                                                
                                                X
                                                
                                                XFrancis-Grace
      #3
                                                
                                                X
                                                
                                                2,578Golden
      Eagle #1
                                                
                                                X
 
 We have
recently staked out locations for the drilling of a number of additional wells
on our Leasehold, as listed in the chart below. We have identified these
drilling prospects through recent data analysis and we expect to begin drilling
these additional wells during the next few months, as permitting is
approved.
  
 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.
  7
 
 Well Name
                          
                          Drilling Permit GrantedBilly
      Johnston #2Hunter
      Wells #4
                          
                          XJ
      & J Johnston #4Walker
      #2Slinker
      2B
                          
                          XJ
      & J Johnston #2
                          
                          XJ
      & J Johnston #3
                          
                          X
  We have
signed a contract with Atmos Energy Marketing, LLC (“Atmos”), one of the largest
natural gas distributors in the United States. The distributor will purchase the
gas produced from our wells. This gas will be purchased on a delivered basis
into Atmos’ utility system or the pipeline system that it
manages.  Atmos has agreed to pay us ninety-five percent (95%) of the
price per million Btu (“MMBtu”) for delivered volumes equal to the published
Platt’s, Gas Daily, Daily price survey Midpoint, under the subheading
Louisiana-Onshore South, Texas Gas, zone SL, less the incremental cost of third
party transportation, processing, or blending, if any.  We intend to
begin laying the gathering system from our initial wells to the Atmos pipe as
soon as weather permits and we expect to begin delivering gas to the Atmos
pipeline within the next three to six months.
  Change
in Fiscal Year
  Prior to
the Merger our fiscal year end was February 28 and the fiscal year end of
KY USA (the accounting acquirer) was October 31. Following published
Securities and Exchange Commission (“SEC”) accounting and financial reporting
interpretations and guidance and in connection with the Merger, we changed our
fiscal year end to October 31 to match that of KY USA.
  Employees
  We
currently have two (2) full-time employees, including Steven D. Eversole, our
President and Chief Executive Officer, and C.G. Collins, our Vice President of
Exploration and Development.  Our Interim Chief Financial Officer,
Charles Stivers, is serving in this capacity on an independent contractor
basis.
  The
Natural Shale Gas Business
  Shale gas
is essentially natural gas contained within a sequence of predominantly fine
grained rocks, dominated by shale. Shale gas plays are considered “area
plays”, as natural gas is found over large contiguous areas. Most shales
have low matrix permeabilities, and usually require natural fracture systems to
sustain commercial production rates.
  8
  The name
“New Albany Shale” refers to brownish-black shale exposed along the Ohio River
at New Albany in Floyd County, Indiana, and is present in the subsurface
throughout much of the Illinois Basin. The Illinois Basin covers approximately
60,000 square miles in parts of Illinois, southwestern Indiana and western
Kentucky. The New New Albany Shale has produced natural gas since 1858, mostly
from wells located in southwestern Indiana and western Kentucky. As with other
organic shale reservoirs, the Albany Shale gas is stored both as free gas in
fractures and as absorbed gas on kerogen and clay surfaces within the shale
matrix. Wells typically begin producing high volumes of water and low volumes of
gas when a new area is first brought into production. As more and more wells are
drilled in an area, the formation becomes dewatered and the gas continues to
desorb from the shale. An initially high level of water is a positive indicator
of natural fracturing in the New Albany Shale.
  The
Company has acquired the Leasehold, and is developing that property as discussed
above, and intends to acquire additional producing oil and gas property rights
where the Company believes significant additional value can be created.
Management is primarily interested in properties where some combination of the
following factors exists:
  (1)
              there
      are opportunities for long production life with stable production
      levels;
  (2)
                geological
      formations have multiple producing horizons allowing for gas extraction
      over overlapping time lines;
  (3)
              there
      is substantial exploitation potential;
and
  (4)
              there
      is relatively low capital investment and production
  cost.
  Governmental
Regulation
  Our
operations are or will be subject to various types of regulation at the federal,
state and local levels. Such regulation includes requiring local permits for the
drilling of wells; maintaining bonding requirements in order to drill or operate
wells; implementing spill prevention plans; submitting notification and
receiving permits relating to the presence, use and release of certain materials
incidental to oil and gas operations; and regulating the location of wells, the
method of drilling and casing wells, the use, transportation, storage and
disposal of fluids and materials used in connection with drilling and production
activities, surface usage and the restoration of properties upon which wells
have been drilled, the plugging and abandoning of wells and the transporting of
production. Our operations are or will also be subject to various conservation
matters, including the regulation of the size of drilling and spacing units or
proration units, the number of wells which may be drilled in a unit and the
unitization or pooling of oil and gas properties. In this regard, some states
allow the forced pooling or integration of tracts to facilitate exploration
while other states rely on voluntary pooling of lands and leases, which may make
it more difficult to develop oil and gas properties. In addition, state
conservation laws establish maximum rates of production from oil and gas wells,
generally limit the venting or flaring of gas, and impose certain requirements
regarding the ratable purchase of production. The effect of these regulations is
to limit the amounts of oil and gas we may be able to produce from the wells and
to limit the number of wells or the locations at which we may be able to
drill.
  9
  Our
business is affected by numerous laws and regulations, including energy,
environmental, conservation, tax and other laws and regulations relating to the
oil and gas industry. We plan to develop internal procedures and policies to
ensure that operations are conducted in full and substantial environmental
regulatory compliance.
  Our
failure to comply with any laws and regulations may result in the assessment of
administrative, civil and criminal penalties, the imposition of injunctive
relief or both. Moreover, changes in any of these laws and regulations could
have a material adverse effect on our business. In view of the many
uncertainties with respect to current and future laws and regulations, including
their applicability to us, we cannot predict the overall effect of such laws and
regulations on future operations.
  We
believe that our operations comply in all material respects with applicable laws
and regulations and that the existence and enforcement of such laws and
regulations have an effect no more restrictive on our operations than on other
similar companies in the energy industry. The Company does not anticipate any
material capital expenditures to comply with federal and state environmental
requirements.
  Environmental
Regulation
  Our
operations on properties in which we have an interest are subject to extensive
federal, state and local environmental laws that regulate the discharge or
disposal of materials or substances into the environment and otherwise are
intended to protect the environment. Numerous governmental agencies issue rules
and regulations to implement and enforce such laws, which are often difficult
and costly to comply with and which carry substantial administrative, civil and
criminal penalties and in some cases injunctive relief for failure to
comply.
  Some
laws, rules and regulations relating to the protection of the environment may,
in certain circumstances, impose “strict liability” for environmental
contamination. These laws render a person or company liable for environmental
and natural resource damages, cleanup costs and, in the case of oil spills in
certain states, consequential damages without regard to negligence or fault.
Other laws, rules and regulations may require the rate of oil and gas production
to be below the economically optimal rate or may even prohibit exploration or
production activities in environmentally sensitive areas. In addition, state
laws often require some form of remedial action, such as closure of inactive
pits and plugging of abandoned wells, to prevent pollution from former or
suspended operations.
  Legislation
has been proposed in the past and continues to be evaluated in Congress from
time to time that would reclassify certain oil and gas exploration and
production wastes as “hazardous wastes.” This reclassification would make these
wastes subject to much more stringent storage, treatment, disposal and clean-up
requirements, which could have a significant adverse impact on our operating
costs. Initiatives to further regulate the disposal of oil and gas wastes are
also proposed in certain states from time to time and may include initiatives at
the county, municipal and local government levels. These various initiatives
could have a similar adverse impact on our operating costs.
  10
  The
regulatory burden of environmental laws and regulations increases the cost and
risk of doing business and consequently affects profitability. The federal
Comprehensive Environmental Response, Compensation and Liability Act, or CERCLA,
also known as the “Superfund” law, imposes liability, without regard to fault,
on certain classes of persons with respect to the release of a “hazardous
substance” into the environment. These persons include the current or prior
owner or operator of the disposal site or sites where the release occurred and
companies that transported, disposed or arranged for the transport or disposal
of the hazardous substances found at the site. Persons who are or were
responsible for releases of hazardous substances under CERCLA may be subject to
joint and several liability for the costs of cleaning up the hazardous
substances that have been released into the environment and for damages to
natural resources, and it is not uncommon for the federal or state government to
pursue such claims.
  It is
also not uncommon for neighboring landowners and other third parties to file
claims for personal injury or property or natural resource damages allegedly
caused by the hazardous substances released into the environment. Under CERCLA,
certain oil and gas materials and products are, by definition, excluded from the
term “hazardous substances.” At least two federal courts have held that certain
wastes associated with the production of crude oil may be classified as
hazardous substances under CERCLA. Similarly, under the federal Resource,
Conservation and Recovery Act, or RCRA, which governs the generation, treatment,
storage and disposal of “solid wastes” and “hazardous wastes,” certain oil and
gas materials and wastes are exempt from the definition of “hazardous wastes.”
This exemption continues to be subject to judicial interpretation and
increasingly stringent state interpretation. During the normal course of our
operations on properties in which we have an interest, exempt and non-exempt
wastes, including hazardous wastes, that are subject to RCRA and comparable
state statutes and implementing regulations are generated or have been generated
in the past. The federal Environmental Protection Agency and various state
agencies continue to promulgate regulations that limit the disposal and
permitting options for certain hazardous and non-hazardous wastes.
  We have
established guidelines and management systems to ensure compliance with
environmental laws, rules and regulations. The existence of these controls
cannot, however, guarantee total compliance with environmental laws, rules and
regulations. We believe that with respect to the Properties, we are in
substantial compliance with applicable environmental laws, rules and
regulations. We do not currently maintain any insurance against the risks
described above, and there is no assurance that we will be able to obtain
insurance that is adequate to cover all such costs or that insurance will be
available at premium levels that justify purchase. The occurrence of a
significant event not fully insured or indemnified against could have a material
adverse effect on our financial condition and operations. Compliance with
environmental requirements, including financial assurance requirements and the
costs associated with the cleanup of any spill, could have a material adverse
effect on our capital expenditures, earnings or competitive position. We do
believe, however, that the operators are in substantial compliance with current
applicable environmental laws and regulations. Nevertheless, changes in
environmental laws have the potential to adversely affect our operations. At
this time, we have no plans to make any material capital expenditures for
environmental control facilities.
  11
  Competition
  The oil
and gas exploration and production industry is highly competitive.  In
the New Albany Shale area, we compete with several large and well known public
and private companies such as Southwestern Energy Corporation, Chesapeake Energy
Resources, CNX Gas Corporation and NGAS Resources Inc., which companies may have
more financial and operational resources than we do.  Western Kentucky
is one of new emerging shale gas areas and is attracting a great deal of
industry interest. Competition for equipment, personnel and services is expected
to be similar to that in the Barnett Shale area of Texas.
  Plan
of Operation
 
 Our
strategy is to pursue selected opportunities that are characterized by
reasonable entry costs, favorable economic terms, high reserve potential
relative to capital expenditures and the availability of existing technical data
that may be further developed using current technology.
  We seek
to achieve attractive returns on capital for the benefit of stockholders through
investment in existing developmental plays, rather than through our own
exploratory efforts. In this way we hope to maintain a strong balance sheet
to enable us to be flexible from an operational and financial
standpoint.
  We expect
to generate long-term reserve and production growth through drilling activities
and further acquisitions. We believe that our management’s experience and
expertise will enable us to identify, evaluate, and develop natural gas
projects.
  While we
anticipate that the majority of our future capital expenditures will be applied
to the drilling of wells, we intend to use our experience and regional expertise
to add leasehold interests as well as direct property acquisitions to our
inventory of properties for future drilling activities.
  Disciplined
Acquisition Strategy
  We intend
to acquire producing oil and gas properties where we believe significant
additional value can be created. Management is primarily interested in
developmental properties where some combination of these factors exist:
(1) opportunities for long production life with stable production levels;
(2) geological formations with multiple producing horizons;
(3) substantial exploitation potential; and (4) relatively low capital
investment for production costs. We are currently reviewing several thousand
lease acres in western Kentucky with an expected potential similar to that of
our Properties.  This property is geologically the same as the acreage
where we are presently drilling, although we cannot assure you that hydrocarbons
will be present in commercial volumes or in volumes similar to those of our
current Properties.
  Exploitation
of Properties
  We intend
to maximize the value of the Properties, and any additional properties we
acquire, through a combination of successful drilling, increasing recoverable
reserves and reducing operating costs. We will employ the latest technologies
where applicable. Newer completion techniques enable operators to produce oil
and gas at faster rates and with lower operating costs.
  12
  Experienced
and Dedicated Personnel
  The
Company is led by an experienced team of energy industry veterans with direct
exploration and production experience in the region, having worked for companies
that drilled and/or developed over 800 wells in Kentucky, Tennessee, Illinois,
and Indiana.
  We intend
to maintain a highly competitive team of experienced and technically proficient
employees and motivate them through a positive work environment, competitive
salaries and stock ownership. We believe that employee ownership, which is
encouraged through our 2007 Plan, is essential for attracting, retaining and
motivating qualified personnel.
  13
 
 ITEM
1A.  RISK FACTORS
 
 RISKS
RELATED TO OUR BUSINESS AND FINANCIAL CONDITION
  We
have a limited operating history and if we are not successful in continuing to
grow the business, then we may have to scale back or even cease ongoing business
operations.
  We are in
the “developmental” stage of business and have just recently, through our wholly
owned subsidiary KY USA, begun substantive commercial operations. We have no
history of revenues from operations. We have yet to generate positive earnings
and there can be no assurance that we will ever operate profitably. KY USA has a
limited operating history and must be considered in the exploration stage.
Success is significantly dependent on a successful drilling, completion and
production program. Operations will be subject to all the risks inherent in the
establishment of a developing enterprise and the uncertainties arising from the
absence of a significant operating history. We may be unable to locate
recoverable reserves or operate on a profitable basis. We are in the exploration
stage and potential investors should be aware of the difficulties normally
encountered by enterprises in the exploration stage. If the business plan is not
successful, and we are not able to operate profitably, investors may lose some
or all of their investment in the Company.
  Inability
to raise sufficient funds to drill enough wells each year would result in the
loss of KY USA’s leases.
  Pursuant
to the Assignments, we are required to drill 12 wells per year. We currently
estimate that the cost to drill each well will be in the range of $165,000 to
$225,000, for an estimated maximum total of approximately $2.7 million each
year. We currently do not have the funds to complete these drillings over the
expected life of the Assignments and we will require additional funds to do so.
In the event that we cannot raise the necessary funds or do not drill 12 wells
per year, we would lose the rights to the Properties. The loss of the leasehold
land would have a material adverse impact on our business.
  If
we are unable to obtain additional funding, business operations will be harmed
and if we do obtain additional financing, existing shareholders may suffer
substantial dilution.
  We will
require additional funds to drill wells on the Properties. We anticipate that we
will require up to approximately $10,000,000 to fund continued operations for
the next twelve months, depending on revenue, if any, from operations.
Additional capital will be required to effectively support the operations and to
otherwise implement our overall business strategy. We have raised some capital
to date, including through the sale of the Note and the Credit Agreement (both
discussed below) which we expect to provide sufficient capital for our drilling
program for at least the next three to six months, but we currently do not have
any contracts or firm commitments for additional financing. There can be no
assurance that additional financing will be available in amounts or on terms
acceptable to us, if at all. The inability to obtain additional capital will
restrict our ability to grow and may diminish our ability to continue to conduct
our business operations. If we are unable to obtain additional financing, we
will likely be required to curtail drilling and development plans and, possibly,
cease operations. Any additional equity financing may involve substantial
dilution to then existing shareholders.
  14
  Based
on our recurring losses from operations since inception and our breach of a
certain loan covenant, our auditors have included an explanatory paragraph in
their opinion as to the substantial doubt about our ability to continue as a
going concern.
  Due to,
among other factors, our history of losses (excluding gains from valuation
changes in embedded derivatives) and our breach of a negative covenant in the
Credit Agreement (defined below), our independent auditors have included an
explanatory paragraph in their opinion for the year ended December 31, 2008
as to the substantial doubt about our ability to continue as a going concern.
Our financial statements have been prepared in accordance with accounting
principles generally accepted in the United States, which contemplate that we
will continue to operate as a going concern. Our financial statements do not
contain any adjustments that might result if we are unable to continue as a
going concern.
 
 Because
we are small and do not have much capital, we may have to limit exploration
activity which may result in a loss of your investment.
  Because
we are a small, development stage company and do not have much capital, we must
limit exploration activity. As such, we may not be able to complete an
exploration program that is as thorough as we would like. In that event,
existing reserves may go undiscovered. Without finding reserves, we cannot
generate revenues and you may lose your investment.
  If
we are unable to continue to retain the services of Messrs. Steven D. Eversole
and C. G. Collins or if we are unable to successfully recruit qualified
managerial and field personnel having experience in oil and gas exploration, we
may not be able to continue operations.
  Success
depends to a significant extent upon the continued services of
Mr. Steven D. Eversole, the President, and C. G. Collins, the Vice
President of Exploration and Development. Loss of the services of Messrs.
Eversole or Collins could have a material adverse effect on growth, revenues,
and prospective business. We have obtained, however, key-man insurance covering
both Messrs. Eversole and Collins. We can not assure you, however, that this
insurance will continue to be available at a reasonable cost or at
all.  In order to successfully implement and manage our business plan,
we will be dependent upon, among other things, successfully recruiting qualified
managerial and field personnel having experience in the oil and gas exploration
business. Competition for qualified individuals is intense. There can be no
assurance that we will be able to find and attract new employees and retain
existing employees or that we will be able to find, attract and retain qualified
personnel on acceptable terms.
  As
our properties are in the exploration stage, there can be no assurance that we
will establish commercial discoveries on the Properties.
  Exploration
for economic reserves of oil and gas is subject to a number of risk factors. Few
properties that are explored are ultimately developed into producing oil and/or
gas wells. The Properties are in the exploration stage only and while our
initial third party engineering report indicated that we have proven,
undeveloped reserves on the Properties, we have not yet begun production at any
well. We may not establish commercial discoveries on any of the
Properties.
  15
  Estimates
of oil and gas reserves are uncertain and inherently imprecise.
 
 Estimating
our proved reserves involves many uncertainties, including factors beyond our
control. The estimates of proved reserves described in this Form 10-K are based
on various assumptions, which may ultimately prove inaccurate. Petroleum
engineers consider many factors and make assumptions in estimating oil and gas
reserves. Lower oil and gas prices generally cause lower estimates of proved
reserves. Ultimately, actual production, revenues, and expenditures relating to
our reserves will vary from any estimates, and these variations may be material.
Also, in the future we may revise estimates of proved reserves to reflect
production history, results of exploration and development, and other factors,
many of which are beyond our control.
  We
are a new entrant into the oil and gas exploration and development industry
without profitable operating history.
  Since
inception, activities have been limited to organizational efforts, obtaining
working capital and acquiring and developing a very limited number of
properties. As a result, there is limited information regarding property related
production potential or revenue generation potential, and future revenues may be
limited or non-existent.
  The
business of oil and gas exploration and development is subject to many risks.
The potential profitability of oil and natural gas properties if economic
quantities are found is dependent on many factors and risks beyond our control,
including, but not limited to: (i) unanticipated ground conditions;
(ii) geological problems; (iii) drilling and other processing
problems; (iv) the occurrence of unusual weather or operating conditions
and other force majeure events; (v) lower than expected reserve quantities;
(vi) accidents; (vii) delays in the receipt of or failure to receive
necessary government permits; (viii) delays in transportation;
(ix) labor disputes; (x) government permit restrictions and regulation
restrictions; (xi) unavailability of materials and equipment; and
(xii) the failure of equipment or drilling to operate in accordance with
specifications or expectations.
  Drilling
operations may not be successful.
  There can
be no assurance that future drilling activities will be
successful.  We cannot be sure that an overall drilling success rate
or production operations within a particular area will ever come to fruition
and, in any event, production rates inevitably decline over time. We may not
recover all or any portion of the capital investment in our wells or the
underlying leaseholds. Unsuccessful drilling activities would have a material
adverse effect upon our results of operations and financial condition. The cost
of drilling, completing, and operating wells is often uncertain, and a number of
factors can delay or prevent drilling operations including, but not limited to:
(i) unexpected drilling conditions; (ii) pressure or irregularities in
geological formations; (iii) equipment failures or accidents;
(iv) adverse weather conditions; and (iv) shortages or delays in
availability of drilling rigs and delivery of equipment.
  16
  Production
initiatives may not prove successful.
  The
shales from which we intend to produce natural gas frequently contain water,
which may hamper the ability to produce gas in commercial quantities. The amount
of natural gas that can be commercially produced depends upon the rock and shale
formation quality, the original free gas content of the shales, the thickness of
the shales, the reservoir pressure, the rate at which gas is released from the
shales, and the existence of any natural fractures through which the gas can
flow to the well bore. However, shale rock formations frequently contain water
that must be removed in order for the gas to detach from the shales and flow to
the well bore. The ability to remove and dispose of sufficient quantities of
water from the shales may determine whether or not we can produce gas in
commercial quantities.
  There is
no guarantee that the potential drilling locations we now have or may acquire in
the future will ever produce natural gas, which could have a material adverse
effect upon our results of operations.
  Prospects
that we decide to drill may not yield natural gas in commercially viable
quantities.
  Prospects
are in various stages of preliminary evaluation, assessment and drilling and we
only have reached the point where we have begun to drill at a limited number of
the subject prospects. The use of seismic data, historical drilling logs,
offsetting well information, and other technologies and the study of producing
fields in the same area will not enable us to know conclusively prior to
drilling and testing whether natural gas will be present or, if present, whether
natural gas or oil will be present in sufficient quantities or quality to
recover drilling or completion costs or to be economically viable. In sum, the
cost of drilling, completing and operating any wells is often uncertain and new
wells may not be productive.
  If
production results from operations, we are dependent upon transportation and
storage services provided by third parties.
  We will
be dependent on the transportation and storage services offered by various
interstate and intrastate pipeline companies for the delivery and sale of gas
supplies. Both the performance of transportation and storage services by
interstate pipelines and the rates charged for such services are subject to the
jurisdiction of the Federal Energy Regulatory Commission or state regulatory
agencies. An inability to obtain transportation and/or storage services at
competitive rates could hinder processing and marketing operations and/or affect
our sales margins.
  The
potential profitability of oil and gas ventures depends upon factors beyond the
control of the Company.
  The
potential profitability of oil and gas properties is dependent upon many factors
beyond our control. For instance, world prices and markets for oil and gas are
unpredictable, highly volatile, potentially subject to governmental fixing,
pegging, controls, or any combination of these and other factors, and respond to
changes in domestic, international, political, social, and economic
environments. Additionally, due to worldwide economic uncertainty, the
availability and cost of funds for production and other expenses have become
increasingly difficult, if not impossible, to project. These changes and events
may materially affect our financial performance.
  17
  Adverse
weather conditions can also hinder drilling operations. A productive well may
become uneconomic in the event that water or other deleterious substances are
encountered which impair or prevent the production of oil and/or gas from the
well. The marketability of oil and gas which may be acquired or discovered will
be affected by numerous factors beyond our control. These factors include the
proximity and capacity of oil and gas pipelines and processing equipment, market
fluctuations of prices, taxes, royalties, land tenure, allowable production and
environmental regulations. These factors cannot be accurately predicted and the
combination of these factors may result in the Company not receiving an adequate
return on invested capital.
  The
oil and gas industry is highly competitive and there is no assurance that we
will be successful in acquiring new leases.
  The oil
and gas industry is intensely competitive. We compete with numerous individuals
and companies, including many major oil and gas companies, which have
substantially greater technical, financial and operational resources and staffs.
Accordingly, there is a high degree of competition for desirable oil and gas
leases, suitable properties for drilling operations and necessary drilling
equipment, as well as for access to funds. We cannot predict whether we will be
able to acquire additional productive properties, whether the necessary funds
can be raised or that any projected work will be completed.
  Oil
and gas operations are subject to comprehensive regulation which may cause
substantial delays or require capital outlays in excess of those anticipated
causing an adverse effect on the Company.
  Oil and
gas operations are subject to federal, state, and local laws relating to the
protection of the environment, including laws regulating removal of natural
resources from the ground and the discharge of materials into the environment.
Oil and gas operations are also subject to federal, state, and local laws and
regulations which seek to maintain health and safety standards by regulating the
design and use of drilling methods and equipment. Various permits from
government bodies are required for drilling operations to be conducted; no
assurance can be given that such permits will be received. Environmental
standards imposed by federal, state or local authorities may be changed and any
such changes may have material adverse effects on activities. Moreover,
compliance with such laws may cause substantial delays or require capital
outlays in excess of those anticipated, thus causing an adverse effect on us.
Additionally, we may be subject to liability for pollution or other
environmental damages which we may elect not to insure against due to
prohibitive premium costs and other reasons. To date, we have not been required
to spend any material amount on compliance with environmental regulations.
However, we may be required to do so in future and this may affect our ability
to expand or maintain operations.
  18
  Exploration
activities are subject to certain environmental regulations which may prevent or
delay the commencement or continuance of operations.
  In
general, exploration activities are subject to certain federal, state and local
laws and regulations relating to environmental quality and pollution control.
Such laws and regulations increase the costs of these activities and may prevent
or delay the commencement or continuance of a given operation. Compliance with
these laws and regulations has not had a material effect on operations or
financial condition to date. Specifically, we are subject to legislation
regarding emissions into the environment, water discharges and storage and
disposition of hazardous wastes. In addition, legislation has been enacted which
requires well and facility sites to be abandoned and reclaimed to the
satisfaction of state authorities. However, such laws and regulations are
frequently changed and we are unable to predict the ultimate cost of compliance.
Generally, environmental requirements do not appear to affect us any differently
or to any greater or lesser extent than other companies in the
industry.
  We
believe that our operations comply, in all material respects, with all
applicable environmental regulations. Our operating partners maintain insurance
coverage customary to the industry; however, we are not fully insured against
all possible environmental risks.
  Exploratory
drilling involves many risks and we may become liable for pollution or other
liabilities which may have an adverse effect on financial position.
  Drilling
operations generally involve a high degree of risk. Hazards such as unusual or
unexpected geological formations, power outages, labor disruptions, blow-outs,
sour gas leakage, fire, inability to obtain suitable or adequate machinery,
equipment or labor, and other risks are involved. We may become subject to
liability for pollution or hazards against which we cannot adequately insure or
which we may elect not to insure. Incurring any such liability may have a
material adverse effect on our financial position and operations.
  Any
change to government regulation/administrative practices may have a negative
impact on the ability to operate and profitability.
  The laws,
regulations, policies or current administrative practices of any government
body, organization or regulatory agency in the United States or any other
jurisdiction, may be changed, applied or interpreted in a manner which will
fundamentally alter the ability of our company to carry on our
business.
  The
actions, policies or regulations, or changes thereto, of any government body or
regulatory agency, or other special interest groups, may have a detrimental
effect on us. Any or all of these situations may have a negative impact on our
ability to operate profitably.
  Current
volatile market conditions and dropping energy prices may continue indefinitely,
negatively affecting our business prospects and viability.
 
 Commodities
and capital markets have been under great stress and volatility during the past
few months in part due to the credit crisis affecting lenders and borrowers on a
worldwide basis. As a result of this crisis, crude oil and natural gas prices
have tumbled, causing companies to re-think existing strategies and new business
ventures. We are vigilant of the situation unfolding and are adjusting our
strategy to reflect these new market conditions. Nonetheless, we will not be
immune to lower commodities prices.  Our ability to acquire new
natural gas leasehold projects may be compromised, and in a continuing
environment of lower crude oil and natural gas prices, our future results of
operations and market value could be affected negatively.
  19
  Difficult
conditions in the global capital markets may significantly affect our ability to
raise additional capital to continue operations.
 
 The
ongoing worldwide financial and credit crisis may continue
indefinitely.  Because of severely reduced market liquidity, we may
not be able to raise additional capital when we need it.  Because the
future of our business will depend on the completion of one or more additional
leasehold acquisitions for which, most likely, we will need additional capital,
we may not be able to complete such transactions or acquire revenue producing
assets.  As a result, we may not be able to generate income and, to
conserve capital, we may be forced to curtail our current business activities or
cease operations entirely.
 
 RISKS
RELATED TO OUR COMMON STOCK
  There
is currently a limited public market for our Common Stock. Failure to develop or
maintain a trading market could negatively affect its value and make it
difficult or impossible for you to sell your shares.
  There has
been a limited public market for our Common Stock and an active public market
for our Common Stock may not develop. Failure to develop or maintain an active
trading market could make it difficult for you to sell your shares or recover
any part of your investment in us. Even if a market for our Common Stock does
develop, the market price of our Common Stock may be highly volatile. In
addition to the uncertainties relating to future operating performance and the
profitability of operations, factors such as variations in interim financial
results or various, as yet unpredictable, factors, many of which are beyond our
control, may have a negative effect on the market price of our Common
Stock.
  We
cannot assure you that the Common Stock will become liquid or that it will be
listed on a securities exchange.
  Until our Common Stock is listed on a
national securities exchange such as the New York Stock Exchange or the Nasdaq
Stock Market, we expect our Common Stock to remain eligible for quotation on the
OTCBB, or on another over-the-counter quotation system, or in the “pink sheets.”
In those venues, however, an investor may find it difficult to obtain accurate
quotations as to the market value of our Common Stock.  In addition,
if we fail to meet the criteria set forth in SEC regulations, various
requirements would be imposed by law on broker-dealers who sell our securities
to persons other than established customers and accredited
investors.  Consequently, such regulations may deter broker-dealers
from recommending or selling our Common Stock, which may further affect the
liquidity of the Common Stock.  This would also make it more difficult
for us to raise capital.
  20
  Our
Common Stock is subject to the “Penny Stock” rules of the SEC and the trading
market in the securities is limited, which makes transactions in the stock
cumbersome and may reduce the value of an investment in the stock.
  The SEC
has adopted Rule 15g-9 which establishes the definition of a “penny stock,” for
the purposes relevant to us, as any equity security that has a market price of
less than $5.00 per share or with an exercise price of less than $5.00 per
share, subject to certain exceptions. For any transaction involving a penny
stock, unless exempt, the rules require:
  •
              that
      a broker or dealer approve a person’s account for transactions in penny
      stocks; and
 •
              the
      broker or dealer receive from the investor a written agreement to the
      transaction, setting forth the identity and quantity of the penny stock to
      be purchased.
  In order
to approve a person’s account for transactions in penny stocks, the broker or
dealer must:
  •
              obtain
      financial information and investment experience objectives of the person;
      and
 •
              make
      a reasonable determination that the transactions in penny stocks are
      suitable for that person and the person has sufficient knowledge and
      experience in financial matters to be capable of evaluating the risks of
      transactions in penny stocks.
  The
broker or dealer must also deliver, prior to any transaction in a penny stock, a
disclosure schedule prescribed by the SEC relating to the penny stock market,
which, in highlight form sets forth:
  •
              the
      basis on which the broker or dealer made the suitability determination;
      and
 •
              that
      the broker or dealer received a signed, written agreement from the
      investor prior to the transaction.
  Generally,
brokers may be less willing to execute transactions in securities subject to the
“penny stock” rules. This may make it more difficult for investors to dispose of
common stock and cause a decline in the market value of stock.
  Disclosure
also has to be made about the risks of investing in penny stocks in both public
offerings and in secondary trading and about the commissions payable to both the
broker-dealer and the registered representative, current quotations for the
securities and the rights and remedies available to an investor in cases of
fraud in penny stock transactions. Finally, monthly statements have to be sent
disclosing recent price information for the penny stock held in the account and
information on the limited market in penny stocks.
  The
price of our Common Stock may become volatile, which could lead to losses by
investors and costly securities litigation.
 
 The trading price of our Common Stock
is likely to be highly volatile and could fluctuate in response to factors such
as:
 
 ·
              actual
      or anticipated variations in our operating
  results;
  21
  ·
              announcements
      of developments by us or our
competitors;
  ·
              announcements
      by us or our competitors of significant acquisitions, strategic
      partnerships, joint ventures or capital
  commitments;
  ·
              adoption
      of new accounting standards affecting our Company’s
    industry;
  ·
              additions
      or departures of key personnel;
  ·
              sales
      of our Common Stock or other securities in the open market;
      and
  ·
              other
      events or factors, many of which are beyond our
  control.
  The stock market is subject to
significant price and volume fluctuations. In the past, following periods of
volatility in the market price of a company’s securities, securities class
action litigation has often been initiated against the company. Litigation
initiated against us, whether or not successful, could result in substantial
costs and diversion of our management’s attention and resources, which could
harm our business and financial condition.
 
 We
do not anticipate dividends to be paid on our Common Stock, and investors may
lose the entire amount of their investment.
  Cash dividends have never been declared
or paid on the Common Stock, and we do not anticipate such a declaration or
payment for the foreseeable future. We expect to use future earnings, if any, to
fund business growth. Therefore, stockholders will not receive any funds absent
a sale of their shares. We cannot assure stockholders of a positive return on
their investment when they sell their shares, nor can we assure that
stockholders will not lose the entire amount of their investment.
 
 If
securities analysts do not initiate coverage or continue to cover our Common
Stock or publish unfavorable research or reports about our business, this may
have a negative impact on the market price of our Common Stock.
 
 The trading market for the Common Stock
will depend on the research and reports that securities analysts publish about
our business and the Company. We do not have any control over these analysts.
There is no guarantee that securities analysts will cover the Common Stock. If
securities analysts do not cover the Common Stock, the lack of research coverage
may adversely affect its market price. If we are covered by securities analysts,
and our stock is the subject of an unfavorable report, our stock price and
trading volume would likely decline. If one or more of these analysts ceases to
cover the Company or fails to publish regular reports on the Company, we could
lose visibility in the financial markets, which could cause our stock price or
trading volume to decline.
 
 Further issuances of our Common
Stock could be dilutive.
 
 We may
issue additional shares of our Common Stock, or other securities convertible
into our Common Stock, to fund capital expenditures, including future
acquisitions, or for working capital. If we issue additional shares of our
Common Stock in the future, this may have a dilutive effect on the ownership
interests of our existing shareholders.
  22
  Our
internal controls over financial reporting may not be considered effective in
the future, which could result in a loss of investor confidence in our financial
reports and in turn have an adverse effect on our stock price.
 
 Pursuant
to Section 404 of the Sarbanes-Oxley Act of 2002 we are required to furnish a
report by our management on our internal controls over financial reporting. Such
report must contain, among other matters, an assessment of the effectiveness of
our internal controls over financial reporting as of the end of the year,
including a statement as to whether or not our internal controls over financial
reporting are effective. This assessment must include disclosure of any material
weaknesses in our internal controls over financial reporting identified by
management.
 
 For the
fiscal year ended October 31, 2008, our management concluded 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. Nevertheless, our management has
determined that all matters to be disclosed in this report have been fully and
accurately reported. 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.  However, if we are
unable to sufficiently improve our internal control processes and procedures in
the near future, our investors could lose confidence in the accuracy and
completeness of our financial reports, which in turn could cause our stock price
to decline.
  23
  ITEM
      2.
              PROPERTIES
 
 Kentucky
USA maintains its principal office at 321 Somerset Road, Suite 1, London, KY
40741 and its telephone number at that office is (606) 878-5987. Kentucky USA’s
current office space is shared with Tri-Global Holdings LLC (“Tri-Global”),
whose office consists of approximately 3,000 square feet. The rent is donated by
the Company’s President, Steven D. Eversole, who is the Managing Partner of
Tri-Global. We believe that our existing facilities are suitable and adequate to
meet our current business requirements.
 
 For a
discussion of the Properties, see Item 1 above
 
 ITEM
      3.
              LEGAL
      PROCEEDINGS
 
 Legal
Proceedings
 
 In the
ordinary course of our business, we may from time to time become subject to
routine litigation or administrative proceedings which are incidental to our
business.  We are not a party to nor are we aware of any existing,
pending or threatened lawsuits or other legal actions involving us.
 
 ITEM
      4.
              SUBMISSION
      OF MATTERS TO A VOTE OF SECURITY
HOLDERS
 
 No
matters were submitted to a vote of security holders, through the solicitation
of proxies or otherwise, during the fourth quarter of the fiscal year covered by
this report.
 
 PART
II
 
 ITEM
      5.
                MARKET
      FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER
      PURCHASES OF EQUITY
SECURITIES
 
 Our
Common Stock is currently listed on the OTC Bulletin Board under the symbol
“KYUS.OB”. Prior to November 7, 2007, our stock was listed on the OTC
Bulletin Board under the symbol “LSRC.OB”.
  For the
period from November 1, 2007 to October 31, 2008, the table sets forth the
high and low closing bid prices based upon information obtained from
inter-dealer quotations on the OTC Bulletin Board without retail markup,
markdown, or commission and may not necessarily represent actual
transactions:
  24
  Quarter Ended
                          
                          High Bid
                          
                          
                          Low BidJanuary 31,
      2008 (1)
                          
                          $
                          1.23
                          
                          
                          $
                          0.53April 30,
      2008
                          
                          $
                          1.69
                          
                          
                          $
                          1.26July
       31, 2008
                          
                          $
                          3.96
                          
                          
                          $
                          1.56October
      31, 2008
                          
                          $
                          1.82
                          
                          
                          $
                          0.41
 
 (1)
              Although
      our stock was approved for listing on the OTC Bulletin Board on July 24,
      2007, no trades occurred prior to November 2007.  All
      information contained herein relating to shares and per share data
      reflects the 12:1 forward stock split effected on November 19,
      2007.  Our Common Stock is thinly traded and, thus, pricing of
      our Common Stock does not necessarily represent its fair market
      value.
  Holders
  As of
February 9, 2009, we had 36,607,092 shares of our Common Stock issued and
outstanding held by 17 shareholders of record.
  Securities
Authorized For Issuance Under Equity Compensation Plans
  On
October 19, 2007, our Board of Directors and stockholders adopted the 2007
Equity Incentive Plan (the “2007 Plan”) which reserves a total of 4,000,000
shares of Common Stock for issuance under the 2007 Plan. If an incentive
award granted under the 2007 Plan expires, terminates, is unexercised or is
forfeited, or if any shares are surrendered to us in connection with an
incentive award, the shares subject to such award and the surrendered shares
will become available for further awards under the 2007 Plan. As of the date
hereof, we have not granted any awards under the 2007 Plan.
 
 Dividends
 
 We have
never declared any cash dividends with respect to our Common
Stock.  Future payment of dividends is within the discretion of our
board of directors and will depend on our earnings, capital requirements,
financial condition and other relevant factors.  Although there are no
material restrictions limiting, or that are likely to limit, our ability to pay
dividends on our Common Stock, we presently intend to retain future earnings, if
any, for use in our business and have no present intention to pay cash dividends
on our Common Stock.
 
 Recent
Sales of Unregistered Securities
 
 Sales
by the Company
 
 On
May 29, 2008 we closed a private offering (the “Note Offering”) of an 8%
senior secured convertible note (the “Note”) and warrants (the “Note Warrants”)
to purchase 2,500,000 shares of the Company’s Common Stock to an institutional
investor (the “Note Investor”) for aggregate gross proceeds of $2.5 million. The
Note Offering was conducted pursuant to the exemption from the registration
requirements of the federal securities laws provided by Regulation D and/or
Regulation S and Section 4(2) of the Securities Act. The Note and Note Warrants
were offered and sold only to “accredited investors,” as that term is defined by
Rule 501 of Regulation D, and/or to persons who were neither resident in, nor
citizens of, the United States. Ten percent commissions on the gross proceeds of
the Offering were paid to Westminster Securities Corporation, a registered
broker-dealer, and its registered designees.
  25
  On December 18, 2008, the Company
issued 25,000, 350,000 and 37,500 shares of its restricted Common Stock to three
consultants, respectively, in exchange for consulting services.  These
shares were issued pursuant to exemptions from the registration requirements of
the federal securities laws provided by Section 4(2) of the Securities
Act.
 
 Sales
by KY USA
 
 On
October 5, 2007, KY USA issued the K & D Promissory Note to K&D for
consideration of $1 million.  On October 5, 2007, KY USA issued the
Somerset Promissory Note and the Somerset Warrants for consideration of
$800,000.  On January 17, 2008, KY USA issued the John Thomas
Promissory Note and the John Thomas Warrants for consideration of
$100,000.  On May 9, 2008, the Company issued the May 9th
Promissory Note and the May 9th Bridge
Warrants for consideration of $100,000.  The securities issued in each
of these transactions were issued pursuant to the exemption from the
registration requirements of the federal securities laws provided by Section
4(2) of the Securities Act. No sales commissions were paid in connection with
these issuances.
 
 On June
27, 2008, KY USA, entered into a credit agreement (the “Credit Agreement”) with
NSES 12, LLC (the “Lender”), a funding vehicle of New Stream Capital, pursuant
to which KY USA may borrow up to $10,000,000 in the aggregate, under certain
conditions (the “Loan”). Under the Loan, KY USA has borrowed $2,500,000 (the
“Initial Loan”), and may borrow up to an additional aggregate amount
of $7,500,000 in installments of a minimum of $2,500,000 each (each, an
“Installment Loan”), solely at the discretion of the Lender.  The term note
evidencing the Loan was issued pursuant to the exemption from the registration
requirements of the federal securities laws provided by Section 4(2) of the
Securities Act. No sales commissions were paid in connection with the Initial
Loan.
 
 ITEM
      6.
              SELECTED
      FINANCIAL DATA
 
 Not
applicable.
 
 ITEM 7.
              MANAGEMENT’S DISCUSSION AND
      ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
      OPERATIONS
 
 The
following discussion highlights the principal factors that have affected our
financial condition and results of operations as well as our liquidity and
capital resources for the periods described. This discussion contains
forward-looking statements. Please see “Forward-Looking Statements” and “Risk
Factors” for a discussion of the uncertainties, risks and assumptions associated
with these forward-looking statements.
  26
  The
following discussion and analysis of the Company’s financial condition and
results of operations are based on the consolidation of KY USA’s financial
statements, which KY USA has prepared in accordance with U.S. generally accepted
accounting principles. You should read the discussion and analysis together
with such financial statements and the related notes thereto.
  Results
of Operations
 
 Fiscal
year Ended October 31, 2008
 
 We are
still in our exploration stage and have generated no revenues to
date.
  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 year ended October
31, 2008, we incurred such total capitalized costs of $3,051,737.
  We
incurred general and administrative expenses of $46,527 for the year ended
October 31, 2008. These expenses consisted of costs incurred in connection with
the start-up and day to day operation of our business and costs relating to the
Merger.
  Amortization
of loan fees for the year ended October 31, 2008 totaled
$145,115.  These costs are related to the Note and the Loan (defined
below).
  We
incurred legal and accounting expenses of $676,217 for the year ended October
31, 2008, respectively. These expenses consisted of costs incurred in connection
with our recent financing activities and SEC filing requirements.
  Our
interest expense for the year ended October 31, 2008, was $7,094,735. This cost
is attributable to interest due and paid on the Note and on the Loan. During the
year ended October 31, 2008, we recognized a net gain on a derivative liability
relating to the Note in the amount of $4,596,769, due to a partial settlement
and revaluation of the derivative liability to market at October 31,
2008.
 
 Our net
operating loss from inception through October 31, 2008 was
$3,373,524.
  Because
KY USA, our operating subsidiary, was incorporated on October 5, 2007 and
did not engage in any material activities through October 31, 2007, we do not
present expenses for the fiscal year ended October 31, 2007 as those numbers are
not meaningful and not necessary to an understanding of our results of
operations.
  27
  Liquidity
and Capital Resources
 
 Our cash
and cash equivalents balance as of October 31, 2008 was $899,037.
  As a
result of the Merger which closed on May 2, 2008, we expect significant
expenditures during the next 12 months.  Pursuant to the terms of the
Assignments, KY USA is required to drill 12 wells per year within the Properties
at an estimated cost of between 165,000 to $225,000 per well, for a maximum
total of approximately $2.7 million for the year.  Since June 27,
2008, we have been using the proceeds of the Note Offering and Initial Loan to
finance our drilling efforts on our initial wells.  We have received
one Installment Loan under the Credit Facility (defined below) on February 12,
2009 in the amount of $2,500,000.  We believe this amount of funds
will provide us with sufficient working capital for the next six to nine
months.  We plan to use these funds to bring our presently drilled
wells online and to drill an additional 10 to 12 wells on our
Leasehold.  There can be no assurance, however, that we will receive
any additional Installment Loans or that if we do receive them, they will be for
the remaining maximum amount available under the Credit Facility,
$5,000,000.  If we do not receive any subsequent Installment Loans
under the Credit Facility we will be required to enter the capital markets to
raise working capital.  If we are unable to obtain the financing
necessary to support our current and planned operations or we do not drill the
required 12 wells per year, we will lose all or part of our rights to the
Leasehold. The loss of the Leasehold would have a substantial material adverse
impact on our business and we might not be able to continue as a going concern.
We currently have no commitments for any additional capital.
 
 In
addition to our current drilling program on the Leasehold, and contingent upon
our ability to raise the required capital, we expect to engage in additional
expenditures over the next 12 months for new seismic data acquisitions and/or
land and drilling rights acquisitions and related drilling
programs.  Although we are not ready to move forward on any particular
project, we would require additional financing in order to proceed with any such
project. There can be no assurance, however, that financing for one or more of
these projects will be available to us or, if it is available, that it will be
available on terms acceptable to us and that it will be sufficient to fund our
needs. If we are unable to obtain the financing necessary to support these
expenditures, we may not be able to proceed with this aspect of our plan of
operation.
 
 Due to
our brief history and historical operating losses, our operations have not been
a source of liquidity. Although we expect to begin generating revenues from the
sale of gas from our wells within the next six months, there can be no
assurances that we will be successful in reaching this milestone in a timely
fashion or that we will be able to generate sufficient liquidity from the sale
of our natural gas to help fund our operations.  If we cannot generate
revenues from the sale of our gas, our business, results of operations,
liquidity and financial condition may suffer materially.
  Various
factors outside of our control, including the price of natural gas, overall
market and economic conditions, the downturn and volatility in the US equity
markets and the trading price of our common stock may limit our ability to raise
the capital needed to execute our plan of operations. We recognize that the US
economy is currently experiencing a period of uncertainty and that the capital
markets have been depressed from recent levels. We also recognize that the price
of natural gas has decreased significantly during the last six months. If the
price of natural gas continues to drop and the markets remain volatile, we
realize that these or other factors could adversely affect our ability to raise
additional capital. As a result of an inability to raise additional capital, our
short-term or long-term liquidity and our ability to execute our plan of
operations could be significantly impaired.
  28




Note
Offering




On
May 29, 2008 we closed the Note Offering for aggregate gross proceeds to us
of $2.5 million. We paid cash commissions of ten percent (10%) and ten percent
(10%) warrant coverage to a registered broker-dealer and its designee in
connection with the Note Offering. We have used the proceeds of this financing
to begin drilling our initial wells, to repay certain outstanding indebtedness
and for general working capital purposes.




Credit
Facility





On June
27, 2008, KY USA entered into the Credit Agreement with the Lender pursuant to
which KY USA may borrow up to $10,000,000 in the aggregate, under certain
conditions. Under the Credit Agreement, KY USA has borrowed $2,500,000, the
Initial Loan, and may borrow up to an additional aggregate amount of
$7,500,000 in installments of a minimum of $2,500,000 each, the Installment
Loans, solely at the discretion of the Lender.  The proceeds of
the Initial Loan, net after expenses of the transaction, including a
$200,000 credit facility fee paid to the Lender and a $200,000 consulting fee
paid to one consultant at closing, are being used by KY USA for
ongoing working capital purposes, including the costs and expenses relating to
the drilling of our initial wells in the New Albany shale on the
Leasehold.





On
February 12, 2009, we received the first Installment Loan in an amount of $2.5
million.  To date, we have received $5,000,000 under the Credit
Facility.





The
Credit Agreement requires that we comply with financial covenants relating to,
among other things, collateral and current ratio coverage. As of October 31,
2008, we were not in compliance with the 1.0 to 1.0 current ratio requirement of
the Credit Agreement.  This breach of the current ration covenant
contained in the Credit Agreement constitutes an event of default under the
Credit Agreement. The breach would permit the Lender under the Credit Agreement
to declare all amounts borrowed thereunder to be immediately due and
payable.  We intend to request from the Lender a waiver of this
current ratio covenant, but we cannot assure you that we will be successful in
obtaining such waiver.  Additionally, even if we
obtain a waiver from the Lender, we may not be able to satisfy these or other
covenants in the future or be able to pursue our strategies within the
constraints of these covenants.These circumstances could
materially and adversely impair our liquidity and, among other factors, raise
substantial doubt regarding our ability to continue as a going
concern.





Notes
Issued by KY USA




On
October 5, 2007, KY USA issued a promissory note to K&D with a
principal amount of $1,000,000 (the “K & D Note”).  The “K & D
Note was due and payable on August 5, 2008 and did not bear interest until that
date.  After the Maturity Date, interest accrues at a rate of nine
percent (9%) per annum on any outstanding principal.  The “K & D
Note was issued in partial payment for KY USA’s acquisition of its interest
in the Properties, which it acquired from K&D.  The Company repaid
$350,000 principal amount of the K & D Note out of the proceeds of the Note
Offering.


29





On
October 5, 2007, KY USA entered into a loan agreement (the “Loan Agreement”)
with Somerset Recycling Service, Inc. (“Somerset”) pursuant to which Somerset
loaned KY USA $800,000 evidenced by a promissory note (the “Somerset Promissory
Note”).  The Somerset Promissory Note was due and payable on June 15,
2008, and bore interest at 10% per annum, payable monthly.   Upon
closing of the Merger, Somerset received warrants to purchase 2,000,000 shares
of Common Stock (the “Somerset Warrants”), such warrants having an exercise
price of $1.00 and expiring five years after issuance.  Somerset
exercised the Somerset Warrants on a cashless basis and received 1,194,592shares of the Common
Stock. The Company repaid $100,000 of the principal amount of the Somerset
Promissory Note out of the proceeds of the May 9th
Promissory Note.  (See below.)  The Company repaid the
remaining $700,000 principal amount of the Somerset Promissory Note out of the
proceeds of the Note Offering.




On
January 17, 2008, KY USA entered into a loan agreement with John Thomas Bridge
and Opportunity Fund (“John Thomas”) pursuant to which John Thomas loaned KY USA
$100,000 evidenced by a promissory note (the “John Thomas Promissory
Note”).  The John Thomas Promissory Note was due and payable on June
17, 2008, and bore interest at 10% per annum.  Upon closing of the
Merger, John Thomas received warrants to purchase 250,000 shares of Common Stock
(the “John Thomas Warrants”), such warrants having an exercise price of $1.00
and expiring five years after issuance.  The Company repaid the John
Thomas Promissory Note out of the proceeds of the Note Offering.




On
May 9, 2008, the Company issued a promissory note (the “May 9th
Promissory Note”) with a principal amount of $100,000 to one lender. The
May 9th
Promissory Note was due and payable on June 15, 2008, and bore interest at
10% per annum.  Upon closing of the Merger, this lender received warrants
to purchase 200,000 shares of Kentucky USA Common Stock (the “May 9th Bridge
Warrants”), such warrants having an initial exercise price of $1.00 per share
and expiring five years after issuance. The Company repaid the May 9th
Promissory Note out of the proceeds of the Note Offering.





Significant
Accounting Policies





Our
consolidated financial statements and accompanying notes have been prepared in
accordance with United States generally accepted accounting principles applied
on a consistent basis. The preparation of financial statements in conformity
with U.S. generally accepted accounting principles requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities, the disclosure of contingent assets and liabilities at the date of
the financial statements and the reported amounts of revenues and expenses
during the reporting periods.





For a
discussion of all of our significant accounting policies, see Note 3 to our
Consolidated Financial Statements included in this Annual Report on Form
10-K.


30


Recent
Accounting Pronouncements




In July
2006, the Financial Accounting Standards Board (FASB) Issued FASB Interpretation
No. 48, “Accounting for Uncertainty in Income Taxes-an Interpretation of FASB
Statement No. 109” (FIN 48), which clarifies the accounting for uncertainty in
tax positions taken or expected to be taken by the Company, including issues
relating to financial statement recognition and measurement.  FIN 48
requires companies to determine whether it is “more likely than not” that a tax
position will be sustained upon examination by the appropriate taxing
authorities before any part of the benefit can be recorded in the financial
statements. It also provides guidance on the recognition, measurement and
classification of income tax uncertainties, along with any related interest and
penalties.  FIN 48 also requires significant additional disclosures.
This Interpretation was effective for fiscal years beginning after December 15,
2006 for publicly traded companies. The Company has evaluated the impact of this
Interpretation on its financial position and results of operations. Adoption of
FIN 48 did not have a material impact in the results of its operations or
financial position.  All of the Company’s tax years since inception
are open to IRS examination.





In
September 2006, the FASB issued SFAS 157, Fair Value
Measurements.  The standard provides guidance for using value to
measure assets and liabilities.  It defines fair value, establishes a
framework for measuring fair value under generally accepted accounting
principles and expands disclosures about fair value
measurement.  Under the standard, fair value refers to the price that
would be received to sell an asset or paid to transfer a liability in an orderly
transaction between market participants in the market in which the reporting
entity transacts.  It clarifies the principle that fair value should
be based on the assumptions market participants would use when pricing the asset
or liability.  In support of this principle, the standard establishes
a fair value hierarchy that prioritizes the information used to develop those
assumptions.  Under the standard, fair value measurements would be
separately disclosed by level within the fair value hierarchy.  SFAS
157 is effective for financial statements issued for fiscal years beginning
after November 15, 2007.  The Company continues to evaluate the impact
the adoption of this statement could have on its financial condition, results of
operations and cash flows and does not believe the standard will have a material
impact on the results of its operations or financial position.





In
September 2006, the Securities and Exchange Commission staff published Staff
Accounting Bulletin SAB No. 108 (“SAB 108”), “Considering the Effects of Prior
Year Misstatements when Quantifying Misstatements in Current Year Financial
Statements.” SAB 108 address quantifying the financial statement effects of
misstatements, specifically, how the effects of prior year uncorrected errors
must be considered in quantifying misstatements in the current year financial
statements.  SAB 108 was effective for fiscal years ending after
November 15, 2006.  The Company has adopted SAB 108 and it has not had
an impact on the Company’s financial statements.





In
February 2007, the FASB issued SFAS No. 159 “The Fair Value Option for Financial
Assets and Financial Liabilities-as amended (“SFAS 159”).  SFAS 159
permits entities to elect to report eligible financial instruments at fair value
subject to conditions stated in the pronouncement including adoption of SFAS 157
discussed above.  The purpose of SFAS 159 is to improve financial
reporting by mitigating volatility in earnings related to current reporting
requirements.  The Company is considering the applicability of SFAS
159 and will determine if adoption is appropriate.  The effective date
for SFAS 159 is for fiscal years beginning after November 15,
2007.


31





In December 2007, the FASB issued SFAS
No. 141(R), Business Combinations (“SFAS 141(R)”), which improves the relevance,
representational faithfulness, and comparability of the information that a
reporting entity provides in its financial reports about a business combination
and its effects.  SFAS 141(R) requires acquisition-related costs and
restructuring costs to be recognized separately from the first annual reporting
period beginning on or after December 15, 2008.  The Company continues
to evaluate the potential impact of this Interpretation on its financial
position and the results of its operations.





ITEM
8.       FINANCIAL STATEMENTS AND
SUPPLEMENTAL DATA





Our
audited financial statements are included beginning immediately following the
signature page to this report.  See Item 15 for a list of the
financial statements included herein.





ITEM
      9.
            CHANGES
      IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
      DISCLOSURE





Not
applicable.





ITEM
9A.[T]  CONTROLS AND PROCEDURES





Evaluation
of Our Disclosure Controls and Internal Controls





Under the
supervision and with the participation of our senior management, including our
Interim Chief Financial Officer, Charles M. Stivers, we 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
Exchange Act of 1934, as amended (the “Exchange Act”), as of the end of the
period covered by this annual report (the “Evaluation Date”).  Based on
this evaluation, our Chief Executive Officer and Interim Chief 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. Nevertheless, our management has determined that all matters to be
disclosed in this report have been fully and accurately reported. 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.





Our
internal control over financial reporting is a process designed to provide
reasonable assurance regarding the reliability of financial reporting and the
preparation of financial statements for external purposes in accordance with
accounting principles generally accepted in the United
States.  Because of its inherent limitations, internal control over
financial reporting may not prevent or detect
misstatements.  Therefore, even those systems determined to be
effective can provide only reasonable assurance of achieving their control
objectives.  In evaluating the effectiveness of our internal control
over financial reporting, our management used the criteria set forth by the
Committee of Sponsoring Organizations of the Treadway Commission (“COSO”) in
Internal Control – Integrated Framework.


32


This
annual report does not include an attestation report of our registered public
accounting firm regarding internal control over financial
reporting.  Management’s report was not subject to attestation by our
registered public accounting firm pursuant to temporary rules of the Securities
and Exchange Commission that permit us to provide only management’s report in
this annual report.





Officers’
Certifications





Appearing
as exhibits to this Annual Report are “Certifications” of our Chief Executive
Officer and Interim Chief Financial Officer.  The Certifications are
required pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (the “Section
302 Certifications”).  This section of the Annual Report contains
information concerning the Controls Evaluation referred to in the Section 302
Certification.  This information should be read in conjunction with
the Section 302 Certifications for a more complete understanding of the topics
presented.





Changes
in Internal Control Over Financial Reporting





During
our most recent fiscal year ended October 31 , 2008 , there were
no changes in our internal control over financial reporting that have materially
affected or are reasonably likely to affect, our internal control over financial
reporting.





ITEM
9B.  OTHER INFORMATION





On July
18, 2008 KY USA entered into a capital lease (the “Lease”) with The Magdovitz
Family Trust (the “Lessor”).  The Lease is for certain drilling
equipment with a total lease price of $307,394. The terms of the Lease require
KY to make forty-two monthly installments on the first day of each month,
beginning on August 1, 2008.  At the conclusion of the Lease, KY will
have available the option to purchase the equipment, which at October 31, 2008
has a carrying value of $299,709, for consideration of $1.00.  Under
the terms of the Lease, KY will assume and bear the entire risk of loss and
damage to the equipment, will be required to insure the equipment and will
indemnify the Lessor against costs and liabilities of KY arising out of its use
of the equipment.  We have agreed to guarantee the Lease.





On August
4, 2008, KY USA paid $15,000 to Hilltopper Energy, LLC for an exclusive and
irrevocable option (the “Option”) to acquire certain rights in two oil and gas
leases (the “Leases”), one covering approximately 1,000 acres in Todd County,
Kentucky, at an acquisition price of $140,000, and one covering approximately
100 acres in Owsley County, Kentucky, for an acquisition price of
$20,000.  Pursuant to the Option and upon acquisition of the Leases,
KY USA would be entitled to all working rights in the Lease properties and an
82% net revenue interest in the oil and gas found from the top of the New Albany
Shale formation under the properties subject to the Leases to the depth
drilled.  The Option expired on February 4, 2009 and on March 3, 2009
was extended until August 4, 2009 for an additional consideration of
$15,000.




33




PART
III





ITEM
10. DIRECTORS, EXECUTIVE OFFICERS, AND CORPORATE GOVERNANCE





Executive
Officers and Directors




Below are
the names and certain information regarding the Company’s current executive
officers and directors who were appointed upon the closing of the
Merger:




Name:
              
              Age
              
              TitleSteven D. Eversole
              
              47
              
              Chief
      Executive Officer and DirectorCharles
      M. Stivers
              
              46
              
              Interim
      Chief Financial OfficerC.
      G. Collins
              
              67
              
              Vice
      President of Engineering and Development and
  Director




Directors
are elected to serve until the next annual meeting of stockholders and until
their successors are elected and qualified.  Pursuant to the terms of
the Merger Agreement, KY USA and the Company agreed that the Company’s Board of
Directors, as of the closing of the Merger, would consist of five members, four
of whom were to be designated by KY USA and one, to be designated by the
Company.  Our Board of directors is now comprised of two members both
of whom were designated by KY USA.  As of the closing of the Merger,
the Company (pre-Merger) had not designated an individual to serve on our Board
of Directors and a current stockholder of the Company who was a stockholder
prior to the Merger has succeeded to that right.




Currently,
directors are not compensated for their services, although their expenses in
attending meetings may be reimbursed. Officers are elected by the Board of
Directors and serve until their successors are appointed by the Board of
Directors. Biographical resumes of each officer and director are set forth
below.




Steven D. Eversole has been
the Chief Executive Officer of KY USA since October 2007 and became the Chief
Executive Officer of the Company after the Merger. Since 2002, Mr. Eversole
has been the Managing Partner of Tri Global Holdings, LLC, a private financing
company for homeowners with financial difficulty. He began his career with
American Electric Power (AEP), a Fortune 100 company. Mr. Eversole received
a Bachelor of Science degree from Eastern Kentucky University in Industrial
Technology.




Charles M. Stiverswas
appointed the Interim Chief Financial Officer of the Company on June 27,
2008.  Mr. Stivers is a certified public accountant who, since 1990,
has operated his own CPA firm, Charles M. Stivers, C.P.A., specializing in the
oil and gas industry. Since 1998, Mr. Stivers has been president of Bowling
Branch Investments, Inc., a private investment company. Mr. Stivers is currently
a director of Miller Petroleum Inc., a publicly traded company, and serves as
head of, and an “audit committee financial expert” for, Miller Petroleum’s Audit
Committee. He received a Bachelor of Science degree in Business
Administration-Accounting from Eastern Kentucky University.


34




C. G. Collins became the Vice
President of Engineering and Development of the Company in connection with the
Merger. Since 1969, Mr. Collins has run his own company, Collins Petroleum,
Inc. and from 1997 to the present, he has been an Independent Petroleum
Engineer, having drilled and/or developed wells in Kentucky, Tennessee,
Illinois, and Indiana. Mr. Collins’ experience ranges from equipment
operator in 1960 to manager-in-charge with Dowell, a division of Dow Chemical.
From 1965 to 1969, Mr. Collins was in charge of completion and
re-completion of oil and gas wells. He was manager-in-charge for the eastern
half of Michigan for Dowell. Mr. Collins has served as President of both
the Tennessee Oil and Gas Association and the Kentucky Oil and Gas Association;
was named Oil Man of the Year – Tennessee; and is affiliated with the American
Institute of Mining, Metallurgical and Petroleum Engineering, the American
Petroleum Institute, and the Society of Petroleum Engineers. He holds a Bachelor
of Science degree in Chemistry from Campbellsville University and a Bachelor of
Science degree in Petroleum Engineering from the University of
Texas.




Samuel L.
Winer who had been appointed as our Chief Financial Officer and director upon
the closing of the Merger resigned from those positions on June 27, 2008. Mr.
Winer did not have any disagreement with us on any matter relating to our
operations, policies or practices.




Board
Committees




The
Company currently has not established any committees of the Board of Directors.
Our Board of Directors may designate from among its members an executive
committee and one or more other committees in the future.  We do not
have a nominating committee or a nominating committee
charter.  Further, we do not have a policy with regard to the
consideration of any director candidates recommended by security
holders.  To date, no security holders have made any such
recommendations.  Our two directors perform all functions that would
otherwise be performed by committees.  Given the present size of our
board it is not practical for us to have committees.  If we are able
to grow our business and increase our operations, we intend to expand the size
of our board and allocate responsibilities accordingly.




Director
Independence





We are
not currently subject to listing requirements of any national securities
exchange or inter-dealer quotation system which has requirements that a majority
of the board of directors be “independent” and, as a result, we are not at this
time required to (and we do not) have our Board of Directors comprised of a
majority of “Independent Directors.”





Code
of Ethics




We have
adopted a written code of ethics (the “Code of Ethics”) that applies to our
principal executive officer, principal financial officer, principal accounting
officer or controller, and persons performing similar functions. We believe that
the Code of Ethics is reasonably designed to deter wrongdoing and promote honest
and ethical conduct; provide full, fair, accurate, timely and understandable
disclosure in public reports; comply with applicable laws; ensure prompt
internal reporting of code violations; and provide accountability for adherence
to the code.  To request a copy of the Code of Ethics, please make
written request to our President c/o Kentucky USA Energy, Inc., 321 Somerset
Road, Suite 1, London, KY 40741.


35




Compliance
with Section 16(a) of the Exchange Act





Our
common stock is not registered pursuant to Section 12 of the Exchange
Act.  Accordingly, our officers, directors and principal shareholders
are not subject to the beneficial ownership reporting requirements of Section
16(a) of the Exchange Act.







ITEM
11.  EXECUTIVE COMPENSATION





The
following table sets forth information concerning the total compensation paid or
accrued by us during the fiscal year ended October 31, 2008 to (i) all
individuals that served as our principal executive officer or acted in a similar
capacity for us at any time during the fiscal year ended October 31, 2008; (ii)
all individuals that served as our principal financial officer or acted in a
similar capacity for us at any time during the fiscal year ended October 31,
2008; and (iii) all individuals that served as executive officers of ours at any
time during the fiscal year ended October 31, 2008 that received annual
compensation during the fiscal year ended October 31, 2008 in excess of
$100,000.





Summary
Compensation Table




Name and
                                        Principal Position
                                      
                                      Year
                                      
                                      Salary
                                        ($)
                                      
                                      
                                      Bonus
                                        ($)
                                      
                                      
                                      Stock
                                        Awards
                                        ($)
                                      
                                      
                                      Option
                                        Awards
                                        ($)
                                      
                                      
                                      Non-
                                        Equity
                                        Incentive
                                        Plan
                                        Compensation($)
                                      
                                      
                                      Change
                                        in
                                        Pension
                                        Value
                                        and Non-
                                        qualified
                                        Deferred
                                        Compensation
                                        Earnings
                                        ($)
                                      
                                      
                                      All Other
                                        Compensation
                                        ($)
                                      
                                      
                                      Total ($)(a)
                                      
                                      (b)
                                      
                                      (c)
                                      
                                      
                                      (d)
                                      
                                      
                                      (e)
                                      
                                      
                                      (f)
                                      
                                      
                                      (g)
                                      
                                      
                                      (h)
                                      
                                      
                                      (i)
                                      
                                      
                                      (j)Steven
      D. Eversole, Chief Executive Office (1)
                                      
                                      2008
                                      
                                      
                                      61,109
                                      
                                      
                                      
                                      0
                                      
                                      
                                      
                                      0
                                      
                                      
                                      
                                      0
                                      
                                      
                                      
                                      0
                                      
                                      
                                      
                                      0
                                      
                                      
                                      
                                      0
                                      
                                      
                                      
                                      61,109Christopher Greenwood,
                                      
                                      2008
                                      
                                      
                                      0
                                      
                                      
                                      
                                      0
                                      
                                      
                                      
                                      0
                                      
                                      
                                      
                                      0
                                      
                                      
                                      
                                      0
                                      
                                      
                                      
                                      0
                                      
                                      
                                      
                                      0
                                      
                                      
                                      
                                      0Chief Executive Officer (1)
                                      
                                      2007
                                      
                                      
                                      0
                                      
                                      
                                      
                                      0
                                      
                                      
                                      
                                      0
                                      
                                      
                                      
                                      0
                                      
                                      
                                      
                                      0
                                      
                                      
                                      
                                      0
                                      
                                      
                                      
                                      0
                                      
                                      
                                      
                                      0Charles
      M. Stivers, Interim Principal Financial Officer (2)
                                      
                                      2008
                                      
                                      
                                      15,000
                                      
                                      
                                      
                                      0
                                      
                                      
                                      
                                      0
                                      
                                      
                                      
                                      0
                                      
                                      
                                      
                                      0
                                      
                                      
                                      
                                      0
                                      
                                      
                                      
                                      0
                                      
                                      
                                      
                                      15,000Samuel
      L. Winer, Principal Financial Officer (3)
                                      
                                      2008
                                      
                                      
                                      28,000
                                      
                                      
                                      
                                      0
                                      
                                      
                                      
                                      0
                                      
                                      
                                      
                                      65,100
                                      (4)
                                      
                                      
                                      0
                                      
                                      
                                      
                                      0
                                      
                                      
                                      
                                      0
                                      
                                      
                                      
                                      93,100





(1)
              Effective
      upon the closing of the Merger on May 2, 2008, Mr. Greenwood resigned as,
      and Mr. Eversole was appointed, our Chief Executive
    Officer.


(2)
              Mr.
      Stivers was appointed our Interim Principal Financial Officer on June 27,
      2008.


(3)
              Mr.
      Winer resigned from the position as Principal Financial Officer on June
      26, 2008.


(4)
              Following
      his resignation on June 26, 2008, we hired Mr. Winer as a consultant with
      cash compensation at an annual rate $84,000, or $28,000 for the period
      from June 27, 2008 through October 31, 2008, along with7,500 shares of our
      Common Stock per month, or an accrued value of $65,100 for the period from
      June 27, 2008 through October 31,
2008.


36




We have
not issued any stock options or maintained any stock option or other incentive
plans other than our 2007 Plan. (See “Item 5. Market for Common Equity and
Related Stockholder Matters – Securities Authorized for Issuance Under Equity
Compensation Plans” above.) We have no plans in place and have never maintained
any plans that provide for the payment of retirement benefits or benefits that
will be paid primarily following retirement including, but not limited to, tax
qualified deferred benefit plans, supplemental executive retirement plans,
tax-qualified deferred contribution plans and nonqualified deferred contribution
plans.




Except as
indicated below, we have no contracts, agreements, plans or arrangements,
whether written or unwritten, that provide for payments to the named executive
officers listed above.





Employment
Agreements with Named Executive Officers





In
connection with the Merger, the Company entered into an employment agreement
with Steven D. Eversole with the following terms:





The
Company entered into an employment agreement with Mr. Eversole to serve as
Chief Executive Officer, effective May 2, 2008. Pursuant to the agreement,
Mr. Eversole will receive annual compensation of $90,000 for a period of
four years. In addition, Mr. Eversole is entitled to participate in any and
all benefit plans, from time to time, in effect for the Company employees, along
with vacation, sick and holiday pay in accordance with policies established and
in effect from time to time. In the event that Mr. Eversole terminates the
employment agreement for “Good Reason” (as defined therein) or the Company
terminates the employment agreement without Cause (as defined therein),
Mr. Eversole will be entitled to a severance payment of one year base
salary. The employment agreement automatically renews for one year periods
thereafter unless terminated pursuant to the agreement.





Compensation
of Directors




Prior to
the Merger, we paid our then sole director, Christopher Greenwood, a fee of $750
per month for serving as sole director. None of our current directors receives
any compensation for serving as such, for serving on committees of the board of
directors or for special assignments. During the fiscal year ended October 31,
2008 and except as set forth above, there were no other arrangements between us
and our directors that resulted in our making payments to any of our directors
for any services provided to us by them as directors.




ITEM
      12.
            SECURITY
      OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED
      STOCKHOLDER MATTERS




The
following table sets forth information with respect to the beneficial ownership
of our common stock known by us as of January 12, 2009 by:


37


·
            each
      person or entity known by us to be the beneficial owner of more than 5% of
      our common stock;





·
            each
      of our directors;





·
            each
      of our executive officers; and





·
            all
      of our directors and executive officers as a
  group.




Except as
otherwise indicated, the persons listed below have sole voting and investment
power with respect to all shares of our common stock owned by them, except to
the extent such power may be shared with a spouse.




Unless
otherwise indicated in the following table, the address for each person named in
the table is c/o Kentucky USA Energy, Inc., 321 Somerset Road, Suite 1, London,
KY 40741.





NAME OF OWNER
                                        
                                        TITLE OF
                                          CLASS
                                        
                                        NUMBER OF
                                          SHARES OWNED (1)
                                        
                                        
                                        PERCENTAGE OF
                                          COMMON STOCK (2)Steven
      D. Eversole
                                        
                                        Common Stock
                                        
                                        
                                        7,600,000
                                        (3)
                                        
                                        
                                        20.76
                                        %Charles M. Stivers
                                        
                                        Common Stock
                                        
                                        
                                        23,750
                                        (4)
                                        
                                        
                                        *C. G. Collins
                                        
                                        Common Stock
                                        
                                        
                                        3,420,000
                                        (5)
                                        
                                        
                                        9.34
                                        %All Officers and Directors
                                        
                                        Common Stock
                                        
                                        
                                        12,100,000
                                        
                                        
                                        
                                        33.05
                                        %As a Group (3 persons)Saddlebrook Holdings, LLC (6)
                                        
                                        Common Stock
                                        
                                        
                                        6,080,000
                                        
                                        
                                        
                                        16.61
                                        %22 Saddlebrook GardenLondon, KY 40744Collins Family Trust (7)
                                        
                                        Common Stock
                                        
                                        
                                        3,420,000
                                        
                                        
                                        
                                        9.34
                                        %107 Forest Hills DriveCampbellsville, KY 42718Trinity Group Holdings, LLC (8)
                                        
                                        Common Stock
                                        
                                        
                                        3,420,000
                                        
                                        
                                        
                                        9.34
                                        %88 Grand Circle DriveSomerset, KY 42503Tillerman Securities, Ltd. (9)
                                        
                                        Common Stock
                                        
                                        
                                        2,500,000
                                        
                                        
                                        
                                        6.83
                                        %88 Grand Circle DriveNassau NP, BahamasWiner Family Trust (10)
                                        
                                        Common Stock
                                        
                                        
                                        2,042,500
                                        
                                        
                                        
                                        5.58
                                        %7270 Maidencane Ct.Largo, FL 33777


38


_______


*Less
than 1%.





(1)
              Beneficial
      Ownership is determined in accordance with the rules of the SEC and
      generally includes voting or investment power with respect to securities.
      Shares of common stock subject to options or warrants currently
      exercisable or convertible, or exercisable or convertible within 60 days
      of January 12, 2009 are deemed outstanding for computing the percentage of
      the person holding such option or warrant but are not deemed outstanding
      for computing the percentage of any other
  person.





(2)
              Percentage
      based upon 36,607,092 shares of common stock outstanding as of
      February 9, 2009.





(3)
              Includes
      6,080,000 shares of Common Stock held by Saddlebrook Holdings, LLC, of
      which Mr. Eversole has voting and investment control over shares held by
      such entity.  Does not include 80,000 shares of Common Stock
      beneficially owned by Mr. Eversole and 320,000 shares of Common Stock
      beneficially owned by Saddlebrook Holdings, LLC but held in the
      Indemnification Escrow pursuant to the Merger
  Agreement.





(4)
              Does
      not include 1,250 shares of Common Stock held in the Indemnification
      Escrow pursuant to the Merger
Agreement.





(5)
              Represents
      shares of Common Stock held by the Collins Family Trust, of which Mr.
      Collins is a trustee and has voting and investment control over shares
      held by such entity.  Does not include 180,000 shares of Common
      Stock beneficially owned by the Collins Family Trust but held in the
      Indemnification Escrow pursuant to the Merger
  Agreement.





(6)
              Steven
      and Katherine Eversole, as members, have voting and investment control
      over shares of Common Stock held by this entity. Does not include 320,000
      shares of Common Stock beneficially owned bySaddlebrook Holdings, LLCbut held in the Indemnification Escrow pursuant to the Merger
      Agreement.





(7)
              C.G.
      and Lynda Collins, as trustees, have voting and investment control over
      shares of Common Stock held by this entity.  Does not include
      180,000 shares of Common Stock beneficially owned by the Collins Family
      Trust but held in the Indemnification Escrow pursuant to the Merger
      Agreement.





(8)
              M.
      Joel and Cynthia A. Patton, as members, have voting and investment control
      over shares of Common Stock held by this
entity.





(9)
              Represents
      shares of Common Stock eligible to be acquired within 60 days through the
      exercise of the Note
Warrants.





(10)
              Scott
      L. Wyler, as trustee, has voting and investment control over shares of
      Common Stock held by this entity.  Does not include 110,000
      shares of Common Stock beneficially owned by the Winer Family Trust but
      held in the Indemnification Escrow pursuant to the Merger
      Agreement.


39


Securities
Authorized for Issuance Under Equity Compensation Plans




We have
one compensation plan approved by our stockholders, the 2007 Plan. As of the
date hereof, we have not granted any awards under the 2007 Plan.





ITEM
      13.
            CERTAIN
      RELATIONSHIPS AND RELATED TRANSACTIONS, ANDDIRECTOR
      INDEPENDENCE





Not
applicable.





ITEM
14. PRINCIPAL ACCOUNTANT FEES AND SERVICES





Audit
Fees.




The
aggregate fees billed to us by our principal accountant for services rendered
during the fiscal years ended October 31, 2008 and 2007 are set forth in the
table below:





Fee Category
                  
                  Fiscal year ended October 31, 2008
                  
                  
                  Fiscal year ended October 31, 2007Audit
      fees (1)
                  
                  $
                  41,493
                  
                  
                  $
                  7,000Audit-related
      fees (2)Tax
      fees (3)
                  
                  
                  
                  
                  
                  $
                  500All
      other fees (4)Total
      fees
                  
                  $
                  41,493
                  
                  
                  $
                  7,500





(1)
            Audit
      fees consists of fees incurred for professional services rendered for the
      audit of consolidated financial statements, for reviews of our interim
      consolidated financial statements included in our quarterly reports on
      Form 10-QSB and for services that are normally provided in connection with
      statutory or regulatory filings or
engagements.





(2)
            Audit-related
      fees consists of fees billed for professional services that are reasonably
      related to the performance of the audit or review of our consolidated
      financial statements, but are not reported under “Audit
    fees.”





(3)
            Tax
      fees consists of fees billed for professional services relating to tax
      compliance, tax planning, and tax
advice.





(4)
            All
      other fees consists of fees billed for all other
  services.





Audit Committee’s
Pre-Approval Practice.




We do not
have an audit committee.  Our board of directors performs the function
of an audit committee.  Section 10A(i) of the Securities Exchange Act
of 1934, as amended, prohibits our auditors from performing audit services for
us as well as any services not considered to be audit services unless such
services are pre-approved by our audit committee or, in cases where no such
committee exists, by our board of directors (in lieu of an audit committee) or
unless the services meet certain de minimis standards.


40


PART
IV





ITEM
15.  EXHIBITS AND FINANCIAL STATEMENT SCHEDULES





Financial
Statement Schedules





All
financial statement schedules are omitted because they are not applicable or the
required information is shown in the financial statements or notes
thereto.





Exhibits





The
following Exhibits are being filed with this Annual Report on Form
10-K:




Exhibit
                  No.
              
              SEC Report
                  Reference Number
              
              Description2.1
              
              2.1
              
              Agreement
      and Plan of Merger and Reorganization, dated as of May 2, 2008, by and
      among Kentucky USA Energy, Inc., KY Acquisition Corp. and KY USA Energy,
      Inc. (1)2.2
              
              2.2
              
              Split-Off
      Agreement, dated as of May 2, 2008, by and among Kentucky USA Energy,
      Inc., Christopher Greenwood, Las Rocas Leaseco Corp. and KY USA Energy,
      Inc. (1)3.1
              
              3.1
              
              Amended
      and Restated Certificate of Incorporation of Registrant as filed with the
      Delaware Secretary of State on October 26, 2007 (2)3.2
              
              3.2
              
              By-Laws
      of Registrant (3)3.3
              
              2.3
              
              Amendment
      to By-laws of Kentucky USA Energy, Inc. (formerly Las Rocas Mining Corp.)
      (1)3.4
              
              3.2
              
              Articles
      of Merger of KY Acquisition Corp. into KY USA Energy, Inc.
    (1)4.1
              
              4.1
              
              Form
      of Senior Secured Credit Agreement Between KY USA Energy, Inc. and NSES
      12, LLC (4)4.2
              
              4.2
              
              Form
      of $10,000,000 Term Note of KY USA Energy, Inc. (4)4.3
              
              4.3
              
              Form
      of Security Agreement between KY USA Energy, Inc. and NSES 12, LLC
      (4)4.4
              
              4.4
              
              Form
      of Leasehold Mortgage, Assignment of Production, Security Agreement and
      Financing Statement from KY USA Energy, Inc. to NSES 12, LLC
      (4)





41





Exhibit
                      No.
                  
                  SEC Report
                      Reference Number
                  
                  Description4.5
                  
                  4.5
                  
                  Form
      of Guarantee Agreement between Kentucky USA Energy, Inc. and NSES 12, LLC
      (4)4.6
                  
                  4.6
                  
                  Form
      of Subordination Agreement by and among Kentucky USA Energy, Inc., KY USA
      Energy, Inc. and NSES 12, LLC (4)4.7
                  
                  4.7
                  
                  Form
      of Subordination Agreement by and among 8% senior secured convertible note
      holder, KY USA Energy, Inc. and NSES 12, LLC (4)4.8
                  
                  4.8
                  
                  Form
      of Subordination Agreement by and among 8% senior secured convertible note
      holder, Kentucky USA Energy, Inc. and NSES 12, LLC
  (4)10.1
                  
                  10.1
                  
                  Registrant’s
      2007 Equity Incentive Plan adopted October 19, 2007, 2007
    (5)10.2
                  
                  10.2
                  
                  Escrow
      Agreement, dated as of May 2, 2008, by and among Kentucky USA Energy,
      Inc., Steven D. Eversole and Gottbetter & Partners,
      LLP (1)10.3
                  
                  10.3
                  
                  IR
      Shares Escrow Agreement, dated as of May 2, 2008, by and between Kentucky
      USA Energy, Inc. and Gottbetter & Partners,
    LLP (1)10.4
                  
                  10.4
                  
                  Form
      of Lock-Up Agreement, dated as of May 2, 2008 (1)10.5
                  
                  10.5
                  
                  General
      Release Agreement, dated as of May 2, 2008, by and among Kentucky USA
      Energy, Inc., Christopher Greenwood, Las Rocas Leaseco, Inc. and KY USA
      Energy, Inc. (1)10.6
                  
                  10.6
                  
                  Employment
      Agreement, dated as of May 2, 2008, by and between Kentucky USA Energy,
      Inc. and Steven D. Eversole (1)10.7
                  
                  10.7
                  
                  Employment
      Agreement, dated as of May 2, 2008, by and between Kentucky USA Energy,
      Inc. and Samuel L. Winer (1)10.8
                  
                  10.8
                  
                  Employment
      Agreement, dated as of May 2, 2008, by and between Kentucky USA Energy,
      Inc. and C. G. Collins (1)10.9
                  
                  10.9
                  
                  Form
      of Bridge Lender Warrant, dated as of May 2,
  2008 (1)10.10
                  
                  10.1
                  
                  Form
      of Securities Purchase Agreement (6)10.11
                  
                  10.2
                  
                  Form
      0f 8% Senior Convertible Note
(6)





42





Exhibit
                            No.
                          
                          SEC Report
                            Reference Number
                          
                          Description10.12
                          
                          10.3
                          
                          Form
      of Warrant to Purchase Common Stock (6)10.13
                          
                          10.4
                          
                          Form
      of Registration Rights Agreement (6)10.14
                          
                          10.5
                          
                          Form
      of Security Agreement (6)10.15
                          
                          10.6
                          
                          Form
      of Subsidiary Guarantee (6)10.16
                          
                          10.1
                          
                          Form
      of Farm-Out Assignment of Correction by and between K & D Energy and
      KY USA Energy, Inc. dated June 18, 2008 (4)10.17
                          
                          10.2
                          
                          Form
      of Farm-Out Assignment by and between K & D Energy and KY USA Energy,
      Inc. dated as of October 4, 2007 (4)10.18
                          
                          10.3
                          
                          Form
      of Supplemental Farm-Out Assignment by and between K & D Energy and KY
      USA Energy, Inc. dated as of December 10, 2007 (4)10.19
                          
                          *
                          
                          Kentucky
      Agreement to Lease Equipment (with Warranty) by and between The Magdovitz
      Family Trust and KY USA Energy, Inc. dated July 18,
200810.20
                          
                          *
                          
                          Option
      to Purchase Lease between KY USA Energy, Inc. and Hilltopper Energy, LLC
      dated as of August 4, 2008 (the “Option”) and Addendum to the Option dated
      as of March 3, 200914.1
                          
                          *
                          
                          Code
      of Ethics21
                          
                          *
                          
                          List
      of Subsidiaries31.1
                          
                          *
                          
                          Certification
      of Principal Executive Officer, pursuant to SEC Rules 13a-14(a) and
      15d-14(a), adopted pursuant to Section 302 of the Sarbanes-Oxley Act
      of 200231.2
                          
                          *
                          
                          Certification
      of Interim Principal Financial Officer, pursuant to SEC
      Rules 13a-14(a) and 15d-14(a), adopted pursuant to Section 302
      of the Sarbanes-Oxley Act of 200232.1
                          
                          *
                          
                          Certification
      of Chief Executive Officer, pursuant to 18 U.S.C. Section 1350,
      adopted pursuant to Section 906 of the Sarbanes-Oxley Act of
      2002**





43











Exhibit
                            No.
                          
                          SEC Report
                            Reference Number
                          
                          Description32.2
                          
                          *
                          
                          Certification
      of Interim Chief Financial Officer, pursuant to 18 U.S.C.
      Section 1350, adopted pursuant to Section 906 of the
      Sarbanes-Oxley Act of 2002**99.1
                          
                          *
                          
                          Map
      of the Registrants Albany Shale well Project99.2
                          
                          99.1
                          
                          Form
      of Registrant’s Stock Subscription Agreement
(3)




(1)
            Filed
      with the Securities and Exchange Commission (the “SEC”) on May 5, 2008 as
      an exhibit, numbered as indicated above, to the Registrant’s current
      report (SEC File No. 333-141480) on Form 8-K, which exhibit is
      incorporated herein by reference




(2)
            Filed
      with the SEC on November 1, 2007 as an exhibit, numbered as indicated
      above, to the Registrant’s current report (SEC File No. 333-141480) on
      Form 8-K, which exhibit is incorporated herein by
    reference.




(3)
            Filed
      with the SEC on March 22, 2007 as an exhibit, numbered as indicated above,
      to the Registrant’s registration statement (SEC File No. 333-141480) on
      Form SB-2, which exhibit is incorporated herein by
    reference.




(4)
            Filed
      with the SEC on July 1, 2008 as an exhibit, numbered as indicated above,
      to the Registrant’s current report (SEC File No. 333-141480) on Form 8-K,
      which exhibit is incorporated herein by
  reference.




(5)
            Filed
      with the SEC on January 14, 2008 as an exhibit, numbered as indicated
      above, to the Registrant’s quarterly report (SEC File No. 333-141480) on
      Form 10-KSB, which exhibit is incorporated herein by
      reference.




(6)
            Filed
      with the SEC on June 4, 2008 as an exhibit, numbered as indicated above,
      to the Registrant’s current report (SEC File No. 333-141480) on Form 8-K,
      which exhibit is incorporated herein by
  reference.




* Filed
herewith.





** 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.





In
reviewing the agreements included as exhibits to this Annual Report on Form
10-K, please remember that they are included to provide you with information
regarding their terms and are not intended to provide any other factual or
disclosure information about the Company or the other parties to the agreements.
The agreements may contain representations and warranties by each of the parties
to the applicable agreement. These representations and warranties have been made
solely for the benefit of the parties to the applicable agreement
and:


44





•
              should
      not in all instances be treated as categorical statements of fact, but
      rather as a way of allocating the risk to one of the parties if those
      statements prove to be
inaccurate;





•
              have
      been qualified by disclosures that were made to the other party in
      connection with the negotiation of the applicable agreement, which
      disclosures are not necessarily reflected in the
  agreement;





•
              may
      apply standards of materiality in a way that is different from what may be
      viewed as material to you or other investors;
  and





•
              were
      made only as of the date of the applicable agreement or such other date or
      dates as may be specified in the agreement and are subject to more recent
      developments.





Accordingly,
these representations and warranties may not describe the actual state of
affairs as of the date they were made or at any other time. Additional
information about the Company may be found elsewhere in this Annual Report on
Form 10-K and the Company’s other public filings, which are available without
charge through the SEC’s website at http://www.sec.gov.


45


SIGNATURES





Pursuant
to the requirements of Section 13 or 15(d) of the Securities Exchange Act of
1934, as amended, the Registrant has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized.





KENTUCKY
      USA ENERGY, INC.Dated:  March
      16, 2009
                    By:
                    /s/
      Steven D. EversoleSteven
      D. Eversole, President andChief
      Executive OfficerBy:
                    /s/
      Charles M. StiversCharles
      M. Stivers, Interim Principal Financial
Officer





In
accordance with the Exchange Act, this report has been signed below by the
following persons on behalf of the registrant and in the capacities and on the
dates indicated.




SIGNATURE
                
                TITLE
                
                DATE/s/ Steven D. Eversole
                
                Director
                
                March 16,
      2009Steven
      D. Eversole/s/ C.G.
      Collins
                
                Director
                
                March 16,
      2009C.G.
      Collins


46




REPORT OF
INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM




To the
Board of Directors




Kentucky
USA Energy, Inc.




We have
audited the accompanying balance sheets of Kentucky USA Energy, Inc. (An
Exploration Stage Company) as of October 31, 2008 and October 31, 2007 and the
related statements of operations, stockholders’ equity (deficit) and cash flows
for the year and period then ended and from October 5, 2007 (inception), to
October 31, 2008. These financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
financial statements based on our audits.




We
conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.





In our
opinion, the financial statements referred to above present fairly, in all
material respects, the financial position of Kentucky USA Energy, Inc. (An
Exploration Stage Company) as of October 31, 2008 and October 31, 2007 and the
results of its operations and cash flows for the year and period then ended and
from October 5, 2007 (inception), to October 31, 2008 in conformity with
accounting principles generally accepted in the United States of
America.





The
accompanying financial statements have been prepared assuming that the Company
will continue as a going concern. As discussed in Note 1 to the financial
statements, the Company has suffered recurring losses from operations and has
breached a loan covenant, whereby funds may be subject to accelerated repayment.
These circumstances raise substantial doubt about the Company’s ability to
continue as a going concern. Management's plans in regard to these matters are
also described in Note 1. The financial statements do not include any
adjustments that might result from the outcome of this uncertainty.




/s/
Rodefer Moss & Co., PLLC




March 10,
2009


F-1


KENTUCKY
USA ENERGY, INC.


(Formerly
Las Rocas Mining Corp.)


(AN
EXPLORATION STAGE COMPANY)


Consolidated
Balance Sheets





October 31, 2008
                    
                    
                    October 31, 2007ASSETSCurrent
      AssetsCash
      and cash equivalents
                    
                    $
                    899,037
                    
                    
                    $
                    30,232Prepaid
      expenses
                    
                    
                    15,613
                    
                    
                    
                    -Total
      current assets
                    
                    
                    914,650
                    
                    
                    
                    30,232Other
      AssetsDeferred
      professional fees
                    
                    
                    -
                    
                    
                    
                    50,040Loan
      fees, net of accumulated amortization of $145,115
                    
                    
                    1,005,090
                    
                    
                    
                    -Investment
      in natural gas properties, using full cost method
                    
                    
                    3,796,351
                    
                    
                    
                    1,719,728Total
      other assets
                    
                    
                    4,801,441
                    
                    
                    
                    1,769,768Other
      property and equipment, net of accumulated depreciation of
      $7,830
                    
                    
                    306,366
                    
                    
                    
                    -Total
      assets
                    
                    $
                    6,022,457
                    
                    
                    $
                    1,800,000LIABILITIES
      AND STOCKHOLDERS' EQUITY (DEFICIT)Current
      LiabilitiesAccounts
      payable
                    
                    $
                    188,225
                    
                    
                    $
                    -Accrued
      interest
                    
                    
                    81,928
                    
                    
                    
                    5,700Stock
      liability
                    
                    
                    188,600
                    
                    
                    
                    -Derivative
      liability - warrants
                    
                    
                    263,425
                    
                    
                    
                    -Notes
      payable, due within one year
                    
                    
                    3,150,000
                    
                    
                    
                    800,000Capital
      lease obligations, due within one year
                    
                    
                    83,268
                    
                    
                    
                    -Total
      current liabilities
                    
                    
                    3,955,446
                    
                    
                    
                    805,700Long-term
      DebtConvertible
      debt, net of discounts of $2,003,502
                    
                    
                    1,807,250
                    
                    
                    
                    -Notes
      payable, less amounts due within one year
                    
                    
                    -
                    
                    
                    
                    1,000,000Capital
      lease obligations, less amounts due within one year
                    
                    
                    202,169
                    
                    
                    
                    -Total
      long-term debt
                    
                    
                    2,009,419
                    
                    
                    
                    1,000,000Total
      liabilities
                    
                    
                    5,964,865
                    
                    
                    
                    1,805,700Stockholders'
      Equity (Deficit)Common
      stock, ($0.0001 par value; 300,000,000 sharesauthorized;
      36,194,592 and 18,000,000 shares issued and outstanding)
                    
                    
                    3,619
                    
                    
                    
                    1,800Additional
      paid-in capital
                    
                    
                    3,427,498
                    
                    
                    
                    200Deficit
      accumulated during exploration stage
                    
                    
                    (3,373,525
                    )
                    
                    
                    (7,700
                    )Total
      stockholders' equity (deficit)
                    
                    
                    57,592
                    
                    
                    
                    (5,700
                    )Total
      liabilities and stockholders' equity (deficit)
                    
                    $
                    6,022,457
                    
                    
                    $
                    1,800,000





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


F-2


KENTUCKY
USA ENERGY, INC.


(Formerly
Las Rocas Mining Corp.)


(AN
EXPLORATION STAGE COMPANY)





Consolidated
Statements of Operations





From Inception,Year Ended
                  
                  
                  Period Ended
                  
                  
                  October 5, 2007, thruOctober 31, 2008
                  
                  
                  October 31, 2007
                  
                  
                  October 31, 2008Revenues
                  
                  $
                  -
                  
                  
                  $
                  -
                  
                  
                  $
                  -General
      and Administrative ExpensesAmortization
      of loan fees
                  
                  
                  145,115
                  
                  
                  
                  -
                  
                  
                  
                  145,115General
      and administrative
                  
                  
                  46,527
                  
                  
                  
                  -
                  
                  
                  
                  46,527Legal
      and accounting
                  
                  
                  676,217
                  
                  
                  
                  2,000
                  
                  
                  
                  678,217Loss
      from operations
                  
                  
                  (867,859
                  )
                  
                  
                  (2,000
                  )
                  
                  
                  (869,859
                  )Other
      Income (expense)Changes
      in fair value of derivative liability
                  
                  
                  4,596,769
                  
                  
                  
                  -
                  
                  
                  
                  4,596,769Interest
      expense
                  
                  
                  (7,094,735
                  )
                  
                  
                  (5,699
                  )
                  
                  
                  (7,100,434
                  )Income
      (loss) before income taxes
                  
                  
                  (3,365,825
                  )
                  
                  
                  (7,699
                  )
                  
                  
                  (3,373,524
                  )Income
      taxes
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -Net
      income (loss)
                  
                  $
                  (3,365,825
                  )
                  
                  $
                  (7,699
                  )
                  
                  $
                  (3,373,524
                  )Net
      income per shareBasic
      and diluted:Operations
                  
                  $
                  (0.15
                  )
                  
                  $
                  -
                  
                  
                  $
                  (0.15
                  )Total
                  
                  $
                  (0.15
                  )
                  
                  $
                  -
                  
                  
                  $
                  (0.15
                  )





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





F-3


KENTUCKY
USA ENERGY, INC.


(Formerly
Las Rocas Mining Corp.)


(AN
EXPLORATION STAGE COMPANY)





Consolidated
Statement of Changes in Stockholders’ deficit


Deficit
                                                  
                                                  
                                                  TotalCommon
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  Additional
                                                  
                                                  
                                                  Accumulated
                                                  
                                                  
                                                  Stockholders’Stock
                                                  
                                                  
                                                  Common
                                                  
                                                  
                                                  Paid -in
                                                  
                                                  
                                                  During Exploration
                                                  
                                                  
                                                  EquityShares
                                                  
                                                  
                                                  Stock
                                                  
                                                  
                                                  Capital
                                                  
                                                  
                                                  Stage
                                                  
                                                  
                                                  (Deficit)Balance
      at October 5, 2007 (inception)
                                                  
                                                  
                                                  -
                                                  
                                                  
                                                  $
                                                  -
                                                  
                                                  
                                                  $
                                                  -
                                                  
                                                  
                                                  $
                                                  -
                                                  
                                                  
                                                  $
                                                  -18,000,000
      shares of stock issued for serviceson October 5, 2007 at $0.001
      per share
                                                  
                                                  
                                                  18,000,000
                                                  
                                                  
                                                  
                                                  1,800
                                                  
                                                  
                                                  
                                                  200
                                                  
                                                  
                                                  
                                                  -
                                                  
                                                  
                                                  
                                                  2,000Net
      loss for the period
                                                  
                                                  
                                                  -
                                                  
                                                  
                                                  
                                                  -
                                                  
                                                  
                                                  
                                                  -
                                                  
                                                  
                                                  
                                                  (7,700
                                                  )
                                                  
                                                  
                                                  (7,700
                                                  )Balance
      at October 31, 2007
                                                  
                                                  
                                                  18,000,000
                                                  
                                                  
                                                  
                                                  1,800
                                                  
                                                  
                                                  
                                                  200
                                                  
                                                  
                                                  
                                                  (7,700
                                                  )
                                                  
                                                  
                                                  (5,700
                                                  )May
      2008 issuance of 12,000,000 shares for shell acquisition
                                                  
                                                  
                                                  12,000,000
                                                  
                                                  
                                                  
                                                  1,200
                                                  
                                                  
                                                  
                                                  (1,000
                                                  )
                                                  
                                                  
                                                  -
                                                  
                                                  
                                                  
                                                  200May
      2008 application of services provided in connnectionwith
      recapitalization as a cost of the transaction
                                                  
                                                  
                                                  -
                                                  
                                                  
                                                  
                                                  -
                                                  
                                                  
                                                  
                                                  (8,500,000
                                                  )
                                                  
                                                  
                                                  -
                                                  
                                                  
                                                  
                                                  (8,500,000
                                                  )May
      2008 issuance of 5,000,000 shares in connection withservices for
      recapitalization
                                                  
                                                  
                                                  5,000,000
                                                  
                                                  
                                                  
                                                  500
                                                  
                                                  
                                                  
                                                  8,499,500
                                                  
                                                  
                                                  
                                                  -
                                                  
                                                  
                                                  
                                                  8,500,000Issuance
      of stock in partial settlement of derivative liability -May
      2008
                                                  
                                                  
                                                  1,194,592
                                                  
                                                  
                                                  
                                                  119
                                                  
                                                  
                                                  
                                                  3,428,798
                                                  
                                                  
                                                  
                                                  -
                                                  
                                                  
                                                  
                                                  3,428,917Net
      loss for the year
                                                  
                                                  
                                                  -
                                                  
                                                  
                                                  
                                                  -
                                                  
                                                  
                                                  
                                                  -
                                                  
                                                  
                                                  
                                                  (3,365,825
                                                  )
                                                  
                                                  
                                                  (3,365,825
                                                  )Balance
      at October 31, 2008
                                                  
                                                  
                                                  36,194,592
                                                  
                                                  
                                                  $
                                                  3,619
                                                  
                                                  
                                                  $
                                                  3,427,498
                                                  
                                                  
                                                  $
                                                  (3,373,525
                                                  )
                                                  
                                                  $
                                                  57,592





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


F-4


KENTUCKY
USA ENERGY, INC.


(Formerly
Las Rocas Mining Corp.)


(AN
EXPLORATION STAGE COMPANY)


Consolidated
Statements of Cash Flows


Twelve
                                      
                                      
                                      
                                      
                                      
                                      From InceptionMonths Ended
                                      
                                      
                                      Period Ended
                                      
                                      
                                      October 5, 2007 thruOctober 31, 2008
                                      
                                      
                                      October 31, 2007
                                      
                                      
                                      October 31, 2008Net
      loss
                                      
                                      $
                                      (3,365,825
                                      )
                                      
                                      $
                                      (7,699
                                      )
                                      
                                      $
                                      (3,373,524
                                      )Adjustments
      to reconcile net loss to net cashused
      in operating activitiesGains
      on market valuation of derivative liabilities
                                      
                                      
                                      (4,596,769
                                      )
                                      
                                      
                                      -
                                      
                                      
                                      
                                      (4,596,769
                                      )Derivative
      valuation adjustments charged to expense
                                      
                                      
                                      6,851,947
                                      
                                      
                                      
                                      -
                                      
                                      
                                      
                                      6,851,947Amortization
      of loan fees
                                      
                                      
                                      145,115
                                      
                                      
                                      
                                      -
                                      
                                      
                                      
                                      145,115Depreciation
                                      
                                      
                                      7,830
                                      
                                      
                                      
                                      -
                                      
                                      
                                      
                                      7,830Common
      stock issued for services
                                      
                                      
                                      -
                                      
                                      
                                      
                                      2,000
                                      
                                      
                                      
                                      2,000(Increase)
      in assets and increase in liabilitiesPrepaid
      expenses
                                      
                                      
                                      34,425
                                      
                                      
                                      
                                      -
                                      
                                      
                                      
                                      34,425Accounts
      payable
                                      
                                      
                                      188,225
                                      
                                      
                                      
                                      -
                                      
                                      
                                      
                                      188,225Stock
      liability
                                      
                                      
                                      188,600
                                      
                                      
                                      
                                      -
                                      
                                      
                                      
                                      188,600Accrued
      expenses
                                      
                                      
                                      76,229
                                      
                                      
                                      
                                      5,699
                                      
                                      
                                      
                                      81,928Total
      adjustments to reconcile net loss to net cashprovided
      used in operating activities
                                      
                                      
                                      2,895,602
                                      
                                      
                                      
                                      7,699
                                      
                                      
                                      
                                      2,903,301Net
      cash used in operating activities
                                      
                                      
                                      (470,223
                                      )
                                      
                                      
                                      -
                                      
                                      
                                      
                                      (470,223
                                      )Cash
      flows from investing activitiesPurchase
      of other property and equipment
                                      
                                      
                                      (314,195
                                      )
                                      
                                      
                                      -
                                      
                                      
                                      
                                      (314,195
                                      )Retainers
      paid to legal counsel
                                      
                                      
                                      -
                                      
                                      
                                      
                                      (50,040
                                      )
                                      
                                      
                                      (50,040
                                      )Investment
      in oil & gas properties
                                      
                                      
                                      (1,332,009
                                      )
                                      
                                      
                                      (1,719,728
                                      )
                                      
                                      
                                      (3,051,737
                                      )Total
      cash flows from investing activities
                                      
                                      
                                      (1,646,204
                                      )
                                      
                                      
                                      (1,769,768
                                      )
                                      
                                      
                                      (3,415,972
                                      )Cash
      flows from financing activitiesProceeds
      from borrowings
                                      
                                      
                                      5,100,000
                                      
                                      
                                      
                                      1,800,000
                                      
                                      
                                      
                                      6,900,000Proceeds
      from borrowings under capital leases
                                      
                                      
                                      307,394
                                      
                                      
                                      
                                      -
                                      
                                      
                                      
                                      307,394Loan
      fees incurred from borrowings
                                      
                                      
                                      (1,150,205
                                      )
                                      
                                      
                                      -
                                      
                                      
                                      
                                      (1,150,205
                                      )Repayments
      of long-term debt
                                      
                                      
                                      (1,250,000
                                      )
                                      
                                      
                                      -
                                      
                                      
                                      
                                      (1,250,000
                                      )Payments
      on capital lease obligations
                                      
                                      
                                      (21,957
                                      )
                                      
                                      
                                      -
                                      
                                      
                                      
                                      (21,957
                                      )Total
      cash flows from financing activities
                                      
                                      
                                      2,985,232
                                      
                                      
                                      
                                      1,800,000
                                      
                                      
                                      
                                      4,785,232Net
      increase in cash
                                      
                                      
                                      868,805
                                      
                                      
                                      
                                      30,232
                                      
                                      
                                      
                                      899,037Cash
      and cash equivalents, beginning of period
                                      
                                      
                                      30,232
                                      
                                      
                                      
                                      -
                                      
                                      
                                      
                                      -Cash
      and cash equivalents, end of period
                                      
                                      $
                                      899,037
                                      
                                      
                                      $
                                      30,232
                                      
                                      
                                      $
                                      899,037Supplemental
      Disclosures of Cash Flow informationCash
      paid for interest
                                      
                                      $
                                      181,812
                                      
                                      
                                      $
                                      -
                                      
                                      
                                      $
                                      181,812Cash
      paid for income taxes
                                      
                                      $
                                      -
                                      
                                      
                                      $
                                      -
                                      
                                      
                                      $
                                      -




During
the year ended October 31, 2008, the Company incurred noncash financing costs of
$6,300,037. The Company entered into capital lease obligations of $307,394
in order to obtain equipment for drilling. Common stock was issued in the
amount of $3,429,117 was issued in a non-cash transaction in settlement of
warrants booked as derivative liabilities.
  The
accompanying notes are an integral part of these financial
statements.


F-5


KENTUCKY
USA ENERGY, INC.


(Formerly
Las Rocas Mining Corp.)


(AN
EXPLORATION STAGE COMPANY)


NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS


October
31, 2008





Note
1 - Basis of Presentation





The
accompanying financial statements of Kentucky USA Energy, Inc. (the “Company”)
have been prepared in conformity with accounting principles generally accepted
in the United States of America. The company is still in the exploration stage,
has recognized no revenue to date, and therefore has recorded no income tax
expense.





These
financial statements include the accounts of Kentucky USA Energy, Inc. and the
accounts of its subsidiary, KY USA Energy, Inc. All inter-company balances have
been eliminated in consolidation.





The
Company is an exploration-stage company and historically has had no revenues. To
date the Company's activities have generally been restricted to fundraising,
drilling and exploring for natural gas.





The
Company’s working capital ratio is less than one-to-one, which is a breach of
our loan covenants in effect with regard to loans outstanding from our principal
lender.  Because of the breach of our loan covenant, the $2.5 million
listed as due on our balance sheet at October and an additional $2.5 million
that we received in February 2009 (Note 12) may be called by our lender. Should
this happen, we would have to seek additional financing. There is no guarantee
that additional financing would be available. If the loan is called and we are
unable to find additional financing, we believe we have ample funding to last
through October 31, 2009.





We
continue to maintain a good relationship with this lender and believe that there
is no intention by the lender to call our loan.





As a
result of the covenant violation our loans with this lender are classified as
currently due on our balance sheet at October 31, 2008.





Note
2 – Acquisition





On May 2,
2008 the Company completed a reverse takeover in which it merged into KENTUCKY
USA ENERGY, INC (“Delaware”), a DELAWARE public shell corporation formerly
listed on the over-the-counter bulletin board (OTCBB).  KY USA Energy, Inc.
(“KY”) survived the merger for accounting purposes and changed its name to
KENTUCKY USA ENERGY, INC. Accordingly, these financial statements reflect the
historical operations of KY USA Energy, Inc before the reverse merger, but the
capital structure is that of Delaware, the corporation that legally survived the
merger. The surviving entity is listed as KYUS on the OTCBB. Delaware’s
financial activity after the merger has been reflected in the Company’s
financial statements.


F-6


KENTUCKY
USA ENERGY, INC.


(Formerly
Las Rocas Mining Corp.)


(AN
EXPLORATION STAGE COMPANY)


NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS


October
31, 2008





Prior to
the Merger, Delaware had 36,000,000 shares of Common Stock issued and
outstanding.  In connection with the Merger, Delaware issued 18,000,000
shares of Common Stock in exchange for the issued and outstanding shares of the
KY’s Common Stock while 24,000,000 shares of Delaware’s Common Stock were
returned to the Company and cancelled.  Also in connection with the Merger,
5,000,000 shares of the Company’s Common Stock were issued to IR Consultants in
payment for services rendered in the recapitalization.





As a
result of the acquisition, KY became a subsidiary of Delaware.  Upon
consummation of the transaction the existing shareholders of KY held a majority
of the voting power of the Company and controlled the Company’s board of
directors.





Since at
the time of the acquisition, Delaware had no significant operations, liabilities
or assets, the beginning equity balances of Delaware have been presented as a
recapitalization of KY whereby 18,000,000 common shares are considered
constructively outstanding since inception and the transaction is accounted for
as the subsequent issuance of 12,000,000 shares for the net assets of
Kentucky.  The 5,000,000 shares issued to IR Consultants were recorded
as the cost of capital.





As a
result of these transactions, the historical financial statements of KY are the
continuing historical financial statements of the Company.





Note
3 – Significant Accounting Policies





Cash and Cash
Equivalents


The
Company considers all highly liquid investments with a maturity of three months
or less when purchased to be cash equivalents.  Financial instruments that potentially
subject the Company to concentrations of credit risk consist primarily of cash.
The Company’s cash deposits are in a highly rated financial institution in
Kentucky and may at times exceed federally insured amounts.





Estimates


The
preparation of financial statements in conformity with accounting principles
generally accepted in the United States of America requires management to make
estimates and assumptions that affect the amounts reported on the financial
statements and accompanying notes.  Actual results may differ from
those estimates.  Gas reserve estimates are developed from information
provided by the Company’s management to Glenn Robinson, Robinson Engineering of
Evansville, Indiana and Willard F. Glover, Petroleum Engineering and Geologist
of Crossville, Tennessee, at October 31, 2008 and October 31, 2007,
respectively.


F-7


KENTUCKY
USA ENERGY, INC.
 (Formerly
Las Rocas Mining Corp.)
 (AN
EXPLORATION STAGE COMPANY)
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
 October
31, 2008




Natural Gas
Properties


The
Company follows the full cost method of accounting for gas property acquisition,
exploration and development activities.  Under this method, all
productive and non-productive costs incurred in connection with the acquisitions
of, exploration for and development of gas reserves for each cost center are
capitalized.  Capitalized costs include lease acquisitions, geological
and geophysical work, and the costs of drilling, completing and equipping gas
wells.  Costs, however, associated with production and general
corporate activities are expensed in the period incurred.  Interest
costs related to proved properties and properties under development are also
capitalized to gas properties.  Gains or losses are recognized only
upon sales or dispositions of significant amounts of gas reserves representing
an entire cost center.  Proceeds from all other sales or dispositions
are treated as reductions to capitalized costs.  The capitalized gas
property, less accumulated depreciation, depletion and amortization and related
deferred income taxes, if any, is 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 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 that are excluded from the costs being
amortized.





Issuance of Stock for
Non-Cash Consideration


All
issuances of the Company’s stock for non-cash consideration have been assigned a
per share amount equaling either the market value of the shares issued or the
value of consideration received, whichever is more readily
determinable.  The majority of the non-cash consideration received
pertains to services rendered by consultants and others and has been valued at
the market value of the shares on the dates issued.





Earnings per
Share


In
accordance with Statement of Financial Accounting Standards (SFAS) No. 128,
“Earnings per Share” (“SFAS 128”), basic income per share is based on 27,077,979
and 18,000,000 weighted average shares outstanding for the years ended October
31, 2008 and October 31, 2007.  Because the Company recorded a loss at
October 31, 2008 and 2007, all potentially dilutive securities are
anti-dilutive.





Note
4 – Other Property and Equipment





Other
property and equipment consisted of the following:





Depreciable
                          Life
                        
                        October
      31, 2008
                        
                        
                        October
      31, 2007Machinery
      and Equipment
                        5-7
      yrs
                        
                        $
                        314,196
                        
                        
                        
                        0Total
                        
                        
                        
                        314,196
                        
                        
                        
                        0Less
      accumulated depreciation
                        
                        
                        
                        (7,830
                        )
                        
                        
                        0Other
      property and Equipment - net
                        
                        
                        $
                        306,366
                        
                        
                        
                        0




F-8


KENTUCKY
USA ENERGY, INC.
 (Formerly
Las Rocas Mining Corp.)
 (AN
EXPLORATION STAGE COMPANY)
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
 October
31, 2008


The
Company uses the straight-line method of depreciation ranging from five to seven
years, depending on the estimated asset life.





Note
5 – Notes Payable and Convertible Debt





The
Company had the following debt obligations:





October
      31, 2008
                        
                        
                        October
      31, 2007Non-interest
      bearing note payable to K and D Energy, secured by a Second mortgage on
      oil and gas leases, and repayable on or before August 5,
      2008.   This note is past due as at October 31, 2008 and as
      a result is currently bearing interest at 9%
                        
                        $
                        650,000
                        
                        
                        $
                        1,000,000Note
      payable to Somerset Recycling Service, Inc. Secured by oil and gas
      properties, bearing interest at 10%, interest due in monthly payments with
      the principle due May 5, 2008
                        
                        
                        0
                        
                        
                        
                        800,000NSES
      12, LLC-New Stream Capital 12% note with interest payable monthly starting
      October 1, 2008, 85% of adjusted cash flow starting October 1, 2008
      Interest & Principle paid full in 3 years
                        
                        
                        2,500,000
                        
                        
                        
                        0$
                        3,150,000
                        
                        
                        $
                        1,800,000





Maturities
under note obligations at October 31, 2008 and 2007 were:


2008
                      
                      
                      2007Year
      ending October 31:2008
                      
                      $
                      3,150,000
                      
                      
                      $
                      1,800,0002009
                      
                      
                      -
                      
                      
                      
                      -2010
                      
                      
                      -
                      
                      
                      
                      -Thereafter
                      
                      
                      -
                      
                      
                      
                      -Total
      maturities of long-term debt
                      
                      
                      3,150,000
                      
                      
                      
                      1,800,000Less
      current maturities
                      
                      
                      3,150,000
                      
                      
                      
                      1,800,000Long-term
      notes payable
                      
                      $
                      -
                      
                      
                      $
                      -




F-9


KENTUCKY
USA ENERGY, INC.
 (Formerly
Las Rocas Mining Corp.)
 (AN
EXPLORATION STAGE COMPANY)
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
 October
31, 2008


The
balance owing to NSES represents the first draw on a potential $10 million
credit facility with which the Company plans to execute its drilling program.
Management believes the liquidity provided by this arrangement will be
sufficient for its cash needs in its fiscal year ending October 31, 2009. For a
further discussion of this arrangement, see Note 9, below.





The
Company’s investment in natural gas properties reflects capitalized interest of
$744,614 related to its debt obligations.





Note
6 – Capital Lease





On July
18, 2008 KY entered into a capital lease with The Magdovitz Family
Trust.  The lease is for drilling equipment with a total lease price
of $307,394. The terms of the lease require KY to make forty-two monthly
installments, beginning on September 4, 2008.  At the conclusion of
the lease, KY will have available a bargain purchase option for the equipment
which at October 31, 2008 has a carrying value of $299,709.





Year
      ending October 31:2009
                      
                      $    95,7032010
                      
                      95,7032011
                      
                      95,7032012
                      
                      23,926After
      2012
                      
                      -Total
      gross minimum lease payments
                      
                      311,035Less
      amount representing interest (at 3.5% to 9.183%)
                      25,598Present
      value of minimum lease payments
                      
                      285,437Less
      current installments of obligations
                      
                      83,268Obligations
      under capital leases excludingcurrent
      installments
                      
                      $  202,169





Note
7 – Provision for Income Taxes





The
Company provides deferred income tax assets and liabilities using the liability
method for temporary differences between book and taxable income.





The
provisions for income taxes for the year and period ended October 31, 2008 and
2007 are comprised as follows:




F-10


KENTUCKY
USA ENERGY, INC.
 (Formerly
Las Rocas Mining Corp.)
 (AN
EXPLORATION STAGE COMPANY)
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
 October
31, 2008


2008
                      
                      
                      2007Currently
      payable
                      
                      $
                      -
                      
                      
                      $
                      -Deferred
      federal tax benefit (expense)
                      
                      
                      147,000
                      
                      
                      
                      2,500Deferred
      state tax benefit (expense)
                      
                      
                      29,000
                      
                      
                      
                      -Valuation
      adjustment
                      
                      
                      (176,000
                      )
                      
                      
                      (2,500
                      )$
                      -
                      
                      
                      $
                      -





Income
tax benefit (expense) attributable to income (loss) before income taxes differed
from the amounts computed by applying the United States of America federal
income tax rate of 34% to income (loss) before income taxes as a result of the
following:




October 31, 2008
                                                                          
                                                                          
                                                                          October 31, 2007Reconciliation
      between statutory and effective tax ratesExpected
      benefit at federal statutory rates
                                                                          
                                                                          $
                                                                          1,144,000
                                                                          
                                                                          
                                                                          $
                                                                          2,500Effect
      of interest expense deductible for book purposes but not deductible for
      income tax purposes
                                                                          
                                                                          
                                                                          (2,324,000
                                                                          )
                                                                          
                                                                          
                                                                          -Effect
      of derivative gains included in book income but not included in taxable
      income
                                                                          
                                                                          
                                                                          1,563,000
                                                                          
                                                                          
                                                                          
                                                                          -Temporary
      difference – capitalization of interest
                                                                          
                                                                          
                                                                          (67,000
                                                                          )State
      income taxes
                                                                          
                                                                          
                                                                          29,000
                                                                          
                                                                          
                                                                          
                                                                          -Effect
      of expected lower applicable rates
                                                                          
                                                                          
                                                                          (169,000
                                                                          )
                                                                          
                                                                          
                                                                          -176,000
                                                                          
                                                                          
                                                                          
                                                                          2,500Valuation
      allowance
                                                                          
                                                                          
                                                                          (176,000
                                                                          )
                                                                          
                                                                          
                                                                          (2,500
                                                                          )Income
      tax provision
                                                                          
                                                                          $
                                                                          -
                                                                          
                                                                          
                                                                          $
                                                                          -





The
Company recorded valuation allowances of $176,000 and $2,500 at October 31, 2008
and October 31, 2007, respectively, fully offsetting estimated deferred tax
benefits, as management is unable to determine that these tax benefits are more
likely than not to be realized.





The tax
effects of temporary differences that give rise to significant portions of the
deferred tax assets at October 31, 2008 are as follows:




F-11


KENTUCKY
USA ENERGY, INC.
 (Formerly
Las Rocas Mining Corp.)
 (AN
EXPLORATION STAGE COMPANY)
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
 October
31, 2008




Net
      operating loss carryforwards
                    
                    $
                    223,000Temporary
      difference:Capitalized interest
                    
                    
                    (47,000
                    )$
                    176,000





Note
8 – Recent Accounting Pronouncements





In July
2006, the Financial Accounting Standards Board (FASB) Issued FASB Interpretation
No. 48, “Accounting for Uncertainty in Income Taxes-an Interpretation of FASB
Statement No. 109” (FIN 48), which clarifies the accounting for uncertainty in
tax positions taken or expected to be taken by the Company, including issues
relating to financial statement recognition and measurement. FIN 48 requires
companies to determine whether it is “more likely than not” that a tax position
will be sustained upon examination by the appropriate taxing authorities before
any part of the benefit can be recorded in the financial statements. It also
provides guidance on the recognition, measurement and classification of income
tax uncertainties, along with any related interest and penalties. FIN 48 also
requires significant additional disclosures. This Interpretation was effective
for fiscal years beginning after December 15, 2006 for publicly traded
companies. The Company has evaluated the impact of this Interpretation on its
financial position and results of operations. Adoption of FIN 48 did not have
have a material impact in the results of its operations or financial position.
All of the Company’s tax years since inception are open to IRS
examination.




In
September 2006, the FASB issued SFAS 157, Fair Value Measurements. The standard
provides guidance for using value to measure assets and liabilities. It defines
fair value, establishes a framework for measuring fair value under generally
accepted accounting principles and expands disclosures about fair value
measurement. Under the standard, fair value refers to the price that would be
received to sell an asset or paid to transfer a liability in an orderly
transaction between market participants in the market in which the reporting
entity transacts. It clarifies the principle that fair value should be based on
the assumptions market participants would use when pricing the asset or
liability. In support of this principle, the standard establishes a fair value
hierarchy that prioritizes the information used to develop those assumptions.
Under the standard, fair value measurements would be separately disclosed by
level within the fair value hierarchy. SFAS 157 is effective for financial
statements issued for fiscal years beginning after November 15, 2007. The
Company continues to evaluate the impact the adoption of this statement could
have on its financial condition, results of operations and cash flows and does
not believe the standard will have a material impact on the results of its
operations or financial position.




F-12


KENTUCKY
USA ENERGY, INC.
 (Formerly
Las Rocas Mining Corp.)
 (AN
EXPLORATION STAGE COMPANY)
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
 October
31, 2008




In
September 2006, the Securities and Exchange Commission staff published Staff
Accounting Bulletin SAB No. 108 (“SAB 108”), “Considering the Effects of Prior
Year Misstatements when Quantifying Misstatements in Current Year Financial
Statements.” SAB 108 address quantifying the financial statement effects of
misstatements, specifically, how the effects of prior year uncorrected errors
must be considered in quantifying misstatements in the current year financial
statements.  SAB 108 is effective for fiscal years ending after
November 15, 2006.  The Company has adopted SAB 108 and it has not had
an impact on the Company’s financial statements.





In
February 2007, the FASB issued SFAS No. 159 “The Fair Value Option for Financial
Assets and Financial Liabilities-as amended (“SFAS 159”).  SFAS 159
permits entities to elect to report eligible financial instruments at fair value
subject to conditions stated in the pronouncement including adoption of SFAS 157
discussed above.  The purpose of SFAS 159 is to improve financial
reporting by mitigating volatility in earnings related to current reporting
requirements.  The Company is considering the applicability of SFAS
159 and will determine if adoption is appropriate.  The effective date
for SFAS 159 is for fiscal years beginning after November 15, 2007.





In December 2007, the FASB issued SFAS
No. 141(R), Business Combinations (“SFAS 141(R)”), which improves the relevance,
representational faithfulness, and comparability of the information that a
reporting entity provides in its financial reports about a business combination
and its effects.  SFAS 141(R) requires acquisition-related costs and
restructuring costs to be recognized separately from the first annual reporting
period beginning on or after December 15, 2008.  The Company continues
to evaluate the potential impact of this Interpretation on its financial
position and the results of its
operations.





Note
9 – Credit Agreements





On May
29, 2008 the Company closed a $2,500,000 securities purchase agreement with a
private investor.  Under the agreement, the Company has authorized a
series of convertible notes of the Company which are convertible into the
Company’s common stock, par value $0.0001 per share. The note bears interest of
a 360-day year with the first interest payment due August 29, 2008 and the first
principal installment due May 29, 2009.  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 Note proceeds were used for operating
purposes of the Company.  The Company incurred closing costs of
approximately $651,000 which will be amortized over the term of the
note.





One 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’s initial borrowing base was set at
$2,500,000.  The initial loan under the facility with NSES 12, LLC
closed on June 25, 2008 in the principal amount of $2.5 million, bearing
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.  Interest is to accrue starting on the day the loan is
funded, with the first interest payment due October 2008.  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 in noncompliance of loan covenants at October 31, 2008. The Company’s
working capital ratio is less than one-to-one, which is a breach of the loan
covenants.  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.




F-13


KENTUCKY
USA ENERGY, INC.
 (Formerly
Las Rocas Mining Corp.)
 (AN
EXPLORATION STAGE COMPANY)
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
 October
31, 2008


Note
10 – Derivative Liabilities, Beneficial Conversion Feature, Convertible Debt,
and Warrants





As of
October 31, 2008, the Company recognized a derivative liability of $263,425 and
convertible debt liability, net of discounts of $2,003,502, of $1,807,250
pursuant to SFAS 133 “Accounting for Derivative Instruments and Hedging
Activities” (SFAS 133) relating to a beneficial conversion feature embedded in
the Company’s debt instrument entered into on May 29, 2008.  The
related debt is a convertible 8% senior secured 36 month note dated May 29, 2008
with Institutional Investor.  Interest only is payable
quarterly.  Principle repayments due in 24 equal payments beginning
with the 1st year
anniversary.  This note is convertible into 2,500.000
shares.  The conversion feature allowed for the conversion of the
underlying debt into shares of the Company’s common Stock at a price of $1.50
per share when the market price of the Company’s stock was $2.80 per
share.  The existence of this discount is called a “beneficial
conversion feature.”





EITF
00-19 “Accounting for Derivative Financial Instruments Indexed to, and
Potentially Settled in, a Company’s Own Stock” (EITF 00-19) specifies
characteristics that financial instruments to be settled in a Company’s own
stock must satisfy in order to be accounted for as equity rather than debt under
SFAS 133.  Among other provisions, under the EITF, instruments must be
categorized as debt if, under terms of the instrument, the Company might be
required to issue a variable number of shares in satisfaction of the conversion
feature.  Provisions of the May 29 instrument
allow net settlement of the instrument upon exercise, resulting in the potential
settlement with a variable number of shares, and the settlement is based upon
the fixed cash value of the debt, known at issuance.





Accordingly
the beneficial conversion feature was recorded at its intrinsic value of $1.98
per warrant, or $3,300,026, which was expensed, the attached debt of $2,500,000
having been previously discounted to zero in connection with warrants issued in
the same transaction and discussed below.  Under provisions of SFAS
133 the valuation of the beneficial conversion feature initially recorded as a
liability is reset at each reporting period to fair value with gain or loss
recognized in income.  At October 31, 2008, the Company recognized a
gain of $4,596,769 on the revaluation of this liability to fair value, using the
Black-Scholes Formula with an expected term of approximately 2.5 years,
volatility of 60%, and a risk-free rate of interest of 4%, consistent with
valuations of warrants outstanding at October 31, 2008, as discussed
below.




F-14




KENTUCKY
USA ENERGY, INC.
 (Formerly
Las Rocas Mining Corp.)
 (AN
EXPLORATION STAGE COMPANY)
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
 October
31, 2008


The
Company recognized derivative liabilities related to detachable warrants issued
with the May 29 instrument and other debt financing in accordance with SFAS 150
“Accounting for Certain Financial Instruments with Characteristics  of
both Liabilities and Equity.”  Under that pronouncement, free-standing
instruments that may require the issuance of a variable number of equity shares
must be accounted for as a liability under circumstances similar to those
enumerated in EITF 00-19.  The detachable warrants issued with the
debt financings are remeasured at each reporting date with the resulting gain or
loss included in income of the period.





In
connection with the Company’s warrants as discussed in Note 5, the Company
incurred initial derivative liabilities totaling $6,300,037 in May,
2008.  To the extent of proceeds received these liabilities were
recorded as debt discount with any excess expensed upon
issuance.  Upon early settlement of a loan, any remaining discount is
written off.  As of October 31, 2008, the unamortized balance of loan
fees amounted to $1,005,090.  The amount on these non-cash items
charged to interest expense during the year ended October 31, 2008 was
$7,596,561, including $612,568 in amortization and $1,986,188 to write off fees
related to an early-settled loan.





Note
11 Stockholders’ Equity





The
Company has authorized capital stock of 320,000,000shares consisting
of300,000,000
shares of common stock, $0.0001 par value per share (the “Common
Stock”),  and 20,000,000 shares of preferred stock with preferences
and rights to be determined by the Board of Directors.





The
Company has 2,700,000 warrants outstanding at October 31, 2008. The following
table summarizes the changes in the company’s outstanding stock based
compensation available through warrants for the year ended October 31,
2008:





Number
      ofz StockOptions
      Available
                    
                    
                    Weighted
      AverageThrough
      Warrants
                    
                    
                    Exercise
      PriceOutstanding
      at beginning of period
                    
                    
                    -
                    
                    
                    
                    -Granted
                    
                    
                    4,700,000
                    
                    
                    
                    1.27Exercised
                    
                    
                    2,000,000
                    
                    
                    
                    1.00Cancelled/forfeited
                    
                    
                    -
                    
                    
                    
                    -Outstanding at October 31, 2008
                    
                    
                    2,700,000
                    
                    
                    
                    1.46Options
      Exercisable at October 31, 2008
                    
                    
                    2,700,000
                    
                    
                    
                    1.46




F-15




KENTUCKY
USA ENERGY, INC.
 (Formerly
Las Rocas Mining Corp.)
 (AN
EXPLORATION STAGE COMPANY)
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
 October
31, 2008




The
following table summarizes the information respecting stock options available
through warrants outstanding and exercisable at October 31, 2008:





Stock
      Options Outstanding
                        
                        
                        Stock
      Options ExercisableExercise
                          Price
                        
                        Number
                          Outstanding
                        
                        
                        Weighted
                          Average
                          Remaining
                          Life
                        
                        
                        Weighted
                          Average
                          Exercise
                          Price
                        
                        
                        Number
                          Exercisable
                        
                        
                        Weighted
                          Average
                          Remaining
                          Contractual
                          Life
                        
                        
                        Weighted
                          Average
                          Exercise
                          Price$
      1.00
                        
                        
                        200,000
                        
                        
                        
                        0.08
                        
                        
                        $
                        1.00
                        
                        
                        
                        200,000
                        
                        
                        
                        0.08
                        
                        
                        $
                        1.00$
      1.50
                        
                        
                        2,500,000
                        
                        
                        
                        3.00
                        
                        
                        $
                        1.50
                        
                        
                        
                        2,500,000
                        
                        
                        
                        3.00
                        
                        
                        $
                        1.50





The
weighted average fair value per share of options granted during 2008 was $1.34,
calculated using the Black-Scholes Option-Pricing model. No options were granted
in 2007.





Interest
expense of $128,187 related to stock warrants was recognized in
2008.





The fair
value of stock warrants is the estimated present value at grant date using the
Black-Scholes option-pricing model with the following weighted average
assumptions for 2006 and 2008: expected volatility of 60% for 2008, a risk free
interest rate of 4.00% in 2008; and an expected option life remaining from 2.5
to 5 years for 2008.





No
warrants were issued or outstanding at October 31, 2007 or for the period then
ended.





Note
12 – Subsequent Events





On
December 18, 2008, the Company issued 25,000, 350,000 and 37,500 shares of its
restricted Common Stock to three consultants, respectively, in exchange for
consulting services.





On
February 12, 2009 we were approved for the second draw of $2.5 million on our
$10 million credit facility.





Note
13 – Supplemental Natural Gas Information (Unaudited)





Information
with respect to the Company’s natural gas producing activities is presented in
the following tables.  Estimates of reserve quantities, as well as
future production and discounted cash flows before income taxes, were developed
from information provided by Glenn Robinson – Robinson Engineering and the
report of Willard F. Glover – Consulting Engineer and Geologist utilizing
information provided by management as of October 31, 2008 and October 31,
2007.




F-16




KENTUCKY
USA ENERGY, INC.
 (Formerly
Las Rocas Mining Corp.)
 (AN
EXPLORATION STAGE COMPANY)
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
 October
31, 2008


Gas
Related Costs





The
following table sets forth information concerning costs related to the Company’s
gas property acquisition, exploration and development activities in the United
States during the periods.





October31,2008
                          
                          
                          October31,2007Property
      acquisitions:Proved
                          
                          $
                          
                          
                          
                          $
                          1,719,728Unproved
                          
                          
                          -
                          
                          
                          
                          -Less
      proceeds from sales of properties
                          
                          
                          -
                          
                          
                          
                          -Development
      cost
                          
                          
                          2,076,623
                          
                          
                          
                          -Total
                          
                          $
                          2,076,623
                          
                          
                          $
                          1,719,728





Results
of Operations from Gas Producing Activities





As of
October 31, 2008 and October 31, 2007, the Company was still in an exploratory
stage and had not begun producing activities.





Natural
Gas Reserves





The
following table sets forth the Company’s net proved gas reserves at October 31,
2008 and October 31, 2007, and the changes in net proved gas reserves for the
year then ended.





Balance,
      October  5, 2007 (inception)
                    
                    Gas
      MMcfRevisions
      of previous estimates
                    
                    
                    -Purchase
      of Reserves in Place
                    
                    
                    26,657Proved
      reserves at October 31, 2007
                    
                    
                    26,657Revisions
      of previous estimates
                    
                    
                    (1,107
                    )Sales
      of Reserves in Place
                    
                    
                    -Proved
      reserves at October 31, 2008
                    
                    
                    25,550





Proved
reserves represent the quantities of natural gas which geological and
engineering data demonstrate with reasonable certainty to be recoverable in the
future years from known reservoirs under existing economic and operating
conditions.  Reserves are measured in units of one thousand cubic feet
(Mcf) or one million cubic feet (MMcf) in the case of gas.




F-17


KENTUCKY
USA ENERGY, INC.
 (Formerly
Las Rocas Mining Corp.)
 (AN
EXPLORATION STAGE COMPANY)
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
 October
31, 2008




At
October 31, 2008 1,825 thousand Mcf of gas reserves were classified as proved
developed reserves, and the balance of the proved reserves, or 23,725 thousand
Mcf of gas reserves were classified as proved undeveloped. Proved developed oil
and gas reserves are reserves that can be expected to be recovered through
existing wells with existing equipment and operating methods.





Standardized
Measure of Discounted Future Net Cash Flows





The
standardized measure of discounted future net cash flows from the Company’s
proved gas reserves is presented in the following tables:





October
      31, 2008
                    
                    
                    October
      31, 2007Amount
      in Thousands
                    
                    
                    Amount
      in ThousandsFuture
      cash inflows
                    
                    $
                    129,922
                    
                    
                    $
                    119,958Future
      production costs and taxes
                    
                    
                    (10,696
                    )
                    
                    
                    (8,769
                    )Future
      development costs
                    
                    
                    (11,550
                    )
                    
                    
                    (14,000
                    )Future
      income tax expenses
                    
                    
                    (25,842
                    )
                    
                    
                    (23,325
                    )Net
      future cash flows
                    
                    
                    81,834
                    
                    
                    
                    73,864Discount
      at 10% for timing of cash
                    
                    
                    (50,287
                    )
                    
                    
                    (29,102
                    )-Discounted
      future net cash flows from proved reserves
                    
                    $
                    31,506
                    
                    
                    $
                    44,762





Standardized
Measure of Discounted Future Net Cash Flows





Estimated
future net cash flows represent an estimate of future net revenues from the
production of proved reserves using current sales prices, along with estimates
of the operating costs, productions taxes and future development and abandonment
costs (less salvage value) necessary to produce such reserves.  The
average price used at October 31, 2008 and October 31, 2007 was $6.78 and $6.00
per MCF of gas.  No deduction has been made for depreciation,
depletion or any indirect costs such as general corporate overhead or interest
expense.





Operating
costs and production taxes are estimated based on estimated current costs with
respect to producing properties.  Future Development costs are based
on the best estimate of such costs assuming current economic and operating
conditions.




F-18


KENTUCKY
USA ENERGY, INC.
 (Formerly
Las Rocas Mining Corp.)
 (AN
EXPLORATION STAGE COMPANY)
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
 October
31, 2008




Income
tax expense is computed based on applying the appropriate statutory tax rate to
the excess of future cash inflows less future production and development costs
over the current tax basis of the properties involved.





The
future net revenue information assumes no escalation of costs or
prices.  Future costs and prices could significantly vary from current
amounts and, accordingly, revisions in the future could be
significant.





The
Properties





The
Company’s mineral rights were obtained through three farm-out assignments.
Pursuant to the assignments, as supplemented and corrected, the Company is
entitled to all working rights to, and a 75% net revenue interest in, the
hydrocarbons in the New Albany Shale (Devonian).  Under the
Assignments the Company has the right to drill wells on the properties and
extract from these wells and sell the natural gas found in the New Albany Shale
formation running through the properties.  Pursuant to the
Assignments, the Company is required to drill 12 wells per year within the
properties in order to retain its farmed-in rights.





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 are excluded from the costs
being amortized. No ceiling write-downs were recorded during the year ended
October 31, 2008 and October 31, 2007.




F-19