Summary of KENTUCKY USA ENERGY, INC.

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, 2008

We are still in our exploration stage and have generated no revenues to date.

All productive and non-productive costs incurred in connection with the acquisitions of, exploration for and development of our gas reserves are capitalized using the full cost method of accounting. These costs include lease acquisitions, geological and geophysical work, and the costs of drilling, completing and equipping our gas wells. For the year ended October 31, 2008, we incurred such total capitalized costs of $3,051,737.

We incurred general and administrative expenses of $46,527 for the year ended October 31, 2008. These expenses consisted of costs incurred in connection with the start-up and day to day operation of our business and costs relating to the Merger.

Amortization of loan fees for the year ended October 31, 2008 totaled $145,115. These costs are related to the Note and the Loan (defined below).

We incurred legal and accounting expenses of $676,217 for the year ended October 31, 2008, respectively. These expenses consisted of costs incurred in connection with our recent financing activities and SEC filing requirements.

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

Our net operating loss from inception through October 31, 2008 was $3,373,524.

Because KY USA, our operating subsidiary, was incorporated on October 5, 2007 and did not engage in any material activities through October 31, 2007, we do not present expenses for the fiscal year ended October 31, 2007 as those numbers are not meaningful and not necessary to an understanding of our results of operations.

Liquidity and Capital Resources

Our cash and cash equivalents balance as of October 31, 2008 was $899,037.

As a result of the Merger which closed on May 2, 2008, we expect significant expenditures during the next 12 months. Pursuant to the terms of the Assignments, KY USA is required to drill 12 wells per year within the Properties at an estimated cost of between 165,000 to $225,000 per well, for a maximum total of approximately $2.7 million for the year. Since June 27, 2008, we have been using the proceeds of the Note Offering and Initial Loan to finance our drilling efforts on our initial wells. We have received one Installment Loan under the Credit Facility (defined below) on February 12, 2009 in the amount of $2,500,000. We believe this amount of funds will provide us with sufficient working capital for the next six to nine months. We plan to use these funds to bring our presently drilled wells online and to drill an additional 10 to 12 wells on our Leasehold. There can be no assurance, however, that we will receive any additional Installment Loans or that if we do receive them, they will be for the remaining maximum amount available under the Credit Facility, $5,000,000. If we do not receive any subsequent Installment Loans under the Credit Facility we will be required to enter the capital markets to raise working capital. If we are unable to obtain the financing necessary to support our current and planned operations or we do not drill the required 12 wells per year, we will lose all or part of our rights to the Leasehold. The loss of the Leasehold would have a substantial material adverse impact on our business and we might not be able to continue as a going concern. We currently have no commitments for any additional capital.

In addition to our current drilling program on the Leasehold, and contingent upon our ability to raise the required capital, we expect to engage in additional expenditures over the next 12 months for new seismic data acquisitions and/or land and drilling rights acquisitions and related drilling programs. Although we are not ready to move forward on any particular project, we would require additional financing in order to proceed with any such project. There can be no assurance, however, that financing for one or more of these projects will be available to us or, if it is available, that it will be available on terms acceptable to us and that it will be sufficient to fund our needs. If we are unable to obtain the financing necessary to support these expenditures, we may not be able to proceed with this aspect of our plan of operation.

Due to our brief history and historical operating losses, our operations have not been a source of liquidity. Although we expect to begin generating revenues from the sale of gas from our wells within the next six months, there can be no assurances that we will be successful in reaching this milestone in a timely fashion or that we will be able to generate sufficient liquidity from the sale of our natural gas to help fund our operations. If we cannot generate revenues from the sale of our gas, our business, results of operations, liquidity and financial condition may suffer materially.

Various factors outside of our control, including the price of natural gas, overall market and economic conditions, the downturn and volatility in the US equity markets and the trading price of our common stock may limit our ability to raise the capital needed to execute our plan of operations. We recognize that the US economy is currently experiencing a period of uncertainty and that the capital markets have been depressed from recent levels. We also recognize that the price of natural gas has decreased significantly during the last six months. If the price of natural gas continues to drop and the markets remain volatile, we realize that these or other factors could adversely affect our ability to raise additional capital. As a result of an inability to raise additional capital, our short-term or long-term liquidity and our ability to execute our plan of operations could be significantly impaired.

Note Offering

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

Credit Facility

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

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

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

Notes Issued by KY USA

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

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.

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

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

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

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

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

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