U.S.
SECURITIES AND EXCHANGE COMMISSION


WASHINGTON,
D.C. 20549


FORM
10-K/A




Amendment
No. 1




(Mark
One)


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


For
Fiscal Year Ended: October 31, 2009


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)
878-5987




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




Securities
registered under Section 12(g) of the Act:  Common
Stock, $0.0001 par value




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.  Yes ̈Nox




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.  x




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 5, 2010, there were 36,927,092 shares of the registrant's common stock,
par value $0.0001, issued and outstanding.  Of these, 25,883,342
shares are held by non-affiliates of the registrant.  The market value
of securities held by non-affiliates is $11,129,837, based on the closing price
of $0.43 for the registrant’s common stock on April 30, 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.





EXPLANATORY
NOTE




On
February 16, 2010, Kentucky USA Energy, Inc. (“Kentucky USA,” the
“Company,” “we,” “our” or “us”) filed its Annual Report on Form 10-K for the
year ended October 31, 2009 (the “Original Filing”), with the Securities
and Exchange Commission (the “SEC”).  This Amendment No. 1 (this
“Amendment”) on Form-10-K/A, amends and restates Part I, Item 1 (Business”),
Item 7 (Management’s Discussion and Analysis of Financial Condition and Results
of Operations) and Item 8 (Financial Statements and Supplemental
Data).




In
addition, as required by Rule 12b-15 of the Securities Exchange Act of
1934, this Form 10-K/A contains new certifications by our principal
executive officer and our principal financial and accounting officer, filed as
exhibits hereto.




Other
than as described above, no changes have been made to any Items included in the
Original Filing and this Amendment does not reflect events occurring after the
Original Filing or modify or update those disclosures affected by subsequent
events. Accordingly, this Amendment should be read in conjunction with the
Company’s other filings made with the SEC subsequent to the filing of the
Original Filing.


2


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”).


3


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.  As part of an agreement on a $10,000,000 credit
facility to develop this leasehold (discussed below), we have pledged a 6%
overriding royalty interest to NSES 12, LLC.  As a result, our working
interest in this leasehold has been reduced to a net 69% working
interest.


4





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.




Our
Properties




On
October 4, 2007, KY USA entered into three Farm-Out Assignment Agreements,
subsequently supplemented and corrected (the “K&D 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
“K&D Leasehold” or the “K&D Properties”) targeting the New Albany
Shale.  Pursuant to the K&D 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 K&D
Leasehold.  These K&D Assignments give us the right to drill wells
on the K&D Properties and extract from these wells and sell the natural gas
found in or below the New Albany Shale formation running through the K&D
Properties.  Pursuant to the K&D Assignments, KY USA is required
to drill 12 wells per year within the K&D Properties to maintain its rights
under the K&D Assignments.  We expect to meet this drilling
requirement.  We have identified approximately 40-50 drilling
locations on the K&D 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 K&D
Leasehold and that we propose to drill is attached hereto as Exhibit 99.1 and is
incorporated into this report by reference.








1. The
Company had initially reported that its K&D 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.





5





Thomasson
Farm-Out and 7921 Energy Joint Venture





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





KY USA
recently entered into a joint venture (“JV”) agreement with 7921 Energy LLC
(“7921”) to develop natural gas and oil prospects in, above and below the New
Albany Shale formation on the TPE acreage. The wells to be drilled under the JV
agreement will utilize our field gathering system that has been connected to the
Olive Grove Treatment Facility.  Under the terms of the JV agreement,
7921 will have the right to participate with KY USA in drilling and developing
up to 40 wells on the newly acquired TPE farm-out acreage. Phase 1 under this JV
agreement will consist of drilling and completing ten (10) wells. Under the
terms of the JV, 7921 will earn a 50% working interest in each of the first ten
wells, which translates to a 37.5% net revenue interest (assuming each well is
funded by 7921 and drilled to completion), in exchange for providing KY USA with
$1,675,000 in working capital to drill and complete the Phase 1
wells.  7921 will also retain the option to participate with KY USA in
the drilling of the up to 30 additional wells on the TPE
acreage.


6





Thomasson
- Hardison Lease Farm-Out





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





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





Proved
Reserves




Our net
recoverable “proved developed producing reserves2” as of
October 31, 2009, as determined by Robinson Engineering & Oil Company, Inc.,
an independent petroleum engineering firm (“Robinson Engineering”), in a report
to us dated January 26, 2010, 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 January 26, 2010 estimates are the same as
reported to us by Robinson Engineering on February 26, 2009, but 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, 2009 (reflecting
our 69%4 net
revenue interest) over a 20 year production period totaled $20,153,808,
discounted at 10% per year.  These calculations assume, among other
things, a price of $5.04 per thousand cubic feet of gas (“Mcf”), the NYMEX (New
York Mercantile Exchange) market price as of October 31, 2009, a Kentucky State
severance tax of 5% and 70 producing wells on the K&D
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, 2009.





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.


4. 
Net of the 6% override we are required to pay the Lender under the Credit
Agreement (defined below).


7





The
K&D Leasehold is directly adjacent to third party 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 K&D Properties.  Although there are
operating oil wells on the K&D Properties, we do not have any rights to the
oil under the K&D 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.





Well
Development Status




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




We have
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 January 19,
2010.





Well Name
                        Drilling Order
                      
                      Spudded
                      
                      TD
                      
                      Logged
                      
                      Casing
                      
                      Cement
                      
                      Perf’ed
                      
                      Frac’ed
                      
                      4Pt
                        Test
                      
                      CR51.
                      
                      Francis Grace # 1
                      
                      X
                      
                      2626’
                      
                      X
                      
                      X
                      
                      X
                      
                      X
                      
                      X
                      
                      X
                      
                      X2.
                      
                      Hunter Wells # 3
                      
                      X
                      
                      2509’
                      
                      X
                      
                      X
                      
                      X
                      
                      X
                      
                      X
                      
                      X3.
                      
                      Hunter Wells # 2
                      
                      X
                      
                      2340’
                      
                      X
                      
                      X
                      
                      X64.
                      
                      B. Johnston # 1
                      
                      X
                      
                      2387’
                      
                      X
                      
                      X
                      
                      X
                      
                      X
                      
                      X
                      
                      X
                      
                      X5.
                      
                      Slinker # 1B
                      
                      X
                      
                      2340’
                      
                      X
                      
                      X
                      
                      X
                      
                      X
                      
                      X
                      
                      X
                      
                      X6.
                      
                      Walker #1
                      
                      X
                      
                      2430’
                      
                      X
                      
                      X
                      
                      X
                      
                      X
                      
                      X
                      
                      X
                      
                      X7.
                      
                      Hunter Wells #1
                      
                      X
                      
                      2431’
                      
                      X
                      
                      X
                      
                      X
                      
                      X
                      
                      X
                      
                      X
                      
                      X8.
                      
                      Francis Grace #2
                      
                      X
                      
                      2395’
                      
                      X
                      
                      X
                      
                      X
                      
                      X
                      
                      X
                      
                      X
                      
                      X9.
                      
                      J Johnston #27
                      
                      X
                      
                      3011’
                      
                      X
                      
                      X
                      
                      X
                      
                      X
                      
                      X
                      
                      X
                      
                      X10.
                      
                      Francis Grace #3
                      
                      X
                      
                      2578’
                      
                      X
                      
                      X
                      
                      X
                      
                      X
                      
                      X
                      
                      X
                      
                      X11.
                      
                      Golden Eagle #1
                      
                      X
                      
                      2760’
                      
                      X
                      
                      X
                      
                      X
                      
                      X
                      
                      X
                      
                      X
                      
                      X12.
                      
                      Hunter Wells #4
                      
                      X
                      
                      2721’
                      
                      X
                      
                      X
                      
                      X
                      
                      X
                      
                      X
                      
                      X13.
                      
                      J Johnston #4
                      
                      X
                      
                      2500’
                      
                      X
                      
                      X
                      
                      X
                      
                      X
                      
                      X
                      
                      X
                      
                      X14.
                      
                      B. Johnston #2
                      
                      X
                      
                      2640’
                      
                      X
                      
                      X
                      
                      X
                      
                      X
                      
                      X
                      
                      X
                      
                      X15.
                      
                      Slinker #2
                      
                      X
                      
                      2618’
                      
                      X
                      
                      X
                      
                      X
                      
                      X
                      
                      X








5.
            Indicates
      that Completion Report has been completed and submitted to the state oil
      and gas authority.


6.
            This
      well needs to be re-cemented prior to perfing and
  fracing.


7.
            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.


8





Well Name
                  Drilling Order
                
                Spudded
                
                TD
                
                Logged
                
                Casing
                
                Cement
                
                Perf’ed
                
                Frac’ed
                
                4Pt
                  Test
                
                CR516.
                
                Jackson #1
                
                X
                
                2664’
                
                X17.
                
                Swinney #1
                
                X
                
                3460’
                
                X





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




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




The
Sale of our Natural Gas





On
October 19, 20098, we
entered into a base contract for the purchase and sale of natural gas (the “Base
Contract”) with Seminole Energy Services, L.L.C. (“Seminole”), one of the
largest natural gas distributors in the Oklahoma, Kansas and Texas panhandle
region.  Pursuant to the terms of the Base Contract, Seminole has
agreed to purchase from us up to a maximum of 2,500 MMBtus (million British
thermal units) per day out of the production of gas from our wells on our
leasehold properties located in the western Kentucky region.





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




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


9


Seminole
will pay us the Gas Daily Texas Zone SL daily midpoint spot price for the
gas that it purchases from us.  We and Seminole have agreed to net any
payments due us under the Base Contract against fees due Seminole under that
certain Gas Gathering & Treatment Agreement between the Company and Seminole
(and its related parties) dated August 6, 20099.





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





The sale
of our gas to Seminole since our tie-in to the Seminole gathering and processing
facility has been minimal, however, and the flow of our gas into the Seminole
facility has been intermittent, due to a bottleneck at the Seminole facility
created as a result of the increased gas volume flowing from our wells into the
facility. Because of the potential increased sales volume expected from our
wells, Seminole has been adding new equipment to its facilities to increase
efficiencies and improve Seminole’s ability to accept our natural gas into its
facility. Once the Seminole facility upgrade is complete, we will work with
Seminole to balance the system and maximize our production and delivery of our
gas to the facility. We expect to increase the rate of its production and
delivery of our gas over the several weeks following completion of the facility
upgrade.





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.




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.







9 
As more fully discussed in our Form 8-K filed with the SEC on August 17,
2009.


10


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 exploration 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.




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.




11




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.




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.




12




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 K&D 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.




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.




13




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 K&D 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 estimated to be on our current K&D Properties.




Exploitation
of K&D Properties




We intend
to maximize the value of the K&D 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.




14




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.


15




PART
II





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.




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, 2009 compared to 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, 2009, we incurred such total capitalized costs of $3,999,725, compared to
$3,051,737 for the year ended October 31, 2008.




We
incurred general and administrative expenses of $195,715 for the year ended
October 31, 2009, compared to $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, 2009 totaled $364,396, compared to
$145,115 for the year ended October 31, 2008.  These costs are related
to the Note and the Loan (defined below).




We
incurred legal and accounting expenses of $192,141 for the year ended October
31, 2009, compared to $676,217 for the year ended October 31, 2008. These
expenses consisted of costs incurred in connection with our recent financing
activities and SEC filing requirements.  Also included in this number
for the year ended October 31, 2009 is $894,930 in expenses reflecting the
dollar value of shares of our Common Stock issued to consultants.




16




Our
interest expense for the year ended October 31, 2009, was $159,544, compared to
$7,094,735 for the year ended October 31, 2008.  This cost is
attributable to interest due and paid on the Note and on the Loan. During the
year ended October 31, 2009, we recognized a net gain on a derivative liability
relating to the Note in the amount of $558,206 compared to $4,596,769 for the
year ended October 31, 2008, due to a partial settlement and revaluation of the
derivative liability to market at October 31, 2009 and 2008,
respectively.





Our net
operating loss from inception through October 31, 2009 was
$4,922,556.




Liquidity
and Capital Resources





Our cash
and cash equivalents balance as of October 31, 2009 was $59,105.




As a
result of the Merger which closed on May 2, 2008 and our work program begun
at that time, we expect significant expenditures during the next 12
months.  Pursuant to the terms of the K&D Assignments, KY USA is
required to drill 12 wells per year within the K&D 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.  Additionally, we are
required to drill 10 wells in the first year under the TPE farm-out
agreement.  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.  In addition to the $2,500,000 Initial Loan, we have
received additional Installment Loans under the Credit Facility on February 12,
2009, August 14, 2009 and December 11, 2009 totaling in the aggregate an
additional $4,300,000.  We plan to use the balance of these funds to
bring our presently drilled wells online and to begin our program to drill an
additional 10 to 12 wells on our K&D Leasehold.  With respect to
the drilling requirements under the TPE farm-out agreement, we have entered into
a JV agreement with 7921 under which 7921 will provide working capital to be
used to drill the TPE leasehold wells.  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, $3,150,000.  Also, we cannot be sure that our JV with
7921 will proceed and that 7921 will provide the funds they have agreed to
contribute.  If we do not receive any subsequent Installment Loans
under the Credit Facility or 7921 does not provide its promised funds, 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 K&D Leasehold or TPE
leasehold wells, we will lose all or part of our rights to the K&D Leasehold
and the TPE leasehold, respectively. The loss of the K&D Leasehold or the
TPE 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 K&D 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.




17




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.  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.





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 net proceeds of this
financing to begin drilling our initial wells, to repay certain outstanding
indebtedness and for general working capital purposes.  On May 29,
2009, with the consent of the Note Investor, we amended the Note to extend the
initial installment payment date of the Note to May 29, 2010.





Credit
Facility





On June
27, 2008, KY USA entered into the Credit Agreement with the Lender pursuant to
which KY USA has borrowed $6,850,000 to date.





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 ratio covenant
contained in the Credit Agreement constitutes an event of default under the
Credit Agreement. The breach would permit the Lender under the Credit Agreement
to declare all amounts borrowed thereunder to be immediately due and
payable.  Although the Lender has informed us that it will not take
any actions against us with respect to this breach, we may request from the
Lender a waiver of this current ratio covenant.  If we do request such
a written waiver, we cannot assure you that we will be successful in obtaining
it.  Additionally, even if we
obtain a written 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.




18




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 K&D 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.





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.


19


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.





Recent
Accounting Pronouncements





On
December 31, 2008, the SEC published the final rules and interpretations
updating its oil and gas reporting requirements. Many of the revisions are
updates to definitions in the existing oil and gas rules to make them consistent
with the petroleum resource management system, which is a widely accepted
standard for the management of petroleum resources that was developed by several
industry organizations. Key revisions include changes to the pricing used to
estimate reserves utilizing a 12-month average price rather than a single day
spot price which eliminates the ability to utilize subsequent prices to the end
of a reporting period when the full cost ceiling was exceeded and subsequent
pricing exceeds pricing at the end of a reporting period, the ability to include
nontraditional resources in reserves, the use of new technology for determining
reserves, and permitting disclosure of probable and possible reserves. The SEC
will require companies to comply with the amended disclosure requirements for
registration statements filed after January 1, 2010, and for annual reports on
Form 10-K for fiscal years ending on or after December 15, 2009. Early adoption
is not permitted. The Company is currently assessing the impact that the
adoption will have on the Company’s disclosures, operating results, financial
position and cash flows.





In June
2009, the FASB issued guidance now codified as ASC 105,Generally Accepted Accounting
Principles as the single source of authoritative accounting principles
recognized by the FASB to be applied by nongovernmental entities in the
preparation of financial statements in conformity with U.S. GAAP, aside from
those issued by the SEC.








ASC 105
does not change current U.S. GAAP, but is intended to simplify user access to
all authoritative U.S. GAAP by providing all authoritative literature related to
a particular topic in one place. The adoption of ASC 105 did not have a material
impact on our company’s consolidated financial statements, but did eliminate all
references to pre-codification standards.





In May
2009, FASB issued ASC 855,Subsequent Events which establishes general standards of for the
evaluation, recognition and disclosure of events and transactions that occur
after the balance sheet date. Although there is new terminology, the standard is
based on the same principles as those that currently exist in the auditing
standards. The standard, which includes a new required disclosure of the date
through which an entity has evaluated subsequent events, is effective for
interim or annual periods ending after June 15, 2009. The adoption of ASC 855
did not have a material effect on our company’s consolidated financial
statements. The Company has a evaluated subsequent events through the date of
the issuance of the financials. An additional borrowing of $1.2M on the NSES
credit facility occurred after the balance sheet date and before the date of
issuance.




20




Our
company has implemented all new accounting pronouncements that are in effect and
that may impact our financial statements and we do not believe that there are
any other new accounting pronouncements that have been issued that might have a
material impact on our financial position or results of 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





21


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:  May
      1, 2010
              By:
              /s/ Steven D. EversoleSteven
      D. Eversole, President andChief
      Executive Officer


22




REPORT OF
INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
  To the
Board of Directors and
 Stockholders
of Kentucky USA Energy, Inc.
  We have
audited the accompanying balance sheets of Kentucky USA Energy, Inc. (an
exploration stage company) as of October 31, 2009 and 2008, and the related
statements of operations, stockholders’ equity, and cash flows for each of the
years in the two year period ended October 31 2009 and for the period from
inception (October 5, 2007) to October 31, 2009. The management of Kentucky USA
Energy, Inc. is responsible for these financial statements. 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. The company is not required to
have, nor were we engaged to perform, an audit of its internal control over
financial reporting. Our audit included consideration of internal control over
financial reporting as a basis for designing audit procedures that are
appropriate in the circumstances, but not for the purpose of expressing an
opinion on the effectiveness of the company’s internal control over financial
reporting. Accordingly, we express no such opinion. An audit also includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements, 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. as of
October 31, 2009 and 2008, and the results of its operations and its cash flows
for each of the years in the two-year period ended October 31, 2009 and for the
period from inception (October 5, 2007) to October 31, 2009 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 2 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.
Additionally, the Company is behind schedule on progress specified in its
K&D farm-out agreement, which could trigger forfeiture of its rights under
the farm-out agreement. 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 2. The financial statements do not
include any adjustments that might result from the outcome of this
uncertainty.
  Rodefer
Moss & Co, PLLC
 
 Knoxville,
Tennessee
 February
16, 2010
 F-1


KENTUCKY
USA ENERGY, INC.


(Formerly
Las Rocas Mining Corp.)


(AN
EXPLORATION STAGE COMPANY)


Consolidated
Balance Sheets





October 31, 2009
                          
                          
                          October 31, 2008ASSETSCurrent
      AssetsCash
      and cash equivalents
                          
                          $
                          59,105
                          
                          
                          $
                          899,037Prepaid
      expenses
                          
                          
                          37,006
                          
                          
                          
                          15,613Total
      current assets
                          
                          
                          96,111
                          
                          
                          
                          914,650Other
      AssetsLoan
      fees, net of accumulated amortization of $509,511 and
    $145,115
                          
                          
                          640,694
                          
                          
                          
                          1,005,090Investment
      in natural gas properties, using full cost method
                          
                          
                          7,708,811
                          
                          
                          
                          3,796,351Total
      other assets
                          
                          
                          8,349,505
                          
                          
                          
                          4,801,441Other
      property and equipment, net of accumulated depreciationof
      $42,258 and $7,830
                          
                          
                          450,650
                          
                          
                          
                          306,366Total
      assets
                          
                          $
                          8,896,266
                          
                          
                          $
                          6,022,457LIABILITIES
      AND STOCKHOLDERS' EQUITY (DEFICIT)Current
      LiabilitiesAccounts
      payable
                          
                          $
                          343,890
                          
                          
                          $
                          188,225Accrued
      interest
                          
                          
                          522,303
                          
                          
                          
                          81,928Accrued
      liabilities
                          
                          
                          7,763
                          
                          
                          
                          -Stock
      liability
                          
                          
                          149,125
                          
                          
                          
                          188,600Derivative
      liability
                          
                          
                          1,015,971
                          
                          
                          
                          1,723,453Notes
      payable, due within one year
                          
                          
                          6,300,000
                          
                          
                          
                          3,150,000Capital
      lease obligations, due within one year
                          
                          
                          94,847
                          
                          
                          
                          83,268Total
      current liabilities
                          
                          
                          8,433,899
                          
                          
                          
                          5,415,474Long-term
      DebtConvertible
      debt, net of discounts of $1,527,780 and $2,152,778
                          
                          
                          972,220
                          
                          
                          
                          347,222Capital
      lease obligations, less amounts due within one year
                          
                          
                          110,083
                          
                          
                          
                          202,169Total
      long-term debt
                          
                          
                          1,082,303
                          
                          
                          
                          549,391Total
      liabilities
                          
                          
                          9,516,202
                          
                          
                          
                          5,964,865Stockholders'
      Equity (Deficit)Preferred
      stock (20,000,000 shares authorized, none issued)Common
      stock, ($0.0001 par value; 300,000,000 shares authorized;36,927,092
      and 36,194,592 shares issued and outstanding)
                          
                          
                          3,692
                          
                          
                          
                          3,619Additional
      paid-in capital
                          
                          
                          4,298,928
                          
                          
                          
                          3,427,498Deficit
      accumulated during exploration stage
                          
                          
                          (4,922,556
                          )
                          
                          
                          (3,373,525
                          )Total
      stockholders' equity (deficit)
                          
                          
                          (619,936
                          )
                          
                          
                          57,592Total
      liabilities and stockholders' equity
                          
                          $
                          8,896,266
                          
                          
                          $
                          6,022,457





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
                  
                  
                  Year
      Ended
                  
                  
                  October
      5, 2007, throughOctober 31, 2009
                  
                  
                  October 31, 2008
                  
                  
                  October 31, 2009General
      and Administrative ExpensesAmortization
      of loan fees
                  
                  $
                  364,396
                  
                  
                  $
                  145,115
                  
                  
                  $
                  509,511General
      and administrative
                  
                  
                  195,715
                  
                  
                  
                  46,527
                  
                  
                  
                  242,242Compensation
      expense (including  $895,728 of share-based
      compensation)
                  
                  
                  1,195,441
                  
                  
                  
                  -
                  
                  
                  
                  1,195,441Legal
      and accounting
                  
                  
                  192,141
                  
                  
                  
                  676,217
                  
                  
                  
                  870,358Loss
      from operations
                  
                  
                  (1,947,693
                  )
                  
                  
                  (867,859
                  )
                  
                  
                  (2,817,552
                  )Other
      Income (expense)Changes
      in fair value of derivative liability
                  
                  
                  558,206
                  
                  
                  
                  4,596,769
                  
                  
                  
                  5,154,975Interest
      expense
                  
                  
                  (159,544
                  )
                  
                  
                  (7,094,735
                  )
                  
                  
                  (7,259,979
                  )Loss
      before income taxes
                  
                  
                  (1,549,031
                  )
                  
                  
                  (3,365,825
                  )
                  
                  
                  (4,922,556
                  )Income
      taxes
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -Net
      loss
                  
                  $
                  (1,549,031
                  )
                  
                  $
                  (3,365,825
                  )
                  
                  $
                  (4,922,556
                  )Net
      income per shareBasic
      and diluted:Operations
                  
                  $
                  (0.04
                  )
                  
                  $
                  (0.12
                  )
                  
                  $
                  (0.13
                  )Total
                  
                  $
                  (0.04
                  )
                  
                  $
                  (0.12
                  )
                  
                  $
                  (0.13
                  )





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)







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 services on October 5, 2007 at $0.0001 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 connection with
      recapitalization as a cost of the transaction
                                    
                                    
                                    -
                                    
                                    
                                    
                                    -
                                    
                                    
                                    
                                    (8,500,000
                                    )
                                    
                                    
                                    -
                                    
                                    
                                    
                                    (8,500,000
                                    )May
      2008 issuance of 5,000,000 shares in connection with services 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
                                    )
                                    
                                    
                                    57,592December
      2008 issuance of 412,500 shares in connection with services
      provided
                                    
                                    
                                    412,500
                                    
                                    
                                    
                                    41
                                    
                                    
                                    
                                    562,312
                                    
                                    
                                    
                                    -
                                    
                                    
                                    
                                    562,353June
      2009 issuance of 320,000 shares in connection with services
      provided
                                    
                                    
                                    320,000
                                    
                                    
                                    
                                    32
                                    
                                    
                                    
                                    309,118
                                    
                                    
                                    
                                    -
                                    
                                    
                                    
                                    309,150Net
      loss for the year
                                    
                                    
                                    -
                                    
                                    
                                    
                                    -
                                    
                                    
                                    
                                    -
                                    
                                    
                                    
                                    (1,549,031
                                    )
                                    
                                    
                                    (1,549,031
                                    )Balance
      at October 31, 2009
                                    
                                    
                                    36,927,092
                                    
                                    
                                    $
                                    3,692
                                    
                                    
                                    $
                                    4,298,928
                                    
                                    
                                    $
                                    (4,922,556
                                    )
                                    
                                    $
                                    (619,936
                                    )





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





From InceptionYear Ended
                          
                          
                          Year Ended
                          
                          
                          October 5, 2007 throughOctober 31, 2009
                          
                          
                          October 31, 2008
                          
                          
                          October 31, 2009Net
      loss
                          
                          $
                          (1,549,031
                          )
                          
                          $
                          (3,365,825
                          )
                          
                          $
                          (4,922,556
                          )Adjustments
      to reconcile net loss to net cashflows
      from operating activitiesGains
      on market valuation of derivative liabilities
                          
                          
                          (558,206
                          )
                          
                          
                          (4,596,769
                          )
                          
                          
                          (5,154,975
                          )Derivative
      valuation adjustments charged to expense
                          
                          
                          421,883
                          
                          
                          
                          6,851,947
                          
                          
                          
                          7,273,830Amortization
      of loan fees
                          
                          
                          364,396
                          
                          
                          
                          145,115
                          
                          
                          
                          509,511Depreciation
                          
                          
                          34,428
                          
                          
                          
                          7,830
                          
                          
                          
                          42,258Common
      stock issued for services
                          
                          
                          871,503
                          
                          
                          
                          -
                          
                          
                          
                          873,503(Increase)
      in assets and increase in liabilitiesPrepaid
      expenses
                          
                          
                          (21,391
                          )
                          
                          
                          34,425
                          
                          
                          
                          13,034Accounts
      payable and accrued liabilities
                          
                          
                          163,428
                          
                          
                          
                          188,225
                          
                          
                          
                          351,653Stock
      liability
                          
                          
                          (39,475
                          )
                          
                          
                          188,600
                          
                          
                          
                          149,125Accrued
      interest
                          
                          
                          440,375
                          
                          
                          
                          76,229
                          
                          
                          
                          522,304Total
      adjustments to reconcile net loss to net cashfrom operating
      activities
                          
                          
                          1,676,941
                          
                          
                          
                          2,895,602
                          
                          
                          
                          4,580,243Net
      cash flows from operating activities
                          
                          
                          127,910
                          
                          
                          
                          (470,223
                          )
                          
                          
                          (342,313
                          )Cash
      flows from investing activitiesPurchase
      of other property and equipment
                          
                          
                          (178,712
                          )
                          
                          
                          (314,195
                          )
                          
                          
                          (492,907
                          )Retainers
      paid to legal counsel
                          
                          
                          -
                          
                          
                          
                          -
                          
                          
                          
                          (50,040
                          )Investment
      in oil & gas properties
                          
                          
                          (3,858,622
                          )
                          
                          
                          (1,332,009
                          )
                          
                          
                          (6,910,359
                          )Total
      cash flows from investing activities
                          
                          
                          (4,037,334
                          )
                          
                          
                          (1,646,204
                          )
                          
                          
                          (7,453,306
                          )Cash
      flows from financing activitiesProceeds
      from borrowings
                          
                          
                          3,150,000
                          
                          
                          
                          5,100,000
                          
                          
                          
                          10,050,000Proceeds
      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
                          
                          
                          (80,508
                          )
                          
                          
                          (21,957
                          )
                          
                          
                          (102,465
                          )Total
      cash flows from financing activities
                          
                          
                          3,069,492
                          
                          
                          
                          2,985,232
                          
                          
                          
                          7,854,724Net
      change in cash
                          
                          
                          (839,932
                          )
                          
                          
                          868,805
                          
                          
                          
                          59,105Cash
      and cash equivalents, beginning of period
                          
                          
                          899,037
                          
                          
                          
                          30,232
                          
                          
                          
                          -Cash
      and cash equivalents, end of period
                          
                          $
                          59,105
                          
                          
                          $
                          899,037
                          
                          
                          $
                          59,105Supplemental
      Disclosures of Cash Flow informationCash
      paid for interest
                          
                          $
                          369,167
                          
                          
                          $
                          181,812
                          
                          
                          $
                          550,979





For the
year ended October 31, 2008, the Company entered in the following non-cash
transactions:


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 in settlement of warrants
booked as derivative liabilities.





For the
year ended October 31, 2009, the Company entered in the following non-cash
transaction:


Common
stock was issued in the amount of $871,503 for services provided to the
Company.




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


F-5


KENTUCKY
USA ENERGY


(Formerly
Las Rocas Mining Corp.)


(AN
EXPLORATION STAGE COMPANY)


NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS


October
31, 2009





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 almost 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 $5.65 million
listed as due on our balance sheet at October 31, 2009, (Note 9) 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, 2010.





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, 2009.





Certain
amounts in prior periods have been reclassified to conform to the report
classifications of the year ended October 31, 2009 with no effect on previously
reported net income or stockholders’ equity.





Note
2 – Going Concern





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


F-6


KENTUCKY
USA ENERGY


(Formerly
Las Rocas Mining Corp.)


(AN
EXPLORATION STAGE COMPANY)


NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS


October
31, 2009





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





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  at October 31, 2009 and 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 is
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.


F-7


KENTUCKY
USA ENERGY


(Formerly
Las Rocas Mining Corp.)


(AN
EXPLORATION STAGE COMPANY)


NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS


October
31, 2009





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”), which was primarily codified into Topic 260,
basic income per share is based on 36,927,092 and 36,194,592 weighted average
shares outstanding for the years ended October 31, 2009 and October 31,
2008.  Because the Company recorded a loss at October 31, 2009 and
2008, all potentially dilutive securities are anti-dilutive.





Income
Taxes





Provisions
for income taxes are based on taxes payable or refundable for the current year
(after exclusion of non-taxable income) and deferred taxes on temporary
differences between the amount of taxable and pretax income and between the tax
bases of assets and liabilities and their reported amounts in the financial
statements.  Deferred tax assets and liabilities are reflected in the
financial statements at income tax rates applicable to the period in which the
deferred tax assets or liabilities are expected to be realized or settled as
prescribed in ASC 740, Income Taxes.  As changes in tax laws or rates are
enacted, deferred tax assets and liabilities are adjusted through the provision
for income taxes.





All of
the Company’s tax years since inception are open to IRS
examination.


F-8


KENTUCKY
USA ENERGY


(Formerly
Las Rocas Mining Corp.)


(AN
EXPLORATION STAGE COMPANY)


NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS


October
31, 2009





Note
4 – Other Property and Equipment





Other
property and equipment consisted of the following:





Depreciable
                                      Life
                                    
                                    October 31,
                                      2009
                                    
                                    
                                    October 31,
                                      2008Machinery
      and Equipment
                                    
                                    10-20
      yrs
                                    
                                    $
                                    492,908
                                    
                                    
                                    $
                                    314,196Total
                                    
                                    
                                    
                                    
                                    492,908
                                    
                                    
                                    
                                    314,196Less
      accumulated depreciation
                                    
                                    
                                    
                                    
                                    (42,258
                                    )
                                    
                                    
                                    (7,830
                                    )Other
      property and Equipment - net
                                    
                                    
                                    
                                    $
                                    450,650
                                    
                                    
                                    $
                                    306,366





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





Note
5 – Notes Payable and Convertible Debt





The
Company had the following debt obligations:


October 31,
                      2009
                    
                    
                    October 31,
                      2008Non-interest
      bearing note payable to K & 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
                    
                    
                    $
                    650,000Note
      payable to Tillerman Securities. Secured by oil and gas properties,
      bearing interest at 8%, interest due quarterly. See Note
9.
                    
                    
                    2,500,000
                    
                    
                    
                    2,500,000NSES
      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 & Principal paid full in 3 years
                    
                    
                    5,650,000
                    
                    
                    
                    2,500,000$
                    8,800,000
                    
                    
                    $
                    5,650,000




F-9


KENTUCKY
USA ENERGY


(Formerly
Las Rocas Mining Corp.)


(AN
EXPLORATION STAGE COMPANY)


NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS


October
31, 2009




Maturities
under note obligations at October 31, 2009 and 2008 were:


2009
                              
                              
                              2008Year
      ending October 31:2010
                              
                              $
                              6,300,000
                              
                              
                              $
                              3,150,0002011
                              
                              
                              2,500,000
                              
                              
                              
                              2,500,000Total
      maturities of long-term debt
                              
                              
                              8,800,000
                              
                              
                              
                              5,650,000Less
      current maturities
                              
                              
                              6,300,000
                              
                              
                              
                              3,150,000Long-term
      notes payable
                              
                              $
                              2,500,000
                              
                              
                              $
                              2,500,000





The
convertible Tillerman note is included on the balance sheets, net of discount,
as follows:





2009
                        
                        
                        2008Face
      amount of note
                        
                        $
                        2,500,000
                        
                        
                        $
                        2,500,000Discount
                        
                        
                        (1,527,780
                        )
                        
                        
                        (2,152,778
                        )$
                        972,220
                        
                        
                        $
                        347,222





The
balance owed to NSES represents drawdowns 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, 2010. For a
further discussion of this arrangement, see Note 9.





The
Company’s investment in natural gas properties reflects capitalized interest of
$1,997,416 and $744,614 related to its debt obligations for October 31, 2009 and
2008, respectively.





Note
6 – Capital Lease





On August
4, 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 the Company to make forty-two
monthly installments, beginning on August 4, 2008.  At the conclusion
of the lease, the Company will have available a bargain purchase option for the
equipment which at October 31, 2009 has a carrying value of
$204,910.


F-10


KENTUCKY
USA ENERGY


(Formerly
Las Rocas Mining Corp.)


(AN
EXPLORATION STAGE COMPANY)


NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS


October
31, 2009





Year
      ending October 31:2010
                  
                  $
                  94,8272011
                  
                  
                  94,8272012
                  
                  
                  15,256Total
      gross minimum lease payments
                  
                  
                  204,910Less
      current installments of obligations
                  
                  
                  94,827Long-term
      capital lease due
                  
                  $
                  110,083





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 years ended October 31, 2009 and 2008 are
comprised as follows:





2009
                  
                  
                  2008Currently
      payable
                  
                  $
                  -
                  
                  
                  $
                  -Deferred
      federal tax benefit (expense)
                  
                  
                  337,000
                  
                  
                  
                  147,000Deferred
      state tax benefit (expense)
                  
                  
                  42,000
                  
                  
                  
                  29,000Valuation
      adjustment
                  
                  
                  (379,000
                  )
                  
                  
                  (176,000
                  )$
                  -
                  
                  
                  $
                  -




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:




F-11




KENTUCKY
USA ENERGY


(Formerly
Las Rocas Mining Corp.)


(AN
EXPLORATION STAGE COMPANY)


NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS


October
31, 2009





October 31, 2009
                      
                      
                      October 31, 2008Reconciliation
      between statutory and effective tax ratesExpected
      benefit at federal statutory rates
                      
                      $
                      527,000
                      
                      
                      $
                      1,144,000Effect
      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
                      
                      
                      190,000
                      
                      
                      
                      1,563,000Temporary
      difference – capitalization of interest
                      
                      
                      
                      
                      
                      
                      (67,000
                      )State
      income taxes
                      
                      
                      42,000
                      
                      
                      
                      29,000Effect
      of expected lower applicable rates
                      
                      
                      (380,000
                      )
                      
                      
                      (169,000
                      )379,000
                      
                      
                      
                      176,000Valuation
      allowance
                      
                      
                      (379,000
                      )
                      
                      
                      (176,000
                      )Income
      tax provision
                      
                      $
                      -
                      
                      
                      $
                      -





The
Company recorded valuation allowances of $379,000 and $176,000 at October 31,
2009 and October 31, 2008, 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 are as follows:





October 31, 2009
                  
                  
                  October 31, 2008Net
      operating loss carryforwards
                  
                  $
                  379,000
                  
                  
                  $
                  223,000Temporary
      difference:Capitalized interest
                  
                  
                  -
                  
                  
                  
                  (47,000
                  )$
                  379,000
                  
                  
                  $
                  176,000




F-12


KENTUCKY
USA ENERGY


(Formerly
Las Rocas Mining Corp.)


(AN
EXPLORATION STAGE COMPANY)


NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS


October
31, 2009





Note
8 – Recent Accounting Pronouncements





On
December 31, 2008, the SEC published the final rules and interpretations
updating its oil and gas reporting requirements. Many of the revisions are
updates to definitions in the existing oil and gas rules to make them consistent
with the petroleum resource management system, which is a widely accepted
standard for the management of petroleum resources that was developed by several
industry organizations. Key revisions include changes to the pricing used to
estimate reserves utilizing a 12-month average price rather than a single day
spot price which eliminates the ability to utilize subsequent prices to the end
of a reporting period when the full cost ceiling was exceeded and subsequent
pricing exceeds pricing at the end of a reporting period, the ability to include
nontraditional resources in reserves, the use of new technology for determining
reserves, and permitting disclosure of probable and possible reserves. The SEC
will require companies to comply with the amended disclosure requirements for
registration statements filed after January 1, 2010, and for annual reports on
Form 10-K for fiscal years ending on or after December 15, 2009. Early adoption
is not permitted. The Company is currently assessing the impact that the
adoption will have on the Company’s disclosures, operating results, financial
position and cash flows.





In June
2009, the FASB issued guidance now codified as ASC 105,Generally Accepted Accounting
Principles as the single source of authoritative accounting principles
recognized by the FASB to be applied by nongovernmental entities in the
preparation of financial statements in conformity with U.S. GAAP, aside from
those issued by the SEC.


ASC 105
does not change current U.S. GAAP, but is intended to simplify user access to
all authoritative U.S. GAAP by providing all authoritative literature related to
a particular topic in one place. The adoption of ASC 105 did not have a material
impact on our company’s consolidated financial statements, but did eliminate all
references to pre-codification standards.




In May
2009, FASB issued ASC 855,Subsequent Events which establishes general standards of for the
evaluation, recognition and disclosure of events and transactions that occur
after the balance sheet date. Although there is no new terminology, the standard
is based on the same principles as those that currently exist in the auditing
standards. The standard, which includes a new required disclosure of the date
through which an entity has evaluated subsequent events, is effective for
interim or annual periods ending after June 15, 2009. The adoption of ASC 855
did not have a material effect on our company’s consolidated financial
statements. The Company has evaluated subsequent events through the date of the
issuance of the financials. An additional borrowing of $1.2M on the NSES credit
facility occurred after the balance sheet date and before the date of issuance.
On February 24, 2010, Accounting Standards Update (“ASU”) 2010-09, amended ASC
855. While an SEC filer is still required by GAAP to evaluate subsequent events
through the date its financial statements are issued, it is no longer required
to disclose in the financial statements that it has done so or the date through
which subsequent events have been evaluated.


F-13


KENTUCKY
USA ENERGY


(Formerly
Las Rocas Mining Corp.)


(AN
EXPLORATION STAGE COMPANY)


NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS


October
31, 2009





In April
2008, the FASB issued EITF 07-5, Determining whether an Instrument (or Embedded
Feature) is indexed to an Entities Own Stock, which was primarily codified into
Topic 815. Topic 815 provides guidance on determining what types of instruments
or embedded features in an instrument held by a reporting entity can be
considered indexed to its own stock for the purpose of evaluating the first
criteria of the scope exception in paragraph 11(a) of SFAS 133, EITF 07-5 was
effective for financial statements issued for fiscal years beginning after
December 15, 2008. Management has adopted this standard and does not believe the
implementation of this standard will have a significant impact on the financial
statements of the Company.





In March
2008, the FASB issued Statement No. 161, Disclosures about Derivative
Instruments and Hedging Activities, - an amendment of FASB No. 133 which was
primarily codified into Topic 815. Topic 815 requires additional disclosures
about the objectives for using derivative instruments and hedging activities,
method of accounting for such instruments under Topic 815 and it’s related
interpretations, the effect of derivative instruments and related hedged items
on financial position, results of operations, and cash flows, and a tabular
disclosure of the fair values of derivative instruments and their gains and
losses. Management has adopted this standard. See Note 10.





Our
company has implemented all new accounting pronouncements that are in effect and
that may impact our financial statements and we do not believe that there are
any other new accounting pronouncements that have been issued that might have a
material impact on our financial position or results of 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 was 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 has borrowed $5,650,000 as of October 31,
2009.  The loan under the facility with NSES 12, LLC, bears interest
at 12% per year.  Interest only is payable during the term of the loan
and the principal balance of the loan is due thirty-six months from
closing.  Interest is to accrue starting on the day the loan is
funded, and the first interest payment was 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, 2009. 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-14


KENTUCKY
USA ENERGY


(Formerly
Las Rocas Mining Corp.)


(AN
EXPLORATION STAGE COMPANY)


NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS


October
31, 2009





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





As of
October 31, 2009 and October 31, 2008, the Company recognized derivative
liabilities of $1,015,971 and $1,723.453 respectively, and a convertible debt
liability, net of discounts of $1,527,780 and $2,152,778, of $972,220 and
$347,222, respectively,  pursuant to SFAS 133 “Accounting for
Derivative Instruments and Hedging Activities” (SFAS 133), primarily codified
into Topic 815, 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.  Principal repayments due in 24 equal payments beginning
with the 1st year
anniversary.  This note is convertible into 2,500,000
shares.  The conversion feature allows 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.” The purpose of issuing the convertible debt was to raise
capital to fund drilling and exploration.





EITF
00-19 “Accounting for Derivative Financial Instruments Indexed to, and
Potentially Settled in, a Company’s Own Stock” (EITF 00-19), primarily codified
into Topic 815, 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,
2008 instrument allows 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.





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 a debt discount with any excess expensed upon
issuance.  Upon early settlement of a loan, any remaining discount is
written off.  As of October 31, 2009 and October 31, 2008, the
unamortized balance of loan fees amounted to $640,694 and
$1,005,090.


F-15


KENTUCKY
USA ENERGY


(Formerly
Las Rocas Mining Corp.)


(AN
EXPLORATION STAGE COMPANY)


NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS


October
31, 2009





Note
11 Fair Value Measurements




SFAS No. 157,
Fair Value Measurements and Disclosures, primarily codified under Topic 820,
established a three-tier fair value hierarchy, which prioritizes the inputs used
in measuring fair value. These tiers include: Level 1, defined as
observable inputs such as quoted prices in active markets; Level 2, defined
as inputs other than quoted prices in active markets that are either directly or
indirectly observable; and Level 3, defined as unobservable inputs in which
little or no market data exists, therefore requiring an entity to develop its
own assumptions. As of October 31, 2009, we held certain derivative asset
and liability positions that lack level 1 and 2 inputs and are thus
required to be measured at fair value on a Level 3 basis.





The fair
value of stock warrants is the estimated present value at grant date using the
Black-Scholes option-pricing model with the following weighted average
assumptions for 2008 and 2009: expected volatility of 60% and 158% respectively,
a risk-free interest rate of 4.00% for both 2008 and 2009; and an expected
option life remaining from 2.5 to 5 years for both 2008 and 2009.





Note
12 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, 2009 and 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, 2009 and October 31, 2008:





Number of Stock
                
                
                WeightedOptions Available
                
                
                AverageThrough Warrants
                
                
                Exercise PriceOutstanding
      at beginning of period
                
                
                -
                
                
                
                -Granted
                
                
                4,700,000
                
                
                
                1.27Exercised
                
                
                2,000,000
                
                
                
                1.00Cancelled/forfeited
                
                
                -
                
                
                
                -Outstanding
      at October 31, 2009 and 2008
                
                
                2,700,000
                
                
                
                1.46Options
      Exercisable at October 31, 2009 and 2008
                
                
                2,700,000
                
                
                
                1.46




The
following table summarizes the information respecting stock options available
through warrants outstanding and exercisable at October 31, 2009 and October 31,
2008:




F-16


KENTUCKY
USA ENERGY


(Formerly
Las Rocas Mining Corp.)


(AN
EXPLORATION STAGE COMPANY)


NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS


October
31, 2009




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 2009.


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 2008 and 2009: expected volatility of 60% and 158% respectively,
a risk-free interest rate of 4.00% for both 2008 and 2009; and an expected
option life remaining from 2.5 to 5 years for both 2008 and 2009.





No
warrants were issued at October 31, 2009 or for the period then
ended.





Note
13 – Subsequent Events





On
December 17, 2009, the Company borrowed an additional $1.2 million on the $10M
NSES Credit Facility which brings the total amount borrowed to $6.85 million
with a remaining $3.15 million available on the credit facility.





Note
14 – Contingency





By terms
of its assignment from K&D enterprises, the Company is required to drill 12
wells per year on the K&D Leasehold. Current estimates are 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. The Company currently
does not have the funds to complete these drillings over the expected life of
the K&D Assignments and will require additional funds to do so. In the event
that the Company cannot raise the necessary funds or does not drill the required
12 wells per year, the Company might lose the rights to the K&D Properties.
Management believes that the possibility of this contingent loss is remote, and,
accordingly, no provision has been made in these financial statements for such a
loss.


F-17


KENTUCKY
USA ENERGY


(Formerly
Las Rocas Mining Corp.)


(AN
EXPLORATION STAGE COMPANY)


NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS


October
31, 2009





Note
15 – 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 utilizing
information provided by management as of October 31, 2009 and 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.





October31,2009
                        
                        
                        October31,2008Property
      acquisitions:Proved
                        
                        $
                        
                        
                        
                        $Unproved
                        
                        
                        -
                        
                        
                        
                        -Less
      proceeds from sales of properties
                        
                        
                        -
                        
                        
                        
                        -Development
      cost
                        
                        
                        3,912,460
                        
                        
                        
                        2,076,623Total
                        
                        $
                        3,912,460
                        
                        
                        $
                        2,076,623





Results
of Operations from Gas Producing Activities





As of
October 31, 2009 and October 31, 2008, the Company was still in an exploratory
stage and had not begun producing activities.


F-18


KENTUCKY
USA ENERGY


(Formerly
Las Rocas Mining Corp.)


(AN
EXPLORATION STAGE COMPANY)


NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS


October
31, 2009





Natural
Gas Reserves





The
following table sets forth the Company’s net proved gas reserves from inception
to  October 31, 2009. 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
                          
                          
                          25,550Revisions
      of previous estimates
                          
                          
                          -Proved
      reserves at October 31, 2009
                          
                          
                          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.





At
October 31, 2009 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:




F-19




KENTUCKY
USA ENERGY


(Formerly
Las Rocas Mining Corp.)


(AN
EXPLORATION STAGE COMPANY)


NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS


October
31, 2009





10/31/2009
                          
                          
                          10/31/2008Amount in Thousands
                          
                          
                          Amount in ThousandsFuture
      cash inflow
                          
                          $
                          98,128
                          
                          
                          $
                          129,922Future
      production costs and taxes
                          
                          
                          (4,906
                          )
                          
                          
                          (10,696
                          )Future
      development costs
                          
                          
                          (12,570
                          )
                          
                          
                          (11,550
                          )Processing,
      metering and gathering
                          
                          
                          (23,826
                          )
                          
                          
                          (25,984
                          )Future
      income tax expenses
                          
                          
                          (19,626
                          )
                          
                          
                          (25,984
                          )Net
      future cash flows
                          
                          
                          37,200
                          
                          
                          
                          55,70810%
      Discount
                          
                          
                          (15,294
                          )
                          
                          
                          (24,216
                          )Discounted
      future net cash flows from proved reserves
                          
                          
                          21,906
                          
                          
                          
                          31,492Less
      portion attrible to NSES ownership
                          
                          
                          (1,752
                          )
                          
                          
                          (2,519
                          )Discounted
      future net cash flows from proved reserves
                          
                          $
                          20,154
                          
                          
                          $
                          28,973





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, production taxes, and future development and abandonment
costs (less salvage value) necessary to produce such reserves.  The
average price used at October 31, 2009 and October 31, 2008 was $5.04 and $6.78
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.





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), less a 6% overriding royalty
interest owned by NSES, LLC.  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.


F-20


KENTUCKY
USA ENERGY


(Formerly
Las Rocas Mining Corp.)


(AN
EXPLORATION STAGE COMPANY)


NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS


October
31, 2009





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, 2009 and October 31, 2008.


F-21