Attached files
file | filename |
---|---|
EX-10.24 - Kentucky USA Energy, Inc. | ex-10_24.htm |
EX-10.25 - Kentucky USA Energy, Inc. | ex-10_25.htm |
EX-21 - Kentucky USA Energy, Inc. | v174748_ex21.htm |
EX-31.1 - Kentucky USA Energy, Inc. | v174748_ex31-1.htm |
EX-32.1 - Kentucky USA Energy, Inc. | v174748_ex32-1.htm |
EX-32.2 - Kentucky USA Energy, Inc. | v174748_ex32-2.htm |
EX-99.1 - Kentucky USA Energy, Inc. | v174748_ex99-1.htm |
EX-31.2 - Kentucky USA Energy, Inc. | v174748_ex31-2.htm |
U.S.
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON,
D.C. 20549
FORM
10-K
(Mark
One)
x
|
ANNUAL
REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934
|
For
Fiscal Year Ended: October 31, 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 ¨ No x
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 ¨ No x
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. Yes x No ¨
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.
TABLE
OF CONTENTS
Item Number and Caption
|
Page
|
||
FORWARD-LOOKING STATEMENTS
|
3
|
||
PART I
|
4
|
||
ITEM 1.
|
BUSINESS
|
4
|
|
ITEM 1A.
|
RISK FACTORS
|
16
|
|
ITEM 2.
|
PROPERTIES
|
26
|
|
ITEM 3.
|
LEGAL PROCEEDINGS
|
26
|
|
ITEM 4.
|
SUBMISSION OF MATTERS TO A VOTE OF SECURITY
HOLDERS
|
26
|
|
PART II
|
26
|
||
ITEM 5.
|
MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED
STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY
SECURITIES
|
26
|
|
ITEM 6.
|
SELECTED FINANCIAL DATA
|
29
|
|
ITEM 7.
|
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
|
29
|
|
ITEM 8.
|
FINANCIAL STATEMENTS AND SUPPLEMENTAL
DATA
|
34
|
|
ITEM 9.
|
CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
ACCOUNTING AND FINANCIAL DISCLOSURE
|
34
|
|
ITEM 9A.[T]
|
CONTROLS AND PROCEDURES
|
34
|
|
ITEM 9B.
|
OTHER INFORMATION
|
35
|
|
PART III
|
|
37
|
|
ITEM 10.
|
DIRECTORS, EXECUTIVE OFFICERS, AND CORPORATE
GOVERNANCE
|
37
|
|
ITEM 11.
|
EXECUTIVE COMPENSATION
|
39
|
|
ITEM 12.
|
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS
AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
|
41
|
|
ITEM 13.
|
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS,
AND DIRECTOR INDEPENDENCE
|
43
|
|
ITEM 14.
|
PRINCIPAL ACCOUNTANT FEES AND
SERVICES
|
43
|
|
PART IV
|
45
|
||
ITEM 15.
|
EXHIBITS AND FINANCIAL STATEMENT
SCHEDULES
|
45
|
2
FORWARD-LOOKING
STATEMENTS
This
report contains forward-looking statements. All statements other than statements
of historical facts included in this Annual Report on Form 10-K, including
without limitation, statements in this Management’s Discussion and Analysis of
Financial Condition and Results of Operations regarding our financial position,
estimated working capital, business strategy, the plans and objectives of our
management for future operations and those statements preceded by, followed by
or that otherwise include the words “believe”, “expects”, “anticipates”,
“intends”, “estimates”, “projects”, “target”, “goal”, “plans”, “objective”,
“should”, or similar expressions or variations on such expressions are
forward-looking statements. We can give no assurances that the assumptions upon
which the forward-looking statements are based will prove to be correct. Because
forward-looking statements are subject to risks and uncertainties, actual
results may differ materially from those expressed or implied by the
forward-looking statements. There are a number of risks, uncertainties and other
important factors that could cause our actual results to differ materially from
the forward-looking statements, including, but not limited to, the availability
and pricing of additional capital to finance operations, including the drilling
of our initial gas wells, longer term drilling programs and additional leasehold
acquisitions, the viability of the shale gas fields in the Illinois Basin in
western Kentucky, our ability to build and maintain a successful operations
infrastructure and to effectively drill and develop producing wells, the
successful negotiation and execution of cost-effective third-party gas drilling
and distribution agreements, the continued commitment of drill rig operators and
future economic conditions and volatility in energy prices.
All
references in this Form 10-K to the “Company,” “Kentucky USA,” “we,” “us” or
“our” are to Kentucky USA Energy, Inc. and when context requires, our wholly
owned subsidiary, KY USA Energy, Inc. (“KY USA”).
3
PART
I
ITEM
1. BUSINESS
History
and General Development of Our Business
Kentucky
USA Energy, Inc. was incorporated in the State of Delaware on September 29, 2006
under the name Las Rocas Mining Corp. Our principal business plan was
to acquire, explore and develop mineral properties and to ultimately seek
earnings by exploiting the mineral claims. We determined that we could not
continue with our original business operations because of a lack of financial
results and resources and, subsequently, we decided to abandon our mineral
property operations and to seek a possible business
combination.
On
October 26, 2007, we changed our name to Kentucky USA Energy, Inc. to facilitate
the merger discussions with KY USA Energy, Inc. (“KY USA”). We also increased
our authorized capital stock to an aggregate of 320,000,000 shares consisting
of 300,000,000
shares of common stock, $0.0001 par value per share (the “Common
Stock”), and 20,000,000 shares of preferred stock with preferences
and rights to be determined by our Board of Directors. Additionally,
our Board of Directors approved a forward stock split in the form of a dividend
with a record date of November 13, 2007 and effective on or about November 19,
2007, as a result of which each share of Common Stock then issued and
outstanding converted into twelve shares of Common Stock.
KY USA
was incorporated in the Commonwealth of Kentucky on October 5, 2007 to acquire,
explore and develop oil and gas resource properties, with a primary focus
initially on shale gas in the Illinois Basin in western Kentucky. Since its
formation, KY USA has focused its business efforts on raising funds, acquiring
working and revenue interests in property leases, putting together an
experienced team of technical and business people and operations related to and
including the drilling of its initial wells.
Our
ability to emerge from the exploration stage with respect to any planned
principal business activity is dependent upon our successful efforts to raise
additional equity financing and generate significant revenue through our
operations. There is no guarantee that our efforts will be sufficient to
accomplish any of the above objectives.
Our
principal offices are located at 321 Somerset Road, London, Kentucky 40741, and
our telephone number is (606) 878-5987. Our website address is www.kusaenergy.com.
Merger
On May 2,
2008, the Company, KY Acquisition Corp., a Kentucky corporation and wholly-owned
subsidiary of the Company (“Acquisition Sub”), and KY USA entered into an
Agreement and Plan of Merger and Reorganization (the “Merger Agreement”), which
closed on May 2, 2008. Pursuant to the terms of the Merger Agreement,
Acquisition Sub merged with and into KY USA, with KY USA being the surviving
corporation and becoming a wholly-owned subsidiary of the Company (the
“Merger”).
4
At the
closing of the Merger, each share of KY USA’s common stock issued and
outstanding immediately prior to the closing of the Merger was converted into
9,000 shares of our Common Stock. An aggregate of 18,000,000 shares of our
Common Stock were issued to the holders of KY USA’s common stock. In order to secure the
indemnification obligations of the KY USA stockholders pursuant to the Merger
Agreement, 5% of the shares of the Company’s Common Stock that KY USA’s
pre-Merger stockholders received in exchange for their shares of KY USA are
being held in escrow until May 2, 2010 (the “Indemnification
Escrow”).
The
Company, KY USA and Acquisition Sub each provided pre-closing covenants and
closing conditions and customary representations and warranties in the Merger
Agreement. Customary indemnification provisions in the Merger Agreement protect
the parties from breaches of these representations and warranties. The Merger
Agreement provided for a post-closing adjustment in an aggregate amount of up to
2,000,000 additional shares of Common Stock issuable pro rata to KY USA’s
pre-Merger stockholders for any breach of the Merger Agreement by the Company
that is discovered during the two-year period following the closing of the
Merger. In order to secure the indemnification obligations of the KY USA
stockholders pursuant to the Merger Agreement, 5% of the shares of Common Stock
that KY USA’s pre-Merger stockholders received in the Merger in exchange for
their shares of KY USA are being held in escrow for two years. Additionally, in
connection with the Merger and pursuant to the Merger Agreement, 5,000,000
shares of the Company’s Common Stock are being held in escrow for issuance to
the Company’s investor relations consultants as payment for their services to be
rendered to the Company.
Split-Off
Immediately
following the closing of the Merger, under the terms of a Split-Off Agreement,
the Company transferred all of its pre-Merger operating assets and liabilities
to its wholly-owned subsidiary, Las Rocas Leaseco Corp., a Delaware corporation
(“Leaseco”). Thereafter, pursuant to the Split-Off Agreement, the Company
transferred all of the outstanding capital stock of Leaseco to Christopher
Greenwood, a former officer and director of the Company, in exchange for
cancellation of 24,000,000 shares of Common Stock held by Mr. Greenwood as well
as certain covenants and indemnifications (the “Split-Off”).
Our
Natural Shale Gas Business
We are a
exploration stage, independent energy company organized to exploit and develop
the plentiful gas resources of the Illinois Basin’s New Albany
Shale. We have acquired a 75% net revenue interest in a leasehold of
approximately 3,000 acres in the Illinois Basin in western Kentucky, which
permits us to extract and sell natural gas from the New Albany Shale formation
in that location.
We expect
to create stockholder value and generate long-term reserve and production growth
through drilling activities on our western Kentucky leasehold and through
further acquisitions of additional properties. We believe that our management’s
experience and expertise will enable us to successfully exploit our current
resources and to identify, evaluate, and develop future natural gas
projects.
5
Our
Properties
On
October 4, 2007, KY USA entered into three Farm-Out Assignment Agreements,
subsequently supplemented and corrected (the “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.
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 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.
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.
6
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.
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 $21,852,000, 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 ½" 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
|
CR5
|
||||||||||
1.
|
Francis
Grace # 1
|
X
|
2626’
|
X
|
X
|
X
|
X
|
X
|
X
|
X
|
|||||||||
2.
|
Hunter
Wells # 3
|
X
|
2509’
|
X
|
X
|
X
|
X
|
X
|
X
|
||||||||||
3.
|
Hunter
Wells # 2
|
X
|
2340’
|
X
|
X
|
X6
|
|||||||||||||
4.
|
B.
Johnston # 1
|
X
|
2387’
|
X
|
X
|
X
|
X
|
X
|
X
|
X
|
|||||||||
5.
|
Slinker
# 1B
|
X
|
2340’
|
X
|
X
|
X
|
X
|
X
|
X
|
X
|
|||||||||
6.
|
Walker
#1
|
X
|
2430’
|
X
|
X
|
X
|
X
|
X
|
X
|
X
|
|||||||||
7.
|
Hunter
Wells #1
|
X
|
2431’
|
X
|
X
|
X
|
X
|
X
|
X
|
X
|
5. Indicates
that Completion Report has been completed and submitted to the state oil and gas
authority.
8
Well
Name
Drilling
Order
|
Spudded
|
TD
|
Logged
|
Casing
|
Cement
|
Perf’ed
|
Frac’ed
|
4Pt
Test
|
CR5
|
||||||||||
8.
|
Francis
Grace #2
|
X
|
2395’
|
X
|
X
|
X
|
X
|
X
|
X
|
X
|
|||||||||
9.
|
J Johnston #27
|
X
|
3011’
|
X
|
X
|
X
|
X
|
X
|
X
|
X
|
|||||||||
10.
|
Francis
Grace #3
|
X
|
2578’
|
X
|
X
|
X
|
X
|
X
|
X
|
X
|
|||||||||
11.
|
Golden
Eagle #1
|
X
|
2760’
|
X
|
X
|
X
|
X
|
X
|
X
|
X
|
|||||||||
12.
|
Hunter
Wells #4
|
X
|
2721’
|
X
|
X
|
X
|
X
|
X
|
X
|
||||||||||
13.
|
J
Johnston #4
|
X
|
2500’
|
X
|
X
|
X
|
X
|
X
|
X
|
X
|
|||||||||
14.
|
B.
Johnston #2
|
X
|
2640’
|
X
|
X
|
X
|
X
|
X
|
X
|
X
|
|||||||||
15.
|
Slinker
#2
|
X
|
2618’
|
X
|
X
|
X
|
X
|
X
|
|||||||||||
16.
|
Jackson
#1
|
X
|
2664’
|
X
|
|||||||||||||||
17.
|
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 Granted
|
|
Walker
#2
|
X
|
|
J
& J Johnston #1
|
||
Golden
Eagle #2
|
||
B.
Johnston #3
|
X
|
|
Hunter
Wells #5
|
||
Lacefield-Taylor
#1
|
X
|
|
Lacefield-Taylor
#2
|
||
Slinker
#3B
|
||
Hardison
#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.
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.
|
As
more fully discussed in our Form 8-K filed with the SEC on October
23, 2009.
|
9
We will
sell our gas to Seminole following treatment of the gas at Seminole’s gathering
and treatment facilities located in Christian and Muhlenberg Counties,
Kentucky. This facility is jointly owned by Seminole and Daugherty
Petroleum, Inc., and is managed by Seminole. We have constructed approximately
67,000 feet of gathering line to connect our wells to Seminole’s gathering and
treatment facility. We completed this system of lines and the
interconnection to Seminole’s gathering facility in October 2009. Fourteen
(14) of our wells are now connected to this
system.
Seminole
will pay us the Gas Daily Texas Zone SL daily midpoint spot price for the
gas that it purchases from us. We and Seminole have agreed to net any
payments due us under the Base Contract against fees due Seminole under that
certain Gas Gathering & Treatment Agreement between the Company and Seminole
(and its related parties) dated August 6, 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.
9
|
As
more fully discussed in our Form 8-K filed with the SEC on August 17,
2009.
|
10
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.
The
Company has acquired the Leasehold, and is developing that property as discussed
above, and intends to acquire additional producing oil and gas property rights
where the Company believes significant additional value can be created.
Management is primarily interested in properties where some combination of the
following factors exists:
(1)
|
there
are opportunities for long production life with stable production
levels;
|
(2)
|
geological
formations have multiple producing horizons allowing for gas extraction
over overlapping time lines;
|
(3)
|
there
is substantial exploitation potential;
and
|
(4)
|
there
is relatively low capital investment and production
cost.
|
Governmental
Regulation
Our
operations are or will be subject to various types of regulation at the federal,
state and local levels. Such regulation includes requiring local permits for the
drilling of wells; maintaining bonding requirements in order to drill or operate
wells; implementing spill prevention plans; submitting notification and
receiving permits relating to the presence, use and release of certain materials
incidental to oil and gas operations; and regulating the location of wells, the
method of drilling and casing wells, the use, transportation, storage and
disposal of fluids and materials used in connection with drilling and production
activities, surface usage and the restoration of properties upon which wells
have been drilled, the plugging and abandoning of wells and the transporting of
production. Our operations are or will also be subject to various conservation
matters, including the regulation of the size of drilling and spacing units or
proration units, the number of wells which may be drilled in a unit and the
unitization or pooling of oil and gas properties. In this regard, some states
allow the forced pooling or integration of tracts to facilitate exploration
while other states rely on voluntary pooling of lands and leases, which may make
it more difficult to develop oil and gas properties. In addition, state
conservation laws establish maximum rates of production from oil and gas wells,
generally limit the venting or flaring of gas, and impose certain requirements
regarding the ratable purchase of production. The effect of these regulations is
to limit the amounts of oil and gas we may be able to produce from the wells and
to limit the number of wells or the locations at which we may be able to
drill.
11
Our
business is affected by numerous laws and regulations, including energy,
environmental, conservation, tax and other laws and regulations relating to the
oil and gas industry. We plan to develop internal procedures and policies to
ensure that operations are conducted in full and substantial environmental
regulatory compliance.
Our
failure to comply with any laws and regulations may result in the assessment of
administrative, civil and criminal penalties, the imposition of injunctive
relief or both. Moreover, changes in any of these laws and regulations could
have a material adverse effect on our business. In view of the many
uncertainties with respect to current and future laws and regulations, including
their applicability to us, we cannot predict the overall effect of such laws and
regulations on future operations.
We
believe that our operations comply in all material respects with applicable laws
and regulations and that the existence and enforcement of such laws and
regulations have an effect no more restrictive on our operations than on other
similar companies in the energy industry. The Company does not anticipate any
material capital expenditures to comply with federal and state environmental
requirements.
Environmental
Regulation
Our
operations on properties in which we have an interest are subject to extensive
federal, state and local environmental laws that regulate the discharge or
disposal of materials or substances into the environment and otherwise are
intended to protect the environment. Numerous governmental agencies issue rules
and regulations to implement and enforce such laws, which are often difficult
and costly to comply with and which carry substantial administrative, civil and
criminal penalties and in some cases injunctive relief for failure to
comply.
Some
laws, rules and regulations relating to the protection of the environment may,
in certain circumstances, impose “strict liability” for environmental
contamination. These laws render a person or company liable for environmental
and natural resource damages, cleanup costs and, in the case of oil spills in
certain states, consequential damages without regard to negligence or fault.
Other laws, rules and regulations may require the rate of oil and gas production
to be below the economically optimal rate or may even prohibit exploration or
production activities in environmentally sensitive areas. In addition, state
laws often require some form of remedial action, such as closure of inactive
pits and plugging of abandoned wells, to prevent pollution from former or
suspended operations.
12
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.
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.
13
Competition
The oil
and gas exploration and production industry is highly competitive. In
the New Albany Shale area, we compete with several large and well known public
and private companies such as Southwestern Energy Corporation, Chesapeake Energy
Resources, CNX Gas Corporation and NGAS Resources Inc., which companies may have
more financial and operational resources than we do. Western Kentucky
is one of new emerging shale gas areas and is attracting a great deal of
industry interest. Competition for equipment, personnel and services is expected
to be similar to that in the Barnett Shale area of Texas.
Plan
of Operation
Our
strategy is to pursue selected opportunities that are characterized by
reasonable entry costs, favorable economic terms, high reserve potential
relative to capital expenditures and the availability of existing technical data
that may be further developed using current technology.
We seek
to achieve attractive returns on capital for the benefit of stockholders through
investment in existing developmental plays, rather than through our own
exploratory efforts. In this way we hope to maintain a strong balance sheet
to enable us to be flexible from an operational and financial
standpoint.
We expect
to generate long-term reserve and production growth through drilling activities
and further acquisitions. We believe that our management’s experience and
expertise will enable us to identify, evaluate, and develop natural gas
projects.
While we
anticipate that the majority of our future capital expenditures will be applied
to the drilling of wells, we intend to use our experience and regional expertise
to add leasehold interests as well as direct property acquisitions to our
inventory of properties for future drilling activities.
Disciplined
Acquisition Strategy
We intend
to acquire producing oil and gas properties where we believe significant
additional value can be created. Management is primarily interested in
developmental properties where some combination of these factors exist:
(1) opportunities for long production life with stable production levels;
(2) geological formations with multiple producing horizons;
(3) substantial exploitation potential; and (4) relatively low capital
investment for production costs. We are currently reviewing several thousand
lease acres in western Kentucky with an expected potential similar to that of
our 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.
14
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.
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
ITEM
1A. RISK FACTORS
RISKS
RELATED TO OUR BUSINESS AND FINANCIAL CONDITION
We
have a limited operating history and if we are not successful in continuing to
grow the business, then we may have to scale back or even cease ongoing business
operations.
We are in
the “exploration” stage of business and, through our wholly owned subsidiary KY
USA, we begun substantive commercial operations less than two years ago. We have
no history of revenues from operations. We have yet to generate positive
earnings and there can be no assurance that we will ever operate profitably. KY
USA has a limited operating history and must be considered in the exploration
stage. Success is significantly dependent on a successful drilling, completion
and production program. Operations will be subject to all the risks inherent in
the establishment of a developing enterprise and the uncertainties arising from
the absence of a significant operating history. We may be unable to locate
recoverable reserves or operate on a profitable basis. We are in the exploration
stage and potential investors should be aware of the difficulties normally
encountered by enterprises in the exploration stage. If the business plan is not
successful, and we are not able to operate profitably, investors may lose some
or all of their investment in the Company.
Inability
to raise sufficient funds to drill enough wells each year would result in the
loss of KY USA’s leases.
Pursuant
to the K&D Assignments, we are required to drill 12 wells per year on the
K&D Leasehold. We currently estimate that the cost to drill each well will
be in the range of $165,000 to $225,000, for an estimated maximum total of
approximately $2.7 million each year. We currently do not have the funds to
complete these drillings over the expected life of the K&D Assignments and
we will require additional funds to do so. In the event that we cannot raise the
necessary funds or do not drill the required 12 wells per year, we would lose
the rights to the K&D Properties. The loss of this leasehold land would have
a material adverse impact on our business.
Additionally,
under the TPE farm-out agreement, we are required to drill 10 wells in the first
year to be eligible to drill additional wells in following years. We
have entered a JV agreement with 7921 who will participate by providing working
capital to us for the drilling of these first 10 wells. If 7921 does
not advance funds to us as agreed and we are not able to raise the required
funds for these wells from other sources, we would lose our rights to drill on
the TPE leasehold.
16
If
we are unable to obtain additional funding, business operations will be harmed
and if we do obtain additional financing, existing shareholders may suffer
substantial dilution.
We will
require additional funds to drill wells on the K&D Properties. We anticipate
that we will require up to approximately $10,000,000 to fund continued
operations for the next twelve months, depending on revenue, if any, from
operations. Additional capital will be required to effectively support the
operations and to otherwise implement our overall business strategy. We have
raised some capital to date, including through the sale of the Note and the
Credit Agreement (both discussed below) which we expect to provide sufficient
capital for our drilling program for at least the next three to six months, but
we currently do not have any contracts or firm commitments for additional
financing. There can be no assurance that additional financing will be available
in amounts or on terms acceptable to us, if at all. The inability to obtain
additional capital will restrict our ability to grow and may diminish our
ability to continue to conduct our business operations. If we are unable to
obtain additional financing, we will likely be required to curtail drilling and
development plans and, possibly, cease operations. Any additional equity
financing may involve substantial dilution to then existing
shareholders.
Based
on our recurring losses from operations since inception and our breach of a
certain loan covenant, our auditors have included an explanatory paragraph in
their opinion as to the substantial doubt about our ability to continue as a going concern.
Due to,
among other factors, our history of losses (excluding gains from valuation
changes in embedded derivatives) and our breach of a negative covenant in the
Credit Agreement (defined below), our independent auditors have included an
explanatory paragraph in their opinion for the year ended October 31, 2009
as to the substantial doubt about our ability to continue as a going concern. Our financial statements
have been prepared in accordance with accounting principles generally accepted
in the United States, which contemplate that we will continue to operate as a
going concern. Our financial
statements do not contain any adjustments that might result if we are unable to
continue as a going concern.
Because
we are small and do not have much capital, we may have to limit exploration
activity which may result in a loss of your investment.
Because
we are a small, development stage company and do not have much capital, we must
limit exploration activity. As such, we may not be able to complete an
exploration program that is as thorough as we would like. In that event,
existing reserves may go undiscovered. Without finding reserves, we cannot
generate revenues and you may lose your investment.
If
we are unable to continue to retain the services of Messrs. Steven D. Eversole
and C. G. Collins or if we are unable to successfully recruit qualified
managerial and field personnel having experience in oil and gas exploration, we
may not be able to continue operations.
Success
depends to a significant extent upon the continued services of
Mr. Steven D. Eversole, the President, and C. G. Collins, the Vice
President of Exploration and Development. Loss of the services of Messrs.
Eversole or Collins could have a material adverse effect on growth, revenues,
and prospective business. We have obtained, however, key-man insurance covering
both Messrs. Eversole and Collins. We can not assure you, however, that this
insurance will continue to be available at a reasonable cost or at
all. In order to successfully implement and manage our business plan,
we will be dependent upon, among other things, successfully recruiting qualified
managerial and field personnel having experience in the oil and gas exploration
business. Competition for qualified individuals is intense. There can be no
assurance that we will be able to find and attract new employees and retain
existing employees or that we will be able to find, attract and retain qualified
personnel on acceptable terms.
17
As
our properties are in the exploration stage, there can be no assurance that we
will establish commercial discoveries on the K&D Properties.
Exploration
for economic reserves of oil and gas is subject to a number of risk factors. Few
properties that are explored are ultimately developed into producing oil and/or
gas wells. The K&D Properties are in the exploration stage only and while
our initial third party engineering report indicated that we have proven,
undeveloped reserves on the K&D Properties, we have not yet begun production
at any well. We may not establish commercial discoveries on any of the K&D
Properties.
Estimates
of oil and gas reserves are uncertain and inherently imprecise.
Estimating
our proved reserves involves many uncertainties, including factors beyond our
control. The estimates of proved reserves described in this Form 10-K are based
on various assumptions, which may ultimately prove inaccurate. Petroleum
engineers consider many factors and make assumptions in estimating oil and gas
reserves. Lower oil and gas prices generally cause lower estimates of proved
reserves. Ultimately, actual production, revenues, and expenditures relating to
our reserves will vary from any estimates, and these variations may be material.
Also, in the future we may revise estimates of proved reserves to reflect
production history, results of exploration and development, and other factors,
many of which are beyond our control.
We
are a new entrant into the oil and gas exploration and development industry
without profitable operating history.
Since
inception, activities have been limited to organizational efforts, obtaining
working capital and acquiring and developing a very limited number of
properties. As a result, there is limited information regarding property related
production potential or revenue generation potential, and future revenues may be
limited or non-existent.
The
business of oil and gas exploration and development is subject to many risks.
The potential profitability of oil and natural gas properties if economic
quantities are found is dependent on many factors and risks beyond our control,
including, but not limited to: (i) unanticipated ground conditions;
(ii) geological problems; (iii) drilling and other processing
problems; (iv) the occurrence of unusual weather or operating conditions
and other force majeure events; (v) lower than expected reserve quantities;
(vi) accidents; (vii) delays in the receipt of or failure to receive
necessary government permits; (viii) delays in transportation;
(ix) labor disputes; (x) government permit restrictions and regulation
restrictions; (xi) unavailability of materials and equipment; and
(xii) the failure of equipment or drilling to operate in accordance with
specifications or expectations.
18
Drilling
operations may not be successful.
There can
be no assurance that future drilling activities will be
successful. We cannot be sure that an overall drilling success rate
or production operations within a particular area will ever come to fruition
and, in any event, production rates inevitably decline over time. We may not
recover all or any portion of the capital investment in our wells or the
underlying leaseholds. Unsuccessful drilling activities would have a material
adverse effect upon our results of operations and financial condition. The cost
of drilling, completing, and operating wells is often uncertain, and a number of
factors can delay or prevent drilling operations including, but not limited to:
(i) unexpected drilling conditions; (ii) pressure or irregularities in
geological formations; (iii) equipment failures or accidents;
(iv) adverse weather conditions; and (iv) shortages or delays in
availability of drilling rigs and delivery of equipment.
Production
initiatives may not prove successful.
The
shales from which we intend to produce natural gas frequently contain water,
which may hamper the ability to produce gas in commercial quantities. The amount
of natural gas that can be commercially produced depends upon the rock and shale
formation quality, the original free gas content of the shales, the thickness of
the shales, the reservoir pressure, the rate at which gas is released from the
shales, and the existence of any natural fractures through which the gas can
flow to the well bore. However, shale rock formations frequently contain water
that must be removed in order for the gas to detach from the shales and flow to
the well bore. The ability to remove and dispose of sufficient quantities of
water from the shales may determine whether or not we can produce gas in
commercial quantities.
There is
no guarantee that the potential drilling locations we now have or may acquire in
the future will ever produce natural gas, which could have a material adverse
effect upon our results of operations.
Prospects
that we decide to drill may not yield natural gas in commercially viable
quantities.
Prospects
are in various stages of preliminary evaluation, assessment and drilling and we
only have reached the point where we have begun to drill at a limited number of
the subject prospects. The use of seismic data, historical drilling logs,
offsetting well information, and other technologies and the study of producing
fields in the same area will not enable us to know conclusively prior to
drilling and testing whether natural gas will be present or, if present, whether
natural gas or oil will be present in sufficient quantities or quality to
recover drilling or completion costs or to be economically viable. In sum, the
cost of drilling, completing and operating any wells is often uncertain and new
wells may not be productive.
If
production results from operations, we are dependent upon transportation and
storage services provided by third parties.
We will
be dependent on the transportation and storage services offered by various
interstate and intrastate pipeline companies for the delivery and sale of gas
supplies. Both the performance of transportation and storage services by
interstate pipelines and the rates charged for such services are subject to the
jurisdiction of the Federal Energy Regulatory Commission or state regulatory
agencies. An inability to obtain transportation and/or storage services at
competitive rates could hinder processing and marketing operations and/or affect
our sales margins.
19
Third
party purchasers may not have the capacity to accept and process the gas they
buy from us and, as a result, our ability to sell the gas that we produce may be
constrained.
In
October 2009, we began the production and delivery of natural gas to treatment
facilities owned by Seminole Energy Services, LLC, 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. If Seminole is
unable to adequately expand their facilities to accept our gas or if Seminole is
for any other reasons unable to accept and buy our gas, our sales and revenues
will suffer, and this may have a negative impact on our share
value.
The
potential profitability of oil and gas ventures depends upon factors beyond the
control of the Company.
The
potential profitability of oil and gas properties is dependent upon many factors
beyond our control. For instance, world prices and markets for oil and gas are
unpredictable, highly volatile, potentially subject to governmental fixing,
pegging, controls, or any combination of these and other factors, and respond to
changes in domestic, international, political, social, and economic
environments. Additionally, due to worldwide economic uncertainty, the
availability and cost of funds for production and other expenses have become
increasingly difficult, if not impossible, to project. These changes and events
may materially affect our financial performance.
Adverse
weather conditions can also hinder drilling operations. A productive well may
become uneconomic in the event that water or other deleterious substances are
encountered which impair or prevent the production of oil and/or gas from the
well. The marketability of oil and gas which may be acquired or discovered will
be affected by numerous factors beyond our control. These factors include the
proximity and capacity of oil and gas pipelines and processing equipment, market
fluctuations of prices, taxes, royalties, land tenure, allowable production and
environmental regulations. These factors cannot be accurately predicted and the
combination of these factors may result in the Company not receiving an adequate
return on invested capital.
The
oil and gas industry is highly competitive and there is no assurance that we
will be successful in acquiring new leases.
The oil
and gas industry is intensely competitive. We compete with numerous individuals
and companies, including many major oil and gas companies, which have
substantially greater technical, financial and operational resources and staffs.
Accordingly, there is a high degree of competition for desirable oil and gas
leases, suitable properties for drilling operations and necessary drilling
equipment, as well as for access to funds. We cannot predict whether we will be
able to acquire additional productive properties, whether the necessary funds
can be raised or that any projected work will be completed.
20
Oil
and gas operations are subject to comprehensive regulation which may cause
substantial delays or require capital outlays in excess of those anticipated
causing an adverse effect on the Company.
Oil and
gas operations are subject to federal, state, and local laws relating to the
protection of the environment, including laws regulating removal of natural
resources from the ground and the discharge of materials into the environment.
Oil and gas operations are also subject to federal, state, and local laws and
regulations which seek to maintain health and safety standards by regulating the
design and use of drilling methods and equipment. Various permits from
government bodies are required for drilling operations to be conducted; no
assurance can be given that such permits will be received. Environmental
standards imposed by federal, state or local authorities may be changed and any
such changes may have material adverse effects on activities. Moreover,
compliance with such laws may cause substantial delays or require capital
outlays in excess of those anticipated, thus causing an adverse effect on us.
Additionally, we may be subject to liability for pollution or other
environmental damages which we may elect not to insure against due to
prohibitive premium costs and other reasons. To date, we have not been required
to spend any material amount on compliance with environmental regulations.
However, we may be required to do so in future and this may affect our ability
to expand or maintain operations.
Exploration
activities are subject to certain environmental regulations which may prevent or
delay the commencement or continuance of operations.
In
general, exploration activities are subject to certain federal, state and local
laws and regulations relating to environmental quality and pollution control.
Such laws and regulations increase the costs of these activities and may prevent
or delay the commencement or continuance of a given operation. Compliance with
these laws and regulations has not had a material effect on operations or
financial condition to date. Specifically, we are subject to legislation
regarding emissions into the environment, water discharges and storage and
disposition of hazardous wastes. In addition, legislation has been enacted which
requires well and facility sites to be abandoned and reclaimed to the
satisfaction of state authorities. However, such laws and regulations are
frequently changed and we are unable to predict the ultimate cost of compliance.
Generally, environmental requirements do not appear to affect us any differently
or to any greater or lesser extent than other companies in the
industry.
We
believe that our operations comply, in all material respects, with all
applicable environmental regulations. Our operating partners maintain insurance
coverage customary to the industry; however, we are not fully insured against
all possible environmental risks.
Exploratory
drilling involves many risks and we may become liable for pollution or other
liabilities which may have an adverse effect on financial position.
Drilling
operations generally involve a high degree of risk. Hazards such as unusual or
unexpected geological formations, power outages, labor disruptions, blow-outs,
sour gas leakage, fire, inability to obtain suitable or adequate machinery,
equipment or labor, and other risks are involved. We may become subject to
liability for pollution or hazards against which we cannot adequately insure or
which we may elect not to insure. Incurring any such liability may have a
material adverse effect on our financial position and operations.
21
Any
change to government regulation/administrative practices may have a negative
impact on the ability to operate and profitability.
The laws,
regulations, policies or current administrative practices of any government
body, organization or regulatory agency in the United States or any other
jurisdiction, may be changed, applied or interpreted in a manner which will
fundamentally alter the ability of our company to carry on our
business.
The
actions, policies or regulations, or changes thereto, of any government body or
regulatory agency, or other special interest groups, may have a detrimental
effect on us. Any or all of these situations may have a negative impact on our
ability to operate profitably.
Current
volatile market conditions and dropping energy prices may continue indefinitely,
negatively affecting our business prospects and viability.
Commodities
and capital markets have been under great stress and volatility during the past
year in part due to the credit crisis affecting lenders and borrowers on a
worldwide basis. As a result of this crisis, crude oil and natural gas prices
have tumbled, causing companies to re-think existing strategies and new business
ventures. We are vigilant of the situation unfolding and are adjusting our
strategy to reflect these new market conditions. Nonetheless, we will not be
immune to lower commodities prices. Our ability to acquire new
natural gas leasehold projects may be compromised, and in a continuing
environment of lower crude oil and natural gas prices, our future results of
operations and market value could be affected negatively.
Difficult
conditions in the global capital markets may significantly affect our ability to
raise additional capital to continue operations.
The
ongoing worldwide financial and credit crisis may continue
indefinitely. Because of severely reduced market liquidity, we may
not be able to raise additional capital when we need it. Because the
future of our business will depend on the completion of one or more additional
leasehold acquisitions for which, most likely, we will need additional capital,
we may not be able to complete such transactions or acquire revenue producing
assets. As a result, we may not be able to generate income and, to
conserve capital, we may be forced to curtail our current business activities or
cease operations entirely.
RISKS
RELATED TO OUR COMMON STOCK
There
is currently a limited public market for our Common Stock. Failure to develop or
maintain a trading market could negatively affect its value and make it
difficult or impossible for you to sell your shares.
There has
been a limited public market for our Common Stock and an active public market
for our Common Stock may not develop. Failure to develop or maintain an active
trading market could make it difficult for you to sell your shares or recover
any part of your investment in us. Even if a market for our Common Stock does
develop, the market price of our Common Stock may be highly volatile. In
addition to the uncertainties relating to future operating performance and the
profitability of operations, factors such as variations in interim financial
results or various, as yet unpredictable, factors, many of which are beyond our
control, may have a negative effect on the market price of our Common
Stock.
22
We
cannot assure you that the Common Stock will become liquid or that it will be
listed on a securities exchange.
Until our Common Stock is listed on a
national securities exchange such as the New York Stock Exchange or the Nasdaq
Stock Market, we expect our Common Stock to remain eligible for quotation on the
OTCBB, or on another over-the-counter quotation system, or in the “pink sheets.”
In those venues, however, an investor may find it difficult to obtain accurate
quotations as to the market value of our Common Stock. In addition,
if we fail to meet the criteria set forth in SEC regulations, various
requirements would be imposed by law on broker-dealers who sell our securities
to persons other than established customers and accredited
investors. Consequently, such regulations may deter broker-dealers
from recommending or selling our Common Stock, which may further affect the
liquidity of the Common Stock. This would also make it more difficult
for us to raise capital.
Our
Common Stock is subject to the “Penny Stock” rules of the SEC and the trading
market in the securities is limited, which makes transactions in the stock
cumbersome and may reduce the value of an investment in the stock.
The SEC
has adopted Rule 15g-9 which establishes the definition of a “penny stock,” for
the purposes relevant to us, as any equity security that has a market price of
less than $5.00 per share or with an exercise price of less than $5.00 per
share, subject to certain exceptions. For any transaction involving a penny
stock, unless exempt, the rules require:
•
|
that
a broker or dealer approve a person’s account for transactions in penny
stocks; and
|
|
•
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the
broker or dealer receive from the investor a written agreement to the
transaction, setting forth the identity and quantity of the penny stock to
be purchased.
|
In order
to approve a person’s account for transactions in penny stocks, the broker or
dealer must:
|
•
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obtain
financial information and investment experience objectives of the person;
and
|
|
•
|
make
a reasonable determination that the transactions in penny stocks are
suitable for that person and the person has sufficient knowledge and
experience in financial matters to be capable of evaluating the risks of
transactions in penny stocks.
|
The
broker or dealer must also deliver, prior to any transaction in a penny stock, a
disclosure schedule prescribed by the SEC relating to the penny stock market,
which, in highlight form sets forth:
|
•
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the
basis on which the broker or dealer made the suitability determination;
and
|
|
•
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that
the broker or dealer received a signed, written agreement from the
investor prior to the
transaction.
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23
Generally,
brokers may be less willing to execute transactions in securities subject to the
“penny stock” rules. This may make it more difficult for investors to dispose of
common stock and cause a decline in the market value of stock.
Disclosure
also has to be made about the risks of investing in penny stocks in both public
offerings and in secondary trading and about the commissions payable to both the
broker-dealer and the registered representative, current quotations for the
securities and the rights and remedies available to an investor in cases of
fraud in penny stock transactions. Finally, monthly statements have to be sent
disclosing recent price information for the penny stock held in the account and
information on the limited market in penny stocks.
The
price of our Common Stock may become volatile, which could lead to losses by
investors and costly securities litigation.
The trading price of our Common Stock
is likely to be highly volatile and could fluctuate in response to factors such
as:
|
·
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actual
or anticipated variations in our operating
results;
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·
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announcements
of developments by us or our
competitors;
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·
|
announcements
by us or our competitors of significant acquisitions, strategic
partnerships, joint ventures or capital
commitments;
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·
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adoption
of new accounting standards affecting our Company’s
industry;
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·
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additions
or departures of key personnel;
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·
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sales
of our Common Stock or other securities in the open market;
and
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·
|
other
events or factors, many of which are beyond our
control.
|
The stock market is subject to
significant price and volume fluctuations. In the past, following periods of
volatility in the market price of a company’s securities, securities class
action litigation has often been initiated against the company. Litigation
initiated against us, whether or not successful, could result in substantial
costs and diversion of our management’s attention and resources, which could
harm our business and financial condition.
We
do not anticipate dividends to be paid on our Common Stock, and investors may
lose the entire amount of their investment.
Cash dividends have never been declared
or paid on the Common Stock, and we do not anticipate such a declaration or
payment for the foreseeable future. We expect to use future earnings, if any, to
fund business growth. Therefore, stockholders will not receive any funds absent
a sale of their shares. We cannot assure stockholders of a positive return on
their investment when they sell their shares, nor can we assure that
stockholders will not lose the entire amount of their
investment.
24
If
securities analysts do not initiate coverage or continue to cover our Common
Stock or publish unfavorable research or reports about our business, this may
have a negative impact on the market price of our Common Stock.
The trading market for the Common Stock
will depend on the research and reports that securities analysts publish about
our business and the Company. We do not have any control over these analysts.
There is no guarantee that securities analysts will cover the Common Stock. If
securities analysts do not cover the Common Stock, the lack of research coverage
may adversely affect its market price. If we are covered by securities analysts,
and our stock is the subject of an unfavorable report, our stock price and
trading volume would likely decline. If one or more of these analysts ceases to
cover the Company or fails to publish regular reports on the Company, we could
lose visibility in the financial markets, which could cause our stock price or
trading volume to decline.
Further issuances of our Common
Stock could be dilutive.
We may
issue additional shares of our Common Stock, or other securities convertible
into our Common Stock, to fund capital expenditures, including future
acquisitions, or for working capital. If we issue additional shares of our
Common Stock in the future, this may have a dilutive effect on the ownership
interests of our existing shareholders.
Our
internal controls over financial reporting may not be considered effective in
the future, which could result in a loss of investor confidence in our financial
reports and in turn have an adverse effect on our stock price.
Pursuant
to Section 404 of the Sarbanes-Oxley Act of 2002 we are required to furnish a
report by our management on our internal controls over financial reporting. Such
report must contain, among other matters, an assessment of the effectiveness of
our internal controls over financial reporting as of the end of the year,
including a statement as to whether or not our internal controls over financial
reporting are effective. This assessment must include disclosure of any material
weaknesses in our internal controls over financial reporting identified by
management.
For the
fiscal year ended October 31, 2009, our management concluded that, due to the
insufficiency of the depth and breadth of our accounting function, our
disclosure controls and procedures were not adequate and effective to ensure
that our management is alerted to material information required to be included
in our periodic filings with the SEC. Nevertheless, our management has
determined that all matters to be disclosed in this report have been fully and
accurately reported. We are in the process of improving our processes and
procedures to ensure full, accurate and timely disclosure in the current fiscal
year, with the expectation of establishing effective disclosure controls and
procedures as soon as reasonably practicable. However, if we are
unable to sufficiently improve our internal control processes and procedures in
the near future, our investors could lose confidence in the accuracy and
completeness of our financial reports, which in turn could cause our stock price
to decline.
25
ITEM
2. PROPERTIES
Kentucky
USA maintains its principal office at 321 Somerset Road, Suite 1, London, KY
40741 and its telephone number at that office is (606) 878-5987. Kentucky USA’s
current office space is shared with Tri-Global Holdings LLC (“Tri-Global”),
whose office consists of approximately 3,000 square feet. The rent is donated by
the Company’s President, Steven D. Eversole, who is the Managing Partner of
Tri-Global. We believe that our existing facilities are suitable and adequate to
meet our current business requirements.
For a
discussion of the K&D Properties, see Item 1 above
ITEM
3. LEGAL
PROCEEDINGS
Legal
Proceedings
In the
ordinary course of our business, we may from time to time become subject to
routine litigation or administrative proceedings which are incidental to our
business. We are not a party to nor are we aware of any existing,
pending or threatened lawsuits or other legal actions involving
us.
ITEM
4. SUBMISSION
OF MATTERS TO A VOTE OF SECURITY HOLDERS
No
matters were submitted to a vote of security holders, through the solicitation
of proxies or otherwise, during the fourth quarter of the fiscal year covered by
this report.
PART
II
ITEM
5. MARKET
FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES
OF EQUITY SECURITIES
Our
Common Stock is currently listed on the OTC Bulletin Board under the symbol
“KYUS.OB”. Prior to November 7, 2007, our stock was listed on the OTC
Bulletin Board under the symbol “LSRC.OB”.
For the
period from November 1, 2007 to October 31, 2009, the table sets forth the
high and low closing bid prices based upon information obtained from
inter-dealer quotations on the OTC Bulletin Board without retail markup,
markdown, or commission and may not necessarily represent actual
transactions:
26
Quarter Ended
|
High Bid
|
Low Bid
|
||||||
January 31,
2008 (1)
|
$ | 1.23 | $ | 0.53 | ||||
April 30,
2008
|
$ | 1.69 | $ | 1.26 | ||||
July
31, 2008
|
$ | 3.96 | $ | 1.56 | ||||
October
31, 2008
|
$ | 1.82 | $ | 0.41 | ||||
January 31,
2009
|
$ | 0.75 | $ | 0.50 | ||||
April 30,
2009
|
$ | 0.62 | $ | 0.35 | ||||
July
31, 2009
|
$ | 0.44 | $ | 0.38 | ||||
October
31, 2009
|
$ | 0.425 | $ | 0.38 | ||||
January 31,
2010
|
$ | 0.42 | $ | 0.29 |
(1)
|
Although
our stock was approved for listing on the OTC Bulletin Board on July 24,
2007, no trades occurred prior to November 2007. All
information contained herein relating to shares and per share data
reflects the 12:1 forward stock split effected on November 19,
2007. Our Common Stock is thinly traded and, thus, pricing of
our Common Stock does not necessarily represent its fair market
value.
|
Holders
As of
February 5, 2010, we had 36,927,092 shares of our Common Stock issued and
outstanding held by 22 shareholders of record.
Securities
Authorized For Issuance Under Equity Compensation Plans
On
October 19, 2007, our Board of Directors and stockholders adopted the 2007
Equity Incentive Plan (the “2007 Plan”) which reserves a total of 4,000,000
shares of Common Stock for issuance under the 2007 Plan. If an incentive
award granted under the 2007 Plan expires, terminates, is unexercised or is
forfeited, or if any shares are surrendered to us in connection with an
incentive award, the shares subject to such award and the surrendered shares
will become available for further awards under the 2007 Plan. As of the date
hereof, we have not granted any awards under the 2007 Plan.
27
Dividends
We have
never declared any cash dividends with respect to our Common
Stock. Future payment of dividends is within the discretion of our
board of directors and will depend on our earnings, capital requirements,
financial condition and other relevant factors. Although there are no
material restrictions limiting, or that are likely to limit, our ability to pay
dividends on our Common Stock, we presently intend to retain future earnings, if
any, for use in our business and have no present intention to pay cash dividends
on our Common Stock.
Recent
Sales of Unregistered Securities
Sales
by the Company
On
May 29, 2008 we closed a private offering (the “Note Offering”) of an 8%
senior secured convertible note (the “Note”) and warrants (the “Note Warrants”)
to purchase 2,500,000 shares of the Company’s Common Stock to an institutional
investor (the “Note Investor”) for aggregate gross proceeds of $2.5 million. The
Note Offering was conducted pursuant to the exemption from the registration
requirements of the federal securities laws provided by Regulation D and/or
Regulation S and Section 4(2) of the Securities Act. The Note and Note Warrants
were offered and sold only to “accredited investors,” as that term is defined by
Rule 501 of Regulation D, and/or to persons who were neither resident in, nor
citizens of, the United States. Ten percent commissions on the gross proceeds of
the Offering were paid to Westminster Securities Corporation, a registered
broker-dealer, and its registered designees.
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.
In July 2009, we issued 45,000, 150,000
and 125,000 restricted shares of our Common Stock to three consultants,
respectively, in exchange for consulting services. These shares were
issued pursuant to exemptions from the registration requirements of the federal
securities laws provided by Section 4(2) of the Securities Act.
Sales
by KY USA
On
October 5, 2007, KY USA issued the K & D Promissory Note to K&D for
consideration of $1 million. On October 5, 2007, KY USA issued the
Somerset Promissory Note and the Somerset Warrants for consideration of
$800,000. On January 17, 2008, KY USA issued the John Thomas
Promissory Note and the John Thomas Warrants for consideration of
$100,000. On May 9, 2008, the Company issued the May 9th
Promissory Note and the May 9th Bridge
Warrants for consideration of $100,000. The securities issued in each
of these transactions were issued pursuant to the exemption from the
registration requirements of the federal securities laws provided by Section
4(2) of the Securities Act. No sales commissions were paid in connection with
these issuances.
On June
27, 2008, KY USA, entered into a credit agreement (the “Credit Agreement”) with
NSES 12, LLC (the “Lender”), a funding vehicle of New Stream Capital, pursuant
to which KY USA may borrow up to $10,000,000 in the aggregate, under certain
conditions (the “Loan”). Under the Loan, KY USA initially borrowed $2,500,000
(the “Initial Loan”), and may borrow up to an additional aggregate
amount of $7,500,000 in installments of a minimum of $2,500,000 (or such lesser
amounts as the Lender may approve) each (each, an “Installment Loan”), solely at
the discretion of the Lender. The proceeds of the Initial Loan, net
after expenses of the transaction, including a $200,000 credit facility fee paid
to the Lender and a $200,000 consulting fee paid to one consultant at closing,
are being used by KY USA for ongoing working capital purposes,
including the costs and expenses relating to the drilling of our initial wells
in the New Albany shale on the K&D Leasehold. The term note
evidencing the Loan was issued pursuant to the exemption from the registration
requirements of the federal securities laws provided by Section 4(2) of the
Securities Act. No sales commissions were paid in connection with the Initial
Loan.
28
On
February 12, 2009, we received the first Installment Loan in an amount of $2.5
million, on August 14, 2009, we received a second Installment Loan of $600,000
(plus a $50,000 charge to NSES as a fee for waiving certain rights relating to
our breach of the current ration covenant under the Credit Agreement) and on
December 11, 2009, we received an additional Installment Loan of $1.2
million. To date, we have received $6,850,000 under the Credit
Facility.
ITEM
6. SELECTED
FINANCIAL DATA
Not
applicable.
ITEM
7. MANAGEMENT’S
DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
The
following discussion highlights the principal factors that have affected our
financial condition and results of operations as well as our liquidity and
capital resources for the periods described. This discussion contains
forward-looking statements. Please see “Forward-Looking Statements” and “Risk
Factors” for a discussion of the uncertainties, risks and assumptions associated
with these forward-looking statements.
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 $4,740,825, compared to
$3,051,737 for the year ended October 31, 2008.
29
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 $1,387,582 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.
Our
interest expense for the year ended October 31, 2009, was $105,706, 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. We have received one Installment Loan under the Credit
Facility (defined below) on February 12, 2009 in the amount of
$2,500,000. We believe this amount of funds will provide us with
sufficient working capital for the next six to nine months. We plan
to use these funds to bring our presently drilled wells online and to drill an
additional 10 to 12 wells on our 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, $3,200,000. 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 K7D 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.
30
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.
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.
31
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 ration 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.
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 1,194,592 shares 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.
32
On
May 9, 2008, the Company issued a promissory note (the “May 9th
Promissory Note”) with a principal amount of $100,000 to one lender. The
May 9th
Promissory Note was due and payable on June 15, 2008, and bore interest at
10% per annum. Upon closing of the Merger, this lender received warrants
to purchase 200,000 shares of Kentucky USA Common Stock (the “May 9th Bridge
Warrants”), such warrants having an initial exercise price of $1.00 per share
and expiring five years after issuance. The Company repaid the May 9th
Promissory Note out of the proceeds of the Note Offering.
Significant
Accounting Policies
Our
consolidated financial statements and accompanying notes have been prepared in
accordance with United States generally accepted accounting principles applied
on a consistent basis. The preparation of financial statements in conformity
with U.S. generally accepted accounting principles requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities, the disclosure of contingent assets and liabilities at the date of
the financial statements and the reported amounts of revenues and expenses
during the reporting periods.
For a discussion of all of our
significant accounting policies, see
Note 3 to our Consolidated Financial
Statements included in this
Annual Report on Form 10-K.
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.
33
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 hasa 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.
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 of the
financial statements included herein.
ITEM
9. CHANGES
IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
DISCLOSURE
Not
applicable.
ITEM
9A.[T] CONTROLS AND PROCEDURES
Evaluation
of Our Disclosure Controls and Internal Controls
Under the
supervision and with the participation of our senior management, including our
Interim Chief Financial Officer, Charles M. Stivers, we conducted an evaluation
of the effectiveness of the design and operation of our disclosure controls and
procedures, as defined in Rules 13a-15(e) and 15d-15(e) under the Securities
Exchange Act of 1934, as amended (the “Exchange Act”), as of the end of the
period covered by this annual report (the “Evaluation Date”). Based on
this evaluation, our Chief Executive Officer and Interim Chief Financial Officer
concluded as of the Evaluation Date that, due to the insufficiency of the depth
and breadth of our accounting function, our disclosure controls and procedures
were not adequate and effective to ensure that our management is alerted to
material information required to be included in our periodic filings with the
SEC. Nevertheless, our management has determined that all matters to be
disclosed in this report have been fully and accurately reported. We are in the
process of improving our processes and procedures to ensure full, accurate and
timely disclosure in the current fiscal year, with the expectation of
establishing effective disclosure controls and procedures as soon as reasonably
practicable.
34
Our
internal control over financial reporting is a process designed to provide
reasonable assurance regarding the reliability of financial reporting and the
preparation of financial statements for external purposes in accordance with
accounting principles generally accepted in the United
States. Because of its inherent limitations, internal control over
financial reporting may not prevent or detect
misstatements. Therefore, even those systems determined to be
effective can provide only reasonable assurance of achieving their control
objectives. In evaluating the effectiveness of our internal control
over financial reporting, our management used the criteria set forth by the
Committee of Sponsoring Organizations of the Treadway Commission (“COSO”) in
Internal Control – Integrated Framework.
This
annual report does not include an attestation report of our registered public
accounting firm regarding internal control over financial
reporting. Management’s report was not subject to attestation by our
registered public accounting firm pursuant to temporary rules of the Securities
and Exchange Commission that permit us to provide only management’s report in
this annual report.
Officers’
Certifications
Appearing
as exhibits to this Annual Report are “Certifications” of our Chief Executive
Officer and Interim Chief Financial Officer. The Certifications are
required pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (the “Section
302 Certifications”). This section of the Annual Report contains
information concerning the Controls Evaluation referred to in the Section 302
Certification. This information should be read in conjunction with
the Section 302 Certifications for a more complete understanding of the topics
presented.
Changes
in Internal Control Over Financial Reporting
During
our most recent fiscal year ended October 31, 2009, there were no changes
in our internal control over financial reporting that have materially affected
or are reasonably likely to affect, our internal control over financial
reporting.
ITEM
9B. OTHER
INFORMATION
On July
18, 2008 KY USA entered into a capital lease (the “Lease”) with The Magdovitz
Family Trust (the “Lessor”). The Lease is for certain drilling
equipment with a total lease price of $307,394. The terms of the Lease require
KY to make forty-two monthly installments on the first day of each month,
beginning on August 1, 2008. At the conclusion of the Lease, KY will
have available the option to purchase the equipment, which at October 31, 2009
has a carrying value of $197,610, for consideration of $1.00. Under
the terms of the Lease, KY will assume and bear the entire risk of loss and
damage to the equipment, will be required to insure the equipment and will
indemnify the Lessor against costs and liabilities of KY arising out of its use
of the equipment. We have agreed to guarantee the
Lease.
35
On August 4, 2008, KY USA paid $15,000
to Hilltopper Energy, LLC for an exclusive and irrevocable option (the “Option”)
to acquire certain rights in two oil and gas leases (the “Leases”), one covering
approximately 1,000 acres in Todd County, Kentucky, at an acquisition price of
$140,000, and one covering approximately 100 acres in Owsley County, Kentucky,
for an acquisition price of $20,000. Pursuant to the Option
and upon acquisition of the Leases, KY USA would be entitled to all working
rights in the Lease properties and an 82% net revenue interest in the oil and
gas found from the top of the New Albany Shale formation under the properties
subject to the Leases to the depth drilled. The Option expired on February 4, 2009
and on March 3, 2009 was extended until August 4, 2009 for an additional
consideration of $15,000. Although the Option extension has
officially expired, the parties currently have an oral understanding that the
Option may continue to be exercised.
36
PART
III
ITEM
10. DIRECTORS,
EXECUTIVE OFFICERS, AND CORPORATE GOVERNANCE
Executive
Officers and Directors
Below are
the names and certain information regarding the Company’s current executive
officers and directors who were appointed upon the closing of the
Merger:
Name:
|
Age
|
Title
|
||
Steven D. Eversole
|
|
49
|
|
Chief
Executive Officer and Director
|
Charles
M. Stivers
|
|
48
|
|
Interim
Chief Financial Officer
|
C.
G. Collins
|
|
69
|
|
Vice
President of Engineering and Development and
Director
|
Directors
are elected to serve until the next annual meeting of stockholders and until
their successors are elected and qualified. Pursuant to the terms of
the Merger Agreement, KY USA and the Company agreed that the Company’s Board of
Directors, as of the closing of the Merger, would consist of five members, four
of whom were to be designated by KY USA and one, to be designated by the
Company. Our Board of directors is now comprised of two members both
of whom were designated by KY USA. As of the closing of the Merger,
the Company (pre-Merger) had not designated an individual to serve on our Board
of Directors and a current stockholder of the Company who was a stockholder
prior to the Merger has succeeded to that right.
Currently,
directors are not compensated for their services, although their expenses in
attending meetings may be reimbursed. Officers are elected by the Board of
Directors and serve until their successors are appointed by the Board of
Directors. Biographical resumes of each officer and director are set forth
below.
Steven D. Eversole has been
the Chief Executive Officer of KY USA since October 2007 and became the Chief
Executive Officer of the Company after the Merger. Since 2002, Mr. Eversole
has been the Managing Partner of Tri Global Holdings, LLC, a private financing
company for homeowners with financial difficulty. He began his career with
American Electric Power (AEP), a Fortune 100 company. Mr. Eversole received
a Bachelor of Science degree from Eastern Kentucky University in Industrial
Technology.
Charles M. Stivers was
appointed the Interim Chief Financial Officer of the Company on June 27,
2008. Mr. Stivers is a certified public accountant who, since 1990,
has operated his own CPA firm, Charles M. Stivers, C.P.A., specializing in the
oil and gas industry. Since 1998, Mr. Stivers has been president of Bowling
Branch Investments, Inc., a private investment company. Mr. Stivers is currently
a director of Miller Petroleum Inc., a publicly traded company, and serves as
head of, and an “audit committee financial expert” for, Miller Petroleum’s Audit
Committee. He received a Bachelor of Science degree in Business
Administration-Accounting from Eastern Kentucky University.
37
C. G. Collins became the Vice
President of Engineering and Development of the Company in connection with the
Merger. Since 1969, Mr. Collins has run his own company, Collins Petroleum,
Inc. and from 1997 to the present, he has been an Independent Petroleum
Engineer, having drilled and/or developed wells in Kentucky, Tennessee,
Illinois, and Indiana. Mr. Collins’ experience ranges from equipment
operator in 1960 to manager-in-charge with Dowell, a division of Dow Chemical.
From 1965 to 1969, Mr. Collins was in charge of completion and
re-completion of oil and gas wells. He was manager-in-charge for the eastern
half of Michigan for Dowell. Mr. Collins has served as President of both
the Tennessee Oil and Gas Association and the Kentucky Oil and Gas Association;
was named Oil Man of the Year – Tennessee; and is affiliated with the American
Institute of Mining, Metallurgical and Petroleum Engineering, the American
Petroleum Institute, and the Society of Petroleum Engineers. He holds a Bachelor
of Science degree in Chemistry from Campbellsville University and a Bachelor of
Science degree in Petroleum Engineering from the University of
Texas.
Samuel L.
Winer who had been appointed as our Chief Financial Officer and director upon
the closing of the Merger resigned from those positions on June 27, 2008. Mr.
Winer did not have any disagreement with us on any matter relating to our
operations, policies or practices.
Board
Committees
The
Company currently has not established any committees of the Board of Directors.
Our Board of Directors may designate from among its members an executive
committee and one or more other committees in the future. We do not
have a standing audit committee, an audit committee financial expert, or any
committee or person performing a similar function. We do not have a
nominating committee or a nominating committee charter. Further, we
do not have a policy with regard to the consideration of any director candidates
recommended by security holders. To date, no security holders have
made any such recommendations. Our two directors perform all
functions that would otherwise be performed by committees. Given the
present size of our board it is not practical for us to have
committees. Additionally, management does not believe that it would
be in our best interests at this time to retain independent directors to sit on
an audit committee or any other committee. If we are able to grow our business
and increase our operations, we intend to expand the size of our board and
allocate responsibilities accordingly, and we will likely seek out and retain
independent directors and form audit, compensation, and other applicable
committees.
We are
not currently subject to listing requirements of any national securities
exchange or inter-dealer quotation system which has requirements that a majority
of the board of directors be “independent” and, as a result, we are not at this
time required to (and we do not) have our Board of Directors comprised of a
majority of “Independent Directors.”
38
Code
of Ethics
We have
adopted a written code of ethics (the “Code of Ethics”) that applies to our
principal executive officer, principal financial officer, principal accounting
officer or controller, and persons performing similar functions. We believe that
the Code of Ethics is reasonably designed to deter wrongdoing and promote honest
and ethical conduct; provide full, fair, accurate, timely and understandable
disclosure in public reports; comply with applicable laws; ensure prompt
internal reporting of code violations; and provide accountability for adherence
to the code. To request a copy of the Code of Ethics, please make
written request to our President c/o Kentucky USA Energy, Inc., 321 Somerset
Road, Suite 1, London, KY 40741.
Compliance
with Section 16(a) of the Exchange Act
We filed
a Form 8-A to register the Common Stock under Section 12(g) of the Exchange Act
on July 16, 2009. Therefore, since that date, our executive officers,
directors and greater than ten percent shareholders have been subject to the
beneficial ownership reporting requirements of Section 16(a) of the Exchange
Act. Based solely on a review of the copies of Section 16 reports and
written representations from the reporting persons that no other reports were
required, we believe that during the fiscal year ended October 31, 2009, our
Executive Officers, Directors and greater than ten percent shareholders filed on
a timely basis all reports due under Section 16(a) of the Exchange
Act.
ITEM
11. EXECUTIVE
COMPENSATION
The
following table sets forth information concerning the total compensation paid or
accrued by us during the fiscal year ended October 31, 2009 to (i) all
individuals that served as our principal executive officer or acted in a similar
capacity for us at any time during the fiscal year ended October 31, 2009; (ii)
all individuals that served as our principal financial officer or acted in a
similar capacity for us at any time during the fiscal year ended October 31,
2009; and (iii) all individuals that served as executive officers of ours at any
time during the fiscal year ended October 31, 2009 that received annual
compensation during the fiscal year ended October 31, 2009 in excess of
$100,000.
39
Summary
Compensation Table
Name
and
Principal Position
|
Year
|
Salary
($)
|
Bonus
($)
|
Stock
Awards
($)
|
Option
Awards
($)
|
Non-
Equity
Incentive
Plan
Compen-
sation
($)
|
Change
in
Pension
Value
and
Non-
qualified
Deferred
Compen-
sation
Earnings
($)
|
All
Other
Compensation
($)
|
Total
($)
|
|||||||||||||||||||||||||
(a)
|
(b)
|
(c)
|
(d)
|
(e)
|
(f)
|
(g)
|
(h)
|
(i)
|
(j)
|
|||||||||||||||||||||||||
Steven
D. Eversole, Chief
|
2009
|
90,000 | 0 | 0 | 0 | 0 | 0 | 0 | 90,000 | |||||||||||||||||||||||||
Executive
Office (1)
|
2008
|
61,109 | 0 | 0 | 0 | 0 | 0 | 0 | 61,109 | |||||||||||||||||||||||||
Charles
M. Stivers, Interim
|
2009
|
60,000 | 0 | 0 | 0 | 0 | 0 | 0 | 60,000 | |||||||||||||||||||||||||
Principal
Financial Officer (2)
|
2008
|
15,000 | 0 | 0 | 0 | 0 | 0 | 0 | 15,000 |
(1)
|
Effective
upon the closing of the Merger on May 2, 2008, Mr. Greenwood resigned as,
and Mr. Eversole was appointed, our Chief Executive
Officer.
|
(2)
|
Mr.
Stivers was appointed our Interim Principal Financial Officer on June 27,
2008.
|
We have
not issued any stock options or maintained any stock option or other incentive
plans other than our 2007 Plan. (See “Item 5. Market for Common Equity and
Related Stockholder Matters – Securities Authorized for Issuance Under Equity
Compensation Plans” above.) We have no plans in place and have never maintained
any plans that provide for the payment of retirement benefits or benefits that
will be paid primarily following retirement including, but not limited to, tax
qualified deferred benefit plans, supplemental executive retirement plans,
tax-qualified deferred contribution plans and nonqualified deferred contribution
plans.
Except as
indicated below, we have no contracts, agreements, plans or arrangements,
whether written or unwritten, that provide for payments to the named executive
officers listed above.
Employment
Agreements with Named Executive Officers
In
connection with the Merger, the Company entered into an employment agreement
with Steven D. Eversole with the following terms:
The
Company entered into an employment agreement with Mr. Eversole to serve as
Chief Executive Officer, effective May 2, 2008. Pursuant to the agreement,
Mr. Eversole will receive annual compensation of $90,000 for a period of
four years. In addition, Mr. Eversole is entitled to participate in any and
all benefit plans, from time to time, in effect for the Company employees, along
with vacation, sick and holiday pay in accordance with policies established and
in effect from time to time. In the event that Mr. Eversole terminates the
employment agreement for “Good Reason” (as defined therein) or the Company
terminates the employment agreement without Cause (as defined therein),
Mr. Eversole will be entitled to a severance payment of one year base
salary. The employment agreement automatically renews for one year periods
thereafter unless terminated pursuant to the agreement.
40
Compensation
of Directors
None of
our current directors receives any compensation for serving as such, for serving
on committees of the board of directors or for special assignments. During the
fiscal year ended October 31, 2009 and except as set forth above, there were no
other arrangements between us and our directors that resulted in our making
payments to any of our directors for any services provided to us by them as
directors.
ITEM
12. SECURITY OWNERSHIP OF CERTAIN
BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
The
following table sets forth information with respect to the beneficial ownership
of our common stock known by us as of February 5, 2010 by:
|
·
|
each
person or entity known by us to be the beneficial owner of more than 5% of
our common stock;
|
|
·
|
each
of our directors;
|
|
·
|
each
of our executive officers; and
|
|
·
|
all
of our directors and executive officers as a
group.
|
Except as
otherwise indicated, the persons listed below have sole voting and investment
power with respect to all shares of our common stock owned by them, except to
the extent such power may be shared with a spouse.
Unless
otherwise indicated in the following table, the address for each person named in
the table is c/o Kentucky USA Energy, Inc., 321 Somerset Road, Suite 1, London,
KY 40741.
41
NAME
OF OWNER
|
TITLE
OF
CLASS
|
NUMBER
OF
SHARES
OWNED (1)
|
PERCENTAGE
OF
COMMON
STOCK (2)
|
||||||
Steven
D. Eversole
|
Common
Stock
|
7,600,000 | (3) | 20.6 | % | ||||
Charles
M. Stivers
|
Common
Stock
|
23,750 | (4) | * | |||||
C.
G. Collins
|
Common
Stock
|
3,420,000 | (5) | 9.3 | % | ||||
All
Officers and Directors
|
Common
Stock
|
11,043,750 | 29.9 | % | |||||
As
a Group (3 persons)
|
|||||||||
Saddlebrook
Holdings, LLC (6)
|
Common
Stock
|
6,080,000 | 16.5 | % | |||||
22
Saddlebrook Garden
|
|||||||||
London,
KY 40744
|
|||||||||
Collins
Family Trust (7)
|
Common
Stock
|
3,420,000 | 9.3 | % | |||||
107
Forest Hills Drive
|
|||||||||
Campbellsville,
KY 42718
|
|||||||||
Trinity
Group Holdings, LLC (8)
|
Common
Stock
|
3,420,000 | 9.3 | % | |||||
88
Grand Circle Drive
|
|||||||||
Somerset,
KY 42503
|
|||||||||
Tillerman
Securities, Ltd. (9)
|
Common
Stock
|
2,500,000 | 6.8 | % | |||||
One
George Street
|
|||||||||
Nassau
NP, Bahamas
|
|||||||||
Winer
Family Trust (10)
|
Common
Stock
|
2,042,500 | 5.5 | % | |||||
7270
Maidencane Ct.
|
|||||||||
Largo,
FL 33777
|
*Less
than 1%.
(1)
|
Beneficial
Ownership is determined in accordance with the rules of the SEC and
generally includes voting or investment power with respect to securities.
Shares of common stock subject to options or warrants currently
exercisable or convertible, or exercisable or convertible within 60 days
of February 5, 2010 are deemed outstanding for computing the percentage of
the person holding such option or warrant but are not deemed outstanding
for computing the percentage of any other
person.
|
(2)
|
Percentage
based upon 36,927,092 shares of common stock outstanding as of February 5,
2010.
|
(3)
|
Includes
6,080,000 shares of Common Stock held by Saddlebrook Holdings, LLC, of
which Mr. Eversole has voting and investment control over shares held by
such entity. Does not include 80,000 shares of Common Stock
beneficially owned by Mr. Eversole and 320,000 shares of Common Stock
beneficially owned by Saddlebrook Holdings, LLC but held in the
Indemnification Escrow pursuant to the Merger
Agreement.
|
(4)
|
Does
not include 1,250 shares of Common Stock held in the Indemnification
Escrow pursuant to the Merger
Agreement.
|
(5)
|
Represents
shares of Common Stock held by the Collins Family Trust, of which Mr.
Collins is a trustee and has voting and investment control over shares
held by such entity. Does not include 180,000 shares of Common
Stock beneficially owned by the Collins Family Trust but held in the
Indemnification Escrow pursuant to the Merger
Agreement.
|
(6)
|
Steven
and Katherine Eversole, as members, have voting and investment control
over shares of Common Stock held by this entity. Does not include 320,000
shares of Common Stock beneficially owned by Saddlebrook Holdings, LLC
but held in the Indemnification Escrow pursuant to the Merger
Agreement.
|
42
(7)
|
C.G.
and Lynda Collins, as trustees, have voting and investment control over
shares of Common Stock held by this entity. Does not include
180,000 shares of Common Stock beneficially owned by the Collins Family
Trust but held in the Indemnification Escrow pursuant to the Merger
Agreement.
|
(8)
|
M.
Joel and Cynthia A. Patton, as members, have voting and investment control
over shares of Common Stock held by this
entity.
|
(9)
|
Represents
shares of Common Stock eligible to be acquired within 60 days through the
exercise of the Note Warrants.
|
(10)
|
Scott
L. Wyler, as trustee, has voting and investment control over shares of
Common Stock held by this entity. Does not include 110,000
shares of Common Stock beneficially owned by the Winer Family Trust but
held in the Indemnification Escrow pursuant to the Merger
Agreement.
|
Securities
Authorized for Issuance Under Equity Compensation Plans
We have
one compensation plan approved by our stockholders, the 2007 Plan. As of the
date hereof, we have not granted any awards under the 2007 Plan.
ITEM
13. CERTAIN RELATIONSHIPS AND RELATED
TRANSACTIONS, AND DIRECTOR INDEPENDENCE
Not
applicable.
ITEM
14. PRINCIPAL ACCOUNTANT FEES AND
SERVICES
Audit
Fees.
The
aggregate fees billed to us by our principal accountant for services rendered
during the fiscal years ended October 31, 2009 and 2008 are set forth in the
table below:
Fee Category
|
Fiscal year ended October 31,
2009
|
Fiscal year ended October 31,
2008
|
||||||
Audit
fees (1)
|
$ | 87,367 | $ | 41,493 | ||||
Audit-related
fees (2)
|
||||||||
Tax
fees (3)
|
||||||||
All
other fees (4)
|
||||||||
Total
fees
|
$ | 87,367 | $ | 41,493 |
(1)
|
Audit
fees consists of fees incurred for professional services rendered for the
audit of consolidated financial statements, for reviews of our interim
consolidated financial statements included in our quarterly reports on
Form 10-QSB and for services that are normally provided in connection with
statutory or regulatory filings or
engagements.
|
43
(2)
|
Audit-related
fees consists of fees billed for professional services that are reasonably
related to the performance of the audit or review of our consolidated
financial statements, but are not reported under “Audit
fees.”
|
(3)
|
Tax
fees consists of fees billed for professional services relating to tax
compliance, tax planning, and tax
advice.
|
(4)
|
All
other fees consists of fees billed for all other
services.
|
Audit Committee’s
Pre-Approval Practice.
We do not
have an audit committee. Our board of directors performs the function
of an audit committee. Section 10A(i) of the Securities Exchange Act
of 1934, as amended, prohibits our auditors from performing audit services for
us as well as any services not considered to be audit services unless such
services are pre-approved by our audit committee or, in cases where no such
committee exists, by our board of directors (in lieu of an audit committee) or
unless the services meet certain de minimis standards.
44
PART
IV
ITEM
15. EXHIBITS AND FINANCIAL STATEMENT
SCHEDULES
Financial
Statement Schedules
All
financial statement schedules are omitted because they are not applicable or the
required information is shown in the financial statements or notes
thereto.
Exhibits
The
following Exhibits are being filed with this Annual Report on Form
10-K:
Exhibit
No.
|
SEC
Report
Reference
Number
|
Description
|
||
2.1
|
2.1
|
Agreement
and Plan of Merger and Reorganization, dated as of May 2, 2008, by and
among Kentucky USA Energy, Inc., KY Acquisition Corp. and KY USA Energy,
Inc. (1)
|
||
2.2
|
2.2
|
Split-Off
Agreement, dated as of May 2, 2008, by and among Kentucky USA Energy,
Inc., Christopher Greenwood, Las Rocas Leaseco Corp. and KY USA Energy,
Inc. (1)
|
||
3.1
|
3.1
|
Amended
and Restated Certificate of Incorporation of Registrant as filed with the
Delaware Secretary of State on October 26, 2007 (2)
|
||
3.2
|
3.2
|
By-Laws
of Registrant (3)
|
||
3.3
|
2.3
|
Amendment
to By-laws of Kentucky USA Energy, Inc. (formerly Las Rocas Mining Corp.)
(1)
|
||
3.4
|
3.2
|
Articles
of Merger of KY Acquisition Corp. into KY USA Energy, Inc.
(1)
|
||
4.1
|
4.1
|
Form
of Senior Secured Credit Agreement Between KY USA Energy, Inc. and NSES
12, LLC (4)
|
||
4.2
|
4.2
|
Form
of $10,000,000 Term Note of KY USA Energy, Inc. (4)
|
||
4.3
|
4.3
|
Form
of Security Agreement between KY USA Energy, Inc. and NSES 12, LLC
(4)
|
||
4.4
|
|
4.4
|
|
Form
of Leasehold Mortgage, Assignment of Production, Security Agreement and
Financing Statement from KY USA Energy, Inc. to NSES 12, LLC
(4)
|
45
Exhibit
No.
|
SEC
Report
Reference
Number
|
Description
|
||
4.5
|
4.5
|
Form
of Guarantee Agreement between Kentucky USA Energy, Inc. and NSES 12, LLC
(4)
|
||
4.6
|
4.6
|
Form
of Subordination Agreement by and among Kentucky USA Energy, Inc., KY USA
Energy, Inc. and NSES 12, LLC (4)
|
||
4.7
|
4.7
|
Form
of Subordination Agreement by and among 8% senior secured convertible note
holder, KY USA Energy, Inc. and NSES 12, LLC (4)
|
||
4.8
|
4.8
|
Form
of Subordination Agreement by and among 8% senior secured convertible note
holder, Kentucky USA Energy, Inc. and NSES 12, LLC
(4)
|
||
10.1
|
10.1
|
Registrant’s
2007 Equity Incentive Plan adopted October 19, 2007, 2007
(5)
|
||
10.2
|
10.2
|
Escrow
Agreement, dated as of May 2, 2008, by and among Kentucky USA Energy,
Inc., Steven D. Eversole and Gottbetter & Partners,
LLP (1)
|
||
10.3
|
10.3
|
IR
Shares Escrow Agreement, dated as of May 2, 2008, by and between Kentucky
USA Energy, Inc. and Gottbetter & Partners,
LLP (1)
|
||
10.4
|
10.4
|
Form
of Lock-Up Agreement, dated as of May 2, 2008 (1)
|
||
10.5
|
10.5
|
General
Release Agreement, dated as of May 2, 2008, by and among Kentucky USA
Energy, Inc., Christopher Greenwood, Las Rocas Leaseco, Inc. and KY USA
Energy, Inc. (1)
|
||
10.6
|
10.6
|
Employment
Agreement, dated as of May 2, 2008, by and between Kentucky USA Energy,
Inc. and Steven D. Eversole (1)
|
||
10.7
|
10.7
|
Employment
Agreement, dated as of May 2, 2008, by and between Kentucky USA Energy,
Inc. and Samuel L. Winer (1)
|
||
10.8
|
10.8
|
Employment
Agreement, dated as of May 2, 2008, by and between Kentucky USA Energy,
Inc. and C. G. Collins (1)
|
||
10.9
|
10.9
|
Form
of Bridge Lender Warrant, dated as of May 2,
2008 (1)
|
||
10.10
|
10.1
|
Form
of Securities Purchase Agreement (6)
|
||
10.11
|
|
10.2
|
|
Form
0f 8% Senior Convertible Note
(6)
|
46
Exhibit
No.
|
SEC
Report
Reference
Number
|
Description
|
||
10.12
|
10.3
|
Form
of Warrant to Purchase Common Stock (6)
|
||
10.13
|
10.4
|
Form
of Registration Rights Agreement (6)
|
||
10.14
|
10.5
|
Form
of Security Agreement (6)
|
||
10.15
|
10.6
|
Form
of Subsidiary Guarantee (6)
|
||
10.16
|
10.1
|
Form
of Farm-Out Assignment of Correction by and between K & D Energy and
KY USA Energy, Inc. dated June 18, 2008 (4)
|
||
10.17
|
10.2
|
Form
of Farm-Out Assignment by and between K & D Energy and KY USA Energy,
Inc. dated as of October 4, 2007 (4)
|
||
10.18
|
10.3
|
Form
of Supplemental Farm-Out Assignment by and between K & D Energy and KY
USA Energy, Inc. dated as of December 10, 2007 (4)
|
||
10.19
|
10.19
|
Kentucky
Agreement to Lease Equipment (with Warranty) by and between The Magdovitz
Family Trust and KY USA Energy, Inc. dated July 18, 2008
(7)
|
||
10.20
|
10.20
|
Option
to Purchase Lease between KY USA Energy, Inc. and Hilltopper Energy, LLC
dated as of August 4, 2008 (the “Option”) and Addendum to the Option dated
as of March 3, 2009 (7)
|
||
10.21
|
10.1
|
Gas
Gathering & Treatment Agreement dated August 6, 2009 by and among the
Registrant, Seminole Energy Services, L.L.C. and Seminole Gas Company,
L.L.C. (8)
|
||
10.22
|
10.2
|
Farm-out
agreement dated August 20, 2009 by and between the Registrant and
Thomasson Petroleum Enterprises, Inc. (8)
|
||
10.23
|
10.3
|
Participation
agreement dated July 22, 2009 by and between the Registrant and 7921
Energy LLC (8)
|
||
10.24
|
10.24
|
Base
Contract for the Sale and Purchase of Natural Gas by and between Seminole
Energy Services, L.L.C. and the Registrant
|
||
10.25
|
10.25
|
Farm-Out
Agreement by and between Thomasson Petroleum Enterprises, Inc. and KY USA
Energy, Inc. dated January 21, 2010
|
||
14.1
|
14.1
|
Code
of Ethics (7)
|
||
21
|
|
*
|
|
List
of Subsidiaries
|
47
Exhibit
No.
|
SEC
Report
Reference
Number
|
Description
|
||
31.1
|
*
|
Certification
of Principal Executive Officer, pursuant to SEC Rules 13a-14(a) and
15d-14(a), adopted pursuant to Section 302 of the Sarbanes-Oxley Act
of 2002
|
||
31.2
|
*
|
Certification
of Interim Principal Financial Officer, pursuant to SEC
Rules 13a-14(a) and 15d-14(a), adopted pursuant to Section 302
of the Sarbanes-Oxley Act of 2002
|
||
32.1
|
*
|
Certification
of Chief Executive Officer, pursuant to 18 U.S.C. Section 1350,
adopted pursuant to Section 906 of the Sarbanes-Oxley Act of
2002**
|
||
32.2
|
*
|
Certification
of Interim Chief Financial Officer, pursuant to 18 U.S.C.
Section 1350, adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002**
|
||
99.1
|
*
|
Map
of the Registrants Albany Shale well Project
|
||
99.2
|
|
99.1
|
|
Form
of Registrant’s Stock Subscription Agreement
(3)
|
(1)
|
Filed
with the Securities and Exchange Commission (the “SEC”) on May 5, 2008 as
an exhibit, numbered as indicated above, to the Registrant’s current
report (SEC File No. 333-141480) on Form 8-K, which exhibit is
incorporated herein by reference
|
(2)
|
Filed
with the SEC on November 1, 2007 as an exhibit, numbered as indicated
above, to the Registrant’s current report (SEC File No. 333-141480) on
Form 8-K, which exhibit is incorporated herein by
reference.
|
(3)
|
Filed
with the SEC on March 22, 2007 as an exhibit, numbered as indicated above,
to the Registrant’s registration statement (SEC File No. 333-141480) on
Form SB-2, which exhibit is incorporated herein by
reference.
|
(4)
|
Filed
with the SEC on July 1, 2008 as an exhibit, numbered as indicated above,
to the Registrant’s current report (SEC File No. 333-141480) on Form 8-K,
which exhibit is incorporated herein by
reference.
|
(5)
|
Filed
with the SEC on January 14, 2008 as an exhibit, numbered as indicated
above, to the Registrant’s quarterly report (SEC File No. 333-141480) on
Form 10-KSB, which exhibit is incorporated herein by
reference.
|
48
(6)
|
Filed
with the SEC on June 4, 2008 as an exhibit, numbered as indicated above,
to the Registrant’s current report (SEC File No. 333-141480) on Form 8-K,
which exhibit is incorporated herein by
reference.
|
(7)
|
Filed
with the SEC on March 16, 2009 as an exhibit, numbered as indicated above,
to the Registrant’s annual report (SEC File No. 333-141480) on Form 10-K,
which exhibit is incorporated herein by
reference.
|
(8)
|
Filed
with the SEC on September 21, 2009 as an exhibit, numbered as indicated
above, to the Registrant’s quarterly report (SEC File No. 333-141480) on
Form 10-Q, which exhibit is incorporated herein by
reference.
|
* Filed
herewith.
** This
certification is being furnished and shall not be deemed “filed” with the SEC
for purposes of Section 18 of the Exchange Act, or otherwise subject to the
liability of that section, and shall not be deemed to be incorporated by
reference into any filing under the Securities Act or the Exchange Act, except
to the extent that the Registrant specifically incorporates it by
reference.
In
reviewing the agreements included as exhibits to this Annual Report on Form
10-K, please remember that they are included to provide you with information
regarding their terms and are not intended to provide any other factual or
disclosure information about the Company or the other parties to the agreements.
The agreements may contain representations and warranties by each of the parties
to the applicable agreement. These representations and warranties have been made
solely for the benefit of the parties to the applicable agreement
and:
•
|
should
not in all instances be treated as categorical statements of fact, but
rather as a way of allocating the risk to one of the parties if those
statements prove to be inaccurate;
|
•
|
have
been qualified by disclosures that were made to the other party in
connection with the negotiation of the applicable agreement, which
disclosures are not necessarily reflected in the
agreement;
|
•
|
may
apply standards of materiality in a way that is different from what may be
viewed as material to you or other investors;
and
|
•
|
were
made only as of the date of the applicable agreement or such other date or
dates as may be specified in the agreement and are subject to more recent
developments.
|
Accordingly,
these representations and warranties may not describe the actual state of
affairs as of the date they were made or at any other time. Additional
information about the Company may be found elsewhere in this Annual Report on
Form 10-K and the Company’s other public filings, which are available without
charge through the SEC’s website at http://www.sec.gov.
49
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: February
16, 2010
|
By:
|
|
Steven
D. Eversole, President and
|
||
Chief
Executive Officer
|
||
By:
|
/s/ Charles M. Stivers
|
|
Charles
M. Stivers, Interim Principal
|
||
Financial
Officer
|
In
accordance with the Exchange Act, this report has been signed below by the
following persons on behalf of the registrant and in the capacities and on the
dates indicated.
SIGNATURE
|
TITLE
|
DATE
|
||
/s/ Steven D. Eversole
|
Director
|
|||
Steven
D. Eversole
|
February
16, 2010
|
|||
/s/ c.G. Collins
|
Director
|
February
16, 2010
|
||
C.G.
Collins
|
50
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, 2008
|
|||||||
ASSETS
|
||||||||
Current
Assets
|
||||||||
Cash
and cash equivalents
|
$ | 59,105 | $ | 899,037 | ||||
Prepaid
expenses
|
37,006 | 15,613 | ||||||
Total
current assets
|
96,111 | 914,650 | ||||||
Other
Assets
|
||||||||
Loan
fees, net of accumulated amortization of $509,511 and
$145,115
|
640,694 | 1,005,090 | ||||||
Investment
in natural gas properties, using full cost method
|
7,708,811 | 3,796,351 | ||||||
Total
other assets
|
8,349,505 | 4,801,441 | ||||||
Other
property and equipment, net of accumulated depreciation of $42,258
and$7,830
|
450,650 | 306,366 | ||||||
Total
assets
|
$ | 8,896,266 | $ | 6,022,457 | ||||
LIABILITIES
AND STOCKHOLDERS' EQUITY (DEFICIT)
|
||||||||
Current
Liabilities
|
||||||||
Accounts
payable
|
$ | 343,890 | $ | 188,225 | ||||
Accrued
interest
|
522,303 | 81,928 | ||||||
Accrued
liabilities
|
7,763 | - | ||||||
Stock
liability
|
149,125 | 188,600 | ||||||
Derivative
liability
|
1,015,971 | 1,723,453 | ||||||
Notes
payable, due within one year
|
6,300,000 | 3,150,000 | ||||||
Capital
lease obligations, due within one year
|
94,847 | 83,268 | ||||||
Total
current liabilities
|
8,433,899 | 5,415,474 | ||||||
Long-term
Debt
|
||||||||
Convertible
debt, net of discounts of $1,527,779 and $2,152,778
|
972,220 | 347,222 | ||||||
Capital
lease obligations, less amounts due within one year
|
110,083 | 202,169 | ||||||
Total
long-term debt
|
1,082,303 | 549,391 | ||||||
Total
liabilities
|
9,516,202 | 5,964,865 | ||||||
Stockholders'
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 | 3,619 | ||||||
Additional
paid-in capital
|
4,298,928 | 3,427,498 | ||||||
Deficit
accumulated during exploration stage
|
(4,922,556 | ) | (3,373,525 | ) | ||||
Total
stockholders' equity (deficit)
|
(619,936 | ) | 57,592 | |||||
Total
liabilities and stockholders' equity (deficit)
|
$ | 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, through
|
||||||||||
October 31, 2009
|
October 31, 2008
|
October 31, 2009
|
||||||||||
General
and Administrative Expenses
|
||||||||||||
Amortization
of loan fees
|
$ | 418,234 | $ | 145,115 | $ | 563,349 | ||||||
General
and administrative
|
195,715 | 46,527 | 242,242 | |||||||||
Legal
and accounting
|
1,387,582 | 676,217 | 2,065,799 | |||||||||
Loss
from operations
|
(2,001,531 | ) | (867,859 | ) | (2,871,390 | ) | ||||||
Other
Income (expense)
|
||||||||||||
Changes
in fair value of derivative liability
|
558,206 | 4,596,769 | 5,154,975 | |||||||||
Interest
expense
|
(105,706 | ) | (7,094,735 | ) | (7,206,141 | ) | ||||||
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 share
|
||||||||||||
Basic
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)
Consolidated
Statement of Changes in Stockholders’ deficit
Deficit
|
Total
|
|||||||||||||||||||
Common
|
Additional
|
Accumulated
|
Stockholders’
|
|||||||||||||||||
Stock
|
Common
|
Paid
-in
|
During
Exploration
|
Equity
|
||||||||||||||||
Shares
|
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 | - | 2,000 | |||||||||||||||
Net
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 | ) | - | 200 | ||||||||||||||
May
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 | - | 8,500,000 | |||||||||||||||
Issuance
of stock in partial settlement of derivative liability - May
2008
|
1,194,592 | 119 | 3,428,798 | - | 3,428,917 | |||||||||||||||
Net
loss for the year
|
- | - | - | (3,365,825 | ) | (3,365,825 | ) | |||||||||||||
Balance
at October 31, 2008
|
36,194,592 | 3,619 | 3,427,498 | (3,373,525 | ) | 57,592 | ||||||||||||||
December
2008 issuance of 412,500 shares in connection with services
provided
|
412,500 | 41 | 562,312 | - | 562,353 | |||||||||||||||
June
2009 issuance of 320,000 shares in connection with services
provided
|
320,000 | 32 | 309,118 | - | 309,150 | |||||||||||||||
Net
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
Inception
|
||||||||||||
Year
Ended
|
Year
Ended
|
October
5, 2007 through
|
||||||||||
October 31, 2009
|
October 31, 2008
|
October 31, 2009
|
||||||||||
Net
loss
|
$ | (1,549,031 | ) | $ | (3,365,825 | ) | $ | (3,727,115 | ) | |||
Adjustments
to reconcile net loss to net cash flows from operating
activities
|
||||||||||||
Gains
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 | 7,273,830 | |||||||||
Amortization
of loan fees
|
364,396 | 145,115 | 509,511 | |||||||||
Depreciation
|
34,428 | 7,830 | 42,258 | |||||||||
Common
stock issued for services
|
871,503 | - | 873,503 | |||||||||
(Increase)
in assets and increase in liabilities
|
||||||||||||
Prepaid
expenses
|
(21,391 | ) | 34,425 | 13,034 | ||||||||
Accounts
payable and accrued liabilities
|
163,428 | 188,225 | 351,653 | |||||||||
Stock
liability
|
(39,475 | ) | 188,600 | 149,125 | ||||||||
Accrued
interest
|
440,375 | 76,229 | 522,304 | |||||||||
Total
adjustments to reconcile net loss to net cash from operating
activities
|
1,676,941 | 2,895,602 | 4,580,243 | |||||||||
Net
cash flows from operating activities
|
127,910 | (470,223 | ) | 853,128 | ||||||||
Cash
flows from investing activities
|
||||||||||||
Purchase
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 activities
|
||||||||||||
Proceeds
from borrowings
|
3,150,000 | 5,100,000 | 10,050,000 | |||||||||
Proceeds
from borrowings under capital leases
|
- | 307,394 | 307,394 | |||||||||
Loan
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 | 7,854,724 | |||||||||
Net
change in cash
|
(839,932 | ) | 868,805 | 1,254,546 | ||||||||
Cash
and cash equivalents, beginning of period
|
899,037 | 30,232 | - | |||||||||
Cash
and cash equivalents, end of period
|
$ | 59,105 | $ | 899,037 | $ | 1,254,546 | ||||||
Supplemental
Disclosures of Cash Flow information
|
||||||||||||
Cash
paid for interest
|
$ | 369,167 | $ | 181,812 | $ | 550,979 | ||||||
Cash
paid for income taxes
|
$ | - | $ | - | $ | - |
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, INC.
(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.
F-6
KENTUCKY
USA ENERGY, INC.
(Formerly
Las Rocas Mining Corp.)
(AN
EXPLORATION STAGE COMPANY)
NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
October
31, 2009
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.
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.
F-7
KENTUCKY
USA ENERGY, INC.
(Formerly
Las Rocas Mining Corp.)
(AN
EXPLORATION STAGE COMPANY)
NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
October
31, 2009
Natural Gas
Properties
The
Company follows the full cost method of accounting for gas property acquisition,
exploration and development activities. Under this method, all
productive and non-productive costs incurred in connection with the acquisitions
of, exploration for and development of gas reserves for each cost center are
capitalized. Capitalized costs include lease acquisitions, geological
and geophysical work, and the costs of drilling, completing and equipping gas
wells. Costs, however, associated with production and general
corporate activities are expensed in the period incurred. Interest
costs related to proved properties and properties under development are also
capitalized to gas properties. Gains or losses are recognized only
upon sales or dispositions of significant amounts of gas reserves representing
an entire cost center. Proceeds from all other sales or dispositions
are treated as reductions to capitalized costs. The capitalized gas
property, less accumulated depreciation, depletion and amortization and related
deferred income taxes, if any, is generally limited to an amount (the ceiling
limitation) equal to the sum of: (a) the present value of estimated future net
revenues computed by applying current prices in effect as of the balance sheet
date (with consideration of price changes only to the extent provided by
contractual arrangements) to estimated future production of proved gas reserves,
less estimated future expenditures (based on current costs) to be incurred in
developing and producing the reserves using a discount factor of 10%
and assuming continuation of existing economic conditions; and (b) the cost of
investments in unevaluated properties that are excluded from the costs being
amortized.
Issuance of Stock for
Non-Cash Consideration
All
issuances of the Company’s stock for non-cash consideration have been assigned a
per share amount equaling either the market value of the shares issued or the
value of consideration received, whichever is more readily
determinable. The majority of the non-cash consideration received
pertains to services rendered by consultants and others and has been valued at
the market value of the shares on the dates issued.
Earnings per
Share
In
accordance with Statement of Financial Accounting Standards (SFAS) No. 128,
“Earnings per Share” (“SFAS 128”), 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, INC.
(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, 2008
|
|||||||
Machinery
and Equipment
|
10-20
yrs
|
$ | 492,908 | $ | 314,196 | ||||
Total
|
492,908 | 314,196 | |||||||
Less
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, 2008
|
|||||||
Non-interest
bearing note payable to K and D Energy, secured by a Second mortgage on
oil and gas leases, and repayable on or before August 5,
2008. This note is past due as at October 31, 2008 and as
a result is currently bearing interest at 9%
|
$ | 650,000 | $ | 650,000 | ||||
Note
payable to Tillerman Securities. Secured by oil ang gas properties,
bearing interest at 8%, interest due quarterly. See Note
9.
|
2,500,000 | 2,500,000 | ||||||
NSES
12, LLC-New Stream Capital 12% note with interest payable monthly starting
October 1, 2008, 85% of adjusted cash flow starting October 1, 2008
Interest & Principle paid full in 3 years
|
5,650,000 | 2,500,000 | ||||||
$ | 8,800,000 | $ | 5,650,000 |
F-9
KENTUCKY
USA ENERGY, INC.
(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
|
2008
|
|||||||
Year
ending October 31:
|
||||||||
2010
|
$ | 6,300,000 | $ | 3,150,000 | ||||
2011
|
2,500,000 | 2,500,000 | ||||||
2012
|
- | - | ||||||
Thereafter
|
- | - | ||||||
Total
maturities of long-term debt
|
8,800,000 | 5,650,000 | ||||||
Less
current maturities
|
6,300,000 | 3,150,000 | ||||||
Long-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
|
2008
|
|||||||
Face
amount of note
|
$ | 2,500,000 | $ | 2,500,000 | ||||
Discount
|
(1,527,780 | ) | (2,152,778 | ) | ||||
$ | 972,220 | $ | 347,222 |
The
balance owing to NSES represents drawing 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 below.
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.
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 KY to make forty-two monthly
installments, beginning on August 4, 2008. At the conclusion of the
lease, KY will have available a bargain purchase option for the equipment which
at October 31, 2009 has a carrying value of $204,930.
F-10
KENTUCKY
USA ENERGY, INC.
(Formerly
Las Rocas Mining Corp.)
(AN
EXPLORATION STAGE COMPANY)
NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
October
31, 2009
Year
ending October 31:
|
||||
2010
|
$ | 94,827 | ||
2011
|
94,827 | |||
2012
|
15,276 | |||
After
2012
|
- | |||
Total
gross minimum lease payments
|
204,930 | |||
Less
current installments of obligations
|
94,827 | |||
Long-term
capital lease due
|
$ | 110,103 |
Note
7 – Provision for Income Taxes
The
Company provides deferred income tax assets and liabilities using the liability
method for temporary differences between book and taxable income.
The
provisions for income taxes for the year and period ended October 31, 2009 and
2008 are comprised as follows:
2009
|
2008
|
|||||||
Currently
payable
|
$ | - | $ | - | ||||
Deferred
federal tax benefit (expense)
|
337,000 | 147,000 | ||||||
Deferred
state tax benefit (expense)
|
42,000 | 29,000 | ||||||
Valuation
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, INC.
(Formerly
Las Rocas Mining Corp.)
(AN
EXPLORATION STAGE COMPANY)
NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
October
31, 2009
October 31, 2009
|
October 31, 2008
|
|||||||
Reconciliation
between statutory and effective tax rates
|
||||||||
Expected
benefit at federal statutory rates
|
$ | 527,000 | $ | 1,144,000 | ||||
Effect
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 | 1,563,000 | ||||||
Temporary
difference – capitalization of interest
|
(67,000 | ) | ||||||
State
income taxes
|
42,000 | 29,000 | ||||||
Effect
of expected lower applicable rates
|
(380,000 | ) | (169,000 | ) | ||||
379,000 | 176,000 | |||||||
Valuation
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, 2008
|
|||||||
Net
operating loss carryforwards
|
$ | 379,000 | $ | 223,000 | ||||
Temporary
difference:Capitalized interest
|
- | (47,000 | ) | |||||
$ | 379,000 | $ | 176,000 |
F-12
KENTUCKY
USA ENERGY, INC.
(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 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 hasa 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.
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.
F-13
KENTUCKY
USA ENERGY, INC.
(Formerly
Las Rocas Mining Corp.)
(AN
EXPLORATION STAGE COMPANY)
NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
October
31, 2009
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.
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 $1,574,177 respectively, and a convertible debt
liability, net of discounts of $1,527,780 and $2,152,778, of $972,220 and
$347,277, 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. Principle repayments due in 24 equal payments beginning
with the 1st year
anniversary. This note is convertible into 2,500,000
shares. The conversion feature allowed for the conversion of the
underlying debt into shares of the Company’s common Stock at a price of $1.50
per share when the market price of the Company’s stock was $2.80 per
share. The existence of this discount is called a “beneficial
conversion feature.”
EITF 00-19 “Accounting for Derivative
Financial Instruments Indexed to, and Potentially Settled in, a Company’s Own
Stock” (EITF 00-19), 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 instrument allow net
settlement of the instrument upon exercise, resulting in the potential
settlement with a variable number of shares, and the settlement is based upon
the fixed cash value of the debt, known at issuance.
F-14
KENTUCKY
USA ENERGY, INC.
(Formerly
Las Rocas Mining Corp.)
(AN
EXPLORATION STAGE COMPANY)
NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
October
31, 2009
Accordingly
the beneficial conversion feature was recorded at its intrinsic value of $1.98
per warrant, or $3,300,026, which was expensed, the attached debt of $2,500,000
having been previously discounted to zero in connection with warrants issued in
the same transaction and discussed below. Under provisions of SFAS
133 the valuation of the beneficial conversion feature initially recorded as a
liability is reset at each reporting period to fair value with gain or loss
recognized in income. At October 31, 2009 and October 31, 2008, the
Company recognized a gain of $270,910 and $4,596,769 on the revaluation of this
liability to fair value, using the Black-Scholes Formula with an expected term
of approximately 2.5 years, volatility of 60%, and a risk-free rate of interest
of 4%, consistent with valuations of warrants outstanding at October 31, 2009
and 2008, as discussed below.
The
Company recognized derivative liabilities related to detachable warrants issued
with the May 29 instrument and other debt financing in accordance with SFAS 150
“Accounting for Certain Financial Instruments with Characteristics of
both Liabilities and Equity,” primarily codified into Topic 480. Under that
pronouncement, free-standing instruments that may require the issuance of a
variable number of equity shares must be accounted for as a liability under
circumstances similar to those enumerated in EITF 00-19, primarily codified into
Topic 815. The detachable warrants issued with the debt financings
are remeasured at each reporting date with the resulting gain or loss included
in income of the period.
In
connection with the Company’s warrants as discussed in Note 5, the Company
incurred initial derivative liabilities totaling $6,300,037 in May,
2008. To the extent of proceeds received these liabilities were
recorded as debt discount with any excess expensed upon
issuance. Upon early settlement of a loan, any remaining discount is
written off. As of October 31, 2009 and October 31, 2008, the
unamortized balance of loan fees amounted to $640,693 and
$1,005,090. d loan.
Note
11 Stockholders’ Equity
The
Company has authorized capital stock of 320,000,000 shares consisting
of 300,000,000
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:
F-15
KENTUCKY
USA ENERGY, INC.
(Formerly
Las Rocas Mining Corp.)
(AN
EXPLORATION STAGE COMPANY)
NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
October
31, 2009
Number of Stock
|
||||||||
Options Available
|
Weighted Average
|
|||||||
Through Warrants
|
Exercise Price
|
|||||||
Outstanding
at beginning of period
|
- | - | ||||||
Granted
|
4,700,000 | 1.27 | ||||||
Exercised
|
2,000,000 | 1.00 | ||||||
Cancelled/forfeited
|
- | - | ||||||
Outstanding
at October 31, 2009 and 2008
|
2,700,000 | 1.46 | ||||||
Options
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:
Stock Options Outstanding
|
Stock Options Exercisable
|
||||||||||||||||||||||||
Exercise
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.
F-16
KENTUCKY
USA ENERGY, INC.
(Formerly
Las Rocas Mining Corp.)
(AN
EXPLORATION STAGE COMPANY)
NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
October
31, 2009
Note
12 – 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
13 – 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.
Note
14 – 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
|
October31,2008
|
|||||||
Property
acquisitions:
|
||||||||
Proved
|
$ | $ | ||||||
Unproved
|
- | - | ||||||
Less
proceeds from sales of properties
|
- | - | ||||||
Development
cost
|
3,912,460 | 2,076,623 | ||||||
Total
|
$ | 3,912,460 | $ | 2,076,623 |
F-17
KENTUCKY
USA ENERGY, INC.
(Formerly
Las Rocas Mining Corp.)
(AN
EXPLORATION STAGE COMPANY)
NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
October
31, 2009
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.
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.
Gas MMcf
|
||||
Balance, October 5, 2007 (inception)
|
||||
Revisions
of previous estimates
|
- | |||
Purchase
of Reserves in Place
|
26,657 | |||
Proved
reserves at October 31, 2007
|
26,657 | |||
Revisions
of previous estimates
|
(1,107 | ) | ||
Sales
of Reserves in Place
|
- | |||
Proved
reserves at October 31, 2008
|
25,550 | |||
Revisions
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-18
KENTUCKY
USA ENERGY, INC.
(Formerly
Las Rocas Mining Corp.)
(AN
EXPLORATION STAGE COMPANY)
NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
October
31, 2009
10/31/2009
|
10/31/2008
|
|||||||
Amount in Thousands
|
Amount in Thousands
|
|||||||
Future
cash inflow
|
$ | 98,128 | $ | 129,922 | ||||
Future
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 | 55,708 | ||||||
10%
Discount
|
(15,294 | ) | (24,216 | ) | ||||
Discounted
future net cash flows from proved reserves
|
21,906 | 31,492 | ||||||
Less
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, productions 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-19
KENTUCKY
USA ENERGY, INC.
(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-20