10-K 1 v218771_10k.htm Unassociated Document
U. S. SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C.  20549
 

FORM 10-K
(Mark One)
 
x
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the fiscal year ended December 31, 2010
 
o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the transition period from ___________ to _____________
 
Commission File Number 000-32131
 
KENTUCKY ENERGY, INC.
(Name of small business issuer as specified in its charter)
 
Utah
87-0429950
(State or other jurisdiction of
incorporation or organization)
(I.R.S. Employer
Identification No.)
18B East 5th Street
Paterson, NJ  07524
 (Address of principal executive offices, including zip code)
 
Registrant’s telephone number, including area code:  (973) 684-0075
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:  Common Stock, $.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. o 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 Act: o Yes No x
 
 
Indicate by check mark whether the registrant(1) has filed all reports required by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 day. x Yes o No
 
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulations S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy ir information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. o
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 if the Exchange Act.
 
Large accelerated filter o
 
Accelerated filter o
Non-accelerated filter o   
(Do not check if a smaller reporting company)
Smaller reporting company x
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act)  Yes o  No x
 
As of April 12, 2011, 178,219,904 shares of our common stock were issued and outstanding.

Documents Incorporated by Reference: None.
 
 
 

 
 
PART I
 
Kentucky Energy, Inc. (f/k/a Quest Minerals & Mining Corp.), including all its subsidiaries, are collectively referred to herein as “KI,” “the Company,” “us,” or “we.”

Item 1.   DESCRIPTION OF BUSINESS
 
General

We acquire and operate energy and mineral related properties in the southeastern part of the United States.  We focus our efforts on properties that produce quality compliance blend coal.

We are a holding company for Quest Minerals & Mining, Ltd., a Nevada corporation, or Quest (Nevada), which in turn is a holding company for Quest Energy, Ltd., a Kentucky corporation, or Quest Energy, and of Gwenco, Inc., a Kentucky corporation, or Gwenco.

Gwenco leases over 700 acres of coal mines, with approximately 9.8 million tons of proven/probable reserves tons of coal in place in six seams.  At this time, we cannot readily define the difference of assurance between “proven” and “probable” reserves. In 2004, Gwenco had reopened Gwenco’s two former drift mines at Pond Creek and Lower Cedar Grove, and had begun production at the Pond Creek seam.  This seam of high quality compliance coal is located at Slater’s Branch, South Williamson, Kentucky.

Fiscal 2010 and First Quarter 2011 Developments

SEC Settlement.  On October 31, 2008, we received a Wells notice (the “Notice”) from the staff of the Salt Lake Regional Office of the Securities and Exchange Commission (the “Commission”) stating that they are recommending an enforcement action be filed against us based on our financial statements and other information contained in reports filed by us with the Commission by us for our 2004 year and thereafter. The Notice states that the Commission anticipates alleging that we have violated Sections 10(b), 13(a) and 13(b)(2) of the Securities Exchange Act of 1934, as amended and Rules 10b-5, 12b-20, 13a-1 and 13a-13 thereunder.

On April 8, 2011, the SEC announced that it has agreed to a settlement with us.  We entered into the settlement without admitting or denying the allegations set forth in the Notice, as is consistent with standard SEC practice.  Under the terms of the settlement, we consented to a cease and desist order from committing or causing any violations and any future violations of Section 13(a) and 13(b)(2)(A) and (B) of the Exchange Act and Rules 12b-20, 12a-1 and 13a-13 thereunder.  In addition, we agreed to perform certain undertakings including (i) maintaining at least two independent director so that not less than 2/3 of our board will be independent directors (ii) employing a chief financial officer qualified to prepare financial statements in accordance with GAAP; (iii) notify the Division of Enforcement if our chief financial officer resigns or is terminated or if one or more board members leave such that the board as a whole is not independent and (iv) adopt a system of written internal controls and identify and implement actions to improve the effectiveness of our disclosure controls, including plans to enhance our resources and training with respect to financial reporting and disclosure responsibilities, and to review such actions with our independent auditors.

Termination of Letter of Intent.  On February 8, 2011, we announced the signing of a letter of intent to sell our coal mining operation.  As of the date of this report, the purchaser under such letter of intent has not consummated the acquisition within the exclusivity period set forth in the letter of intent.  As such, we intend to resume discussions with other prospective purchasers who have expressed an interest in acquiring our mining assets.  In addition, we are currently seeking a larger credit facility that would allow us to make the necessary capital expenditures and provide sufficient working capital in order to accelerate our desired revenue growth.

Operations Overview.  In the year ended 2010, we continued to conduct mining operations.  We generated coal revenues of approximately $2.4 million for the year ended 2010, compared to approximately $1.6 million for the year ended 2009.  Other than with respect to the West Virginia explosion discussed below, we did not have to shut down our operations during the year ended 2010.  However, we did encounter temporary delays and stoppages, due to either breakdowns in equipment, a lack of necessary supplies, weather-related production issues, or regulatory inspections.  We continue to encounter thicker coal seams as we advance further into the mine.
 
 
2

 
 
While certain general business conditions continue to improve, the continued effects of the recent recession, credit crisis, and related turmoil in the global financial system has had and may continue to have a negative impact on our business, financial condition, and liquidity.  We may face significant future challenges if conditions in the financial markets do not continue to improve.  Worldwide demand for coal has been adversely impacted by the global recession, but the steel industry and the global metallurgical coal markets have shown signs of improvement.   If this trend continues, coal demand should increase and improve our opportunities to sell our coal products at higher prices.  

West Virginia Explosion.  On April 5, 2010, an explosion occurred at the Upper Big Branch mine in Montcoal, West Virginia, operated by Performance Coal Company, a subsidiary of Massey Energy, which resulted in 29 fatalities.  In response to this tragedy, the Federal Mine Safety and Health Administration (“MSHA”) conducted inspections of most mines in the region, including Pond Creek.  As a result of these inspections, MSHA issued an order to Gwenco to take certain precautionary measures, including upgrades to its ventilation system, CO system, and airlock system.  In addition, MSHA conducted simulated evacuations and conducted underground training seminars.  Gwenco ceased mining operations during this period in order to allow the inspections, implement the precautionary measures, and conduct the simulations and training.  Gwenco reopened the mining operations approximately two weeks after the inspections commenced.   However, as an ongoing result of the tragedy at UBB, MSHA significantly increased regulatory enforcement in our mines.  The increased regulatory enforcement had a significant negative impact our productivity and operating results for the third quarter of 2010.  We lost a significant number of shifts during the quarter due to regulatory issues, many of which were due to delays in MSHA’s approval process for ventilation or other mine plan changes.  If MSHA continues to order our mines to be temporarily closed or permanently closes such mines, our ability to meet our customers’ demands could be adversely affected.

In September 2010, MSHA revised the federal standard for the incombustible content of coal dust, rock dust and other dust combined in coal mines. The revised standard is effective for new mining as of October 7, 2010, and for previously mined areas by November 22, 2010.  We expect our cost of mining to increase as we comply with the revised standard for additional rock-dusting materials, equipment and labor.

Name Change.  On June 10, 2010, we filed an amendment to our Articles of Incorporation to change corporate name from Quest Minerals & Mining Corp. to “Kentucky Energy, Inc.”  The change in corporate name took effect on June 16, 2010.

Drilling Contract.   On July 21, 2010, we entered into an agreement with an unrelated third party to obtain up to 100 drill sites and a 100% working interest of the oil and gas rights on approximately 3,000 acres of property located in Rockcastle County, Kentucky for $50,000.  In addition, the unrelated third party will be retained for day to day management of the property, including drilling operations for additional consideration of $155,000 per well.  This well will be used to test thoroughly the main oil and gas horizons. On January 15, 2011, we satisfied the initial deposit requirement pursuant to a lease agreement dated July 21, 2010, where we seeking to obtain the working interests for certain oil and gas properties in Rockcastle County, Kentucky. As part of the agreement, 75%  net revenue interest representing a 100% working interest of said leases totaling 4,640 acres of oil and gas exploration property were assigned to the company by a third party leaseholder representative. We have not yet determined when initial drilling will commence.
 
Industry Overview
 
Coal accounted for 24% of the energy consumed (excluding certain alternative fuels including wind, geothermal and solar power generators) by the United States and 29% of energy consumed globally in 2007, according to the BP Statistical Review of World Energy (“BP”).  In 2007, coal was the fuel source of 49% of the electricity generated nationwide, as reported by the Energy Information Administration (“EIA”), a statistical agency of the United States Department of Energy.
 
According to BP, in 2007, the United States was the second largest coal producer in the world, exceeded only by China.  Other leading coal producers include Australia, India, South Africa, the Russian Federation and Indonesia.  According to BP, the United States has the largest coal reserves in the world, with proved reserves totaling 243 billion tons.  The Russian Federation ranks second in proved coal reserves with 157 billion tons, followed by China with 115 billion tons, according to BP.
 
 
3

 
 
United States coal reserves are more plentiful than oil or natural gas with 234 years of supply at current production rates.  Proved United States reserves of oil amount to 12 years of supply at current production rates and proved United States reserves of natural gas amount to 11 years of supply at current levels of consumption, as reported by BP.

United States coal production has more than doubled over the last 40 years.  In 2008, total United States coal production, as estimated by the EIA, was 1.2 billion tons.

Coal is used in the United States by utilities to generate electricity, by steel companies to make steel products, and by a variety of industrial users to produce heat and to power foundries, cement plants, paper mills, chemical plants and other manufacturing and processing facilities.  Significant quantities of coal are also exported from both East and Gulf Coast terminals.  The breakdown of United States coal consumption for the first ten months of 2008 as estimated by the EIA, is as follows:

End Use
 
% of Total
Electric Power
 
93%
Other Industrial
 
5%
Coke
 
2%
Residential and Commercial
 
<1%
     
Total
 
100%
     
 
Coal has long been favored as an electricity generating fuel because of its basic economic advantage.  The largest cost component in electricity generation is fuel.  This fuel cost is typically lower for coal than competing fuels such as oil and natural gas on a Btu-comparable basis.  The EIA estimates the average cost of various fossil fuels for generating electricity in the first 11 months of 2008 was as follows:

 
Electricity Generation Source
 
Average Cost per
million BTU
 
Petroleum Liquids
  $ 16.56  
Natural Gas
  $ 9.34  
Coal
  $ 2.06  
Petroleum Coke 
  $ 1.85  

There are factors other than fuel cost that influence each utility’s choice of electricity generation mode, including facility construction cost, access to fuel transportation infrastructure, environmental restrictions, and other factors.  The breakdown of United States electricity generation by fuel source in 2007, as estimated by EIA, is as follows:

 
Electricity Generation Source
 
% of Total
Electricity Generation
Coal
 
49%
Natural Gas
 
21%
Nuclear
 
19%
Hydroelectric
 
6%
Oil and other (solar, wind, etc.)
 
5%
     
Total
 
100%
     

Demand for electricity has historically been driven by United States economic growth but it can fluctuate from year to year depending on weather patterns.  In 2008, electricity consumption in the United States decreased 0.4% from 2007, but the average growth rate in the past decade was approximately 1.3% per year according to EIA estimates.  Because coal-fired generation is used in most cases to meet base load requirements, coal consumption has generally grown at the pace of electricity demand growth.
 
 
4

 
 
According to the World Coal Institute (“WCI”), in 2007 the United States ranked seventh among worldwide exporters of coal.  Australia was the largest exporter, with other major exporters including Indonesia, the Russian Federation, Columbia, South Africa and China.  According to EVA, United States exports increased by 37% from 2007 to 2008.  The usage breakdown for 2008 United States coal exports of 80 million tons was 47% for electricity generation and 53% for steel production.  In 2008, United States coal exports were shipped to more than 30 countries.  The largest purchaser of United States exported utility coal in 2008 continued to be Canada, which took 19.1 million tons or 50% of total utility coal exports.  This was up 31% compared to the 14.6 million tons exported to Canada in 2007.  Overall steam coal exports increased 43% in 2008 compared to 2007.  The largest purchasers of United States exported metallurgical coal were Brazil, which imported approximately 5.9 million tons, or 14%, and Canada, which imported 3.7 million tons, or 9%.  In total, metallurgical coal exports increased 31% in 2008 compared to 2007.

Depending on the relative strength of the United States dollar versus currencies in other coal producing regions of the world, United States producers may export more or less coal into foreign countries as they compete on price with other foreign coal producing sources.  Likewise, the domestic coal market may be impacted due to the relative strength of the United States dollar to other currencies, as foreign sources could be cost-advantaged based on a coal producing region’s relative currency position.
 
Since 2003, the global marketplace for coal has experienced swings in the demand/supply balance.  In periods of supply shortfall, as occurred from 2003 to early 2006 and again in late 2007 through late 2008, the prices for coal reached record highs in the United States.  The increased worldwide demand was primarily driven by higher prices for oil and natural gas and economic expansion, particularly in China, India, and elsewhere in Asia.  At the same time, infrastructure and regulatory limitations in China contributed to a tightening of worldwide coal supply, affecting global prices of coal.  The growth in China and India caused an increase in worldwide demand for raw materials and a disruption of expected coal exports from China to Japan, Korea and other countries.  Since mid-2008, the United States and world economies have been in an economic recession and financial credit crisis, significantly reducing the demand for coal.
 
Metallurgical grade coal is distinguished by special quality characteristics that include high carbon content, volatile matter, low expansion pressure, low sulfur content, and various other chemical attributes.  High vol met coal is also high in heat content (as measured in Btus), and therefore is desirable to utilities as fuel for electricity generation.  Consequently, high vol met coal producers have the ongoing opportunity to select the market that provides maximum revenue and profitability.  The premium price offered by steel makers for the metallurgical quality attributes is typically higher than the price offered by utility coal buyers that value only the heat content.  The primary concentration of United States metallurgical coal reserves is located in the Central Appalachian region.  EVA estimates that the Central Appalachian region supplied 89% of domestic metallurgical coal and 76% of United States exported metallurgical coal during 2007.

For utility coal buyers, the primary goal is to maximize heat content, with other specifications like ash content, sulfur content, and size varying considerably among different customers.  Low sulfur coals, such as those produced in the western United States and in Central Appalachia, generally demand a higher price due to restrictions on sulfur emissions imposed by the Federal Clean Air Act, as amended, and implementing regulations (“Clean Air Act”) and the volatility in sulfur dioxide (“SO2”) allowance prices that occurred in recent years when the demand for all specifications of coal increased.  SO2 allowances permit utilities to emit a higher level of SO2 than otherwise required under the Clean Air Act regulations.  The demand and premium price for low sulfur coal is expected to diminish as more utilities install scrubbers at their coal-fired plants.

Coal shipped for North American consumption is typically sold at the mine loading facility with transportation costs being borne by the purchaser.  Offshore export shipments are normally sold at the ship-loading terminal, with the purchaser paying the ocean freight.  According to the National Mining Association (“NMA”), approximately two-thirds of United States coal shipments in recent years were transported via railroads.  Final delivery to consumers often involves more than one transportation mode.  A significant portion of United States production is delivered to customers via barges on the inland waterway system and ships loaded at Great Lakes ports.
 
 
5

 
 
Gwenco Mines

Gwenco holds approximately 30 coal leases, covering an estimated 700 acres, with approximately 9.8 million proven/probable reserves.  At this time we cannot readily define the difference of assurance between “proven” and “probable” tons of coal in place in six seams.  The primary reserves are in the Pond Creek, Lower Cedar Grove, and Taylor seams.  Both the Pond Creek and Lower Cedars Grove seams are permitted and bonded and have been mined to a limited extent.  The coal in the Pond Creek seam is low-sulfur, compliance coal, running at an average of 12,000 to 12,500 BTUs when mined clean.  The coal in the Lower Cedar Grove seam has a shale parting and must be washed to be commercial.  When cleaned it is a high BTU coal with certain metallurgical coal qualities.

The following map provides the location of our operations within the Central Appalachian region:


Each seam has road access and can be reached by truck.

The following table provides key operational information on our Seams in 2010:
 
Seam
 
Active/
Inactive
   
Mine
Type
   
Active
Mine
Count (1)
 
Transportation
 
2010
Production
   
Year
Established
or
 Acquired
 
Winifrede
    I       U       0  
Truck
    0       2004  
Taylor
    I       U       0  
Truck
  0 0       2004  
Cedar Grove
    I       U       0  
Truck
    0       2004  
Pond Creek
    A       U       1  
Truck
    32,898       2004  
 

(1)
Active mine count as of March 31, 2011.


(1)
Active mine count as of March 31, 2011.
S
– surface mine
U
– underground mine

Mining Techniques

There are several basis techniques for mining drift or adit mines.  We have used, and intend to use, a continuous miner on the Pond Creek seam at its Gwenco facility.  We have used, and intend to use, a Joy 14-9 continuous miner at the Gwenco mines.  In this technique, the miner has a cutting head that tears the coal from it natural deposit and transfers the coal to a gather head and then to shuttle cars that can carry from 3 to 10 tons depending on the size.  This method can create higher volume mining than the conventional method, but may mine the coal with a higher content of ash.

Expansion Strategy

We seek to acquire new mines and contracting to produce and market additional coal in its geographic focus area.  We intend to acquire and operate high quality coal properties with established field personnel, primarily in the eastern Kentucky coalfields, with additional properties in southwestern West Virginia and western Virginia.  This region has an excellent infrastructure of workers, truckers, rail sidings on the CSX and N&W rail lines and low cost access to the Big Sandy barge docks near Ashland, KY, for effective coal distribution.  We intend to use its local knowledge to pursue high returns on investment from re-opening profitable properties in this region.  It intends to grow by additional accretive acquisitions, contract mining, and internal development of owned properties.
 
 
6

 

 
We are also seeking to diversify its operations into other sectors of the energy industry, including the oil and gas sector.  Our coal miners collectively have over 50 years of mining experience.  We may also engage key industry experts to assist in the analysis and funding of these properties.  Our management believes that a successful diversification into the oil and gas field would provide us with an opportunity to improve its results of operations while hedging on coal production and prices.

Customers

We had 3 primary customers in the year ended December 31, 2010, which routinely purchase all the coal we can produce at spot market rates.  To the extent that we are able to produce coal beyond the demands of these two customers, it intends to sell its remaining coal to other purchasers or on the spot market to coal brokers.  We may seek to enter into long-term contracts (exceeding one year in duration) with customers if economic circumstances indicate that such arrangements would maximize profitability.  These arrangements would allow customers to secure a supply for their future needs and provide us with greater predictability of sales volume and sales prices.

Competition

The coal industry in the United States is highly competitive.  We compete with many large producers and other small coal producers.  We also compete with other producers primarily on the basis of price, coal quality, transportation cost and reliability of supply.  Many of our competitors are more viable, are better capitalized, and have greater financial resources than us.  Continued demand for coal is also dependent on factors outside of our control, including demand for electricity, environmental and governmental regulations, weather, technological developments, and the availability and cost of alternative fuel sources.

The price at which our production can be sold is dependent upon a variety of factors, many of which are beyond our control.  We sell coal on the spot-market and seek to sell coal under long-term contracts.  Generally, the relative competitiveness of coal vis-a-vis other fuels or other coals is evaluated on a delivered cost per heating value unit basis.  In addition to competition from other fuels, coal quality, the marginal cost of producing coal in various regions of the country and transportation costs are major determinants of the price for which our production can be sold.  Factors that directly influence production cost include geological characteristics (including seam thickness), overburden ratios, depth of underground reserves, transportation costs and labor availability and cost.  Underground mining has higher labor (including reserves for future costs associated with labor benefits and health care) and capital (including modern mining equipment and construction of extensive ventilation systems) costs than those of surface mining.  In recent years, increased development of large surface mining operations, particularly in the western United States, and more efficient mining equipment and techniques, have contributed to excess coal production capacity in the United States.  Competition resulting from excess capacity has encouraged producers to reduce prices and to pass productivity gains through to customers.  Demand for our low sulfur coal and the prices that we will be able to obtain for it will also be affected by the price and availability of high sulfur coal, which can be marketed in tandem with emissions allowances.

Transportation costs are another fundamental factor affecting coal industry competition.  Coordination of the many eastern loadouts, the large number of small shipments, terrain and labor issues all combine to make shipments originating in the eastern United States inherently more expensive on a per-mile basis than shipments originating in the western United States.  Historically, coal transportation rates from the western coal producing areas into Central Appalachian markets limited the use of western coal in those markets.  More recently, however, lower rail rates from the western coal producing areas to markets served by eastern producers have created major competitive challenges for eastern producers.  Barge transportation is the lowest cost method of transporting coal long distances in the eastern United States, and the large numbers of eastern producers with river access keep coal prices competitive.  We believe that many utilities with plants located on the Ohio River system are well positioned for deregulation as competition for river shipments should remain high for Central Appalachian coal.  We also believes that with close proximity to competitively-priced Central Appalachian coal, utilities with plants located on the Ohio River system will become price setters in a deregulated environment.

Although undergoing significant consolidation, the coal industry in the United States remains highly fragmented.  It is possible that our costs will not permit it to compete effectively with other producers seeking to provide coal to a customer; however, it is our goal to maintain low production costs, offer a variety of products and have develop access to multiple transportation systems that will enable it to compete effectively with other producers.
 
 
7

 
 
Environmental, Safety and Health Laws and Regulations
 
The coal mining industry is subject to regulation by federal, state and local authorities on matters such as the discharge of materials into the environment, employee health and safety, permitting and other licensing requirements, reclamation and restoration of mining properties after mining is completed, management of materials generated by mining operations, surface subsidence from underground mining, water pollution, water appropriation, and legislatively mandated benefits for current and retired coal miners, air quality standards, protection of wetlands, endangered plant and wildlife protection, limitations on land use, and storage of petroleum products and substances that are regarded as hazardous under applicable laws.  The possibility exists that new legislation or regulations may be adopted that could have a significant impact on our mining operations or on our customers’ ability to use coal.

Numerous governmental permits and approvals are required for mining operations.  Regulations provide that a mining permit or modification can be delayed, refused or revoked if an officer, director or a stockholder with a 10% or greater interest in the entity is affiliated with or is in a position to control another entity that has outstanding permit violations.  Thus, past or ongoing violations of federal and state mining laws by individuals or companies no longer affiliated with us could provide a basis to revoke existing permits and to deny the issuance of addition permits.  We are required to prepare and present to federal, state, or local authorities data and/or analysis pertaining to the effect or impact that any proposed exploration for or production of coal may have upon the environment, public and employee health and safety.  All requirements imposed by such authorities may be costly and time-consuming and may delay commencement or continuation of exploration or production operations.  Accordingly, the permits we need for our mining and gas operations may not be issued, or, if issued, may not be issued in a timely fashion.  Permits we need may involve requirements that may be changed or interpreted in a manner that restricts our ability to conduct our mining operations or to do so profitably.  Future legislation and administrative regulations may increasingly emphasize the protection of the environment, health and safety and, as a consequence, our activities may be more closely regulated.  Such legislation and regulations, as well as future interpretations of existing laws, may require substantial increases in equipment and operating costs, delays, interruptions or a termination of operations, the extent of which cannot be predicted.
 
While it is not possible to quantify the expenditures we incur to maintain compliance with all applicable federal and state laws, those costs have been and are expected to continue to be significant.  We post surety performance bonds or letters of credit pursuant to federal and state mining laws and regulations for the estimated costs of reclamation and mine closing, often including the cost of treating mine water discharge when necessary.  Compliance with these laws has substantially increased the cost of coal mining for all domestic coal producers.  We endeavor to conduct our mining operations in compliance with all applicable federal, state, and local laws and regulations.  However, even with our substantial efforts to comply with extensive and comprehensive regulatory requirements, violations during mining operations occur from time to time.

Mine Safety and Health
 
Stringent health and safety standards have been in effect since Congress enacted the Federal Coal Mine Health and Safety Act of 1969. The Federal Coal Mine Safety and Health Act of 1977 significantly expanded the enforcement of safety and health standards and imposed safety and health standards on all aspects of mining operations. A further expansion occurred in June 2006 with the enactment of the Mine Improvement and New Emergency Response Act of 2006 (“MINER Act”).

The MINER Act and related Mine Safety and Health Administration (“MSHA”) regulatory actions require, among other things, improved emergency response capability, increased availability of emergency breathable air, enhanced communication and tracking systems, more available mine rescue teams, increased mine seal strength and monitoring of sealed areas in underground mines, and larger penalties by MSHA for noncompliance by mine operators. Coal producing states, including West Virginia and Kentucky, have passed similar legislation.

           In 2008, MSHA published final rules implementing Section 4 of the MINER Act that addressed mine rescue, sealing of abandoned areas, refuge alternatives, fire prevention and detection, use of air from the belt entry and civil penalty assessments.  MSHA also provided guidance on wireless communication and electronic tracking systems and new requirements for the plugging of coal bed methane wells with horizontal branches in coal seams.  Two additional regulations were also published related to measures to achieve alcohol and drug free mines and the use of coal mine dust personal monitors. In February 2009, the United States Court of Appeals for the District of Columbia Circuit held that the 2008 rules were not sufficient to satisfy the requirements of the MINER Act in certain respects, and remanded those portions of the rules to MSHA for reconsideration. New rules issued by the MSHA will likely contain more stringent provisions regarding training of rescue teams.
 
 
8

 
 
On October 19, 2010, MSHA issued a proposed rule, 75 Fed. Reg. 64412 (“PR1”), which would lower the current two milligram dust standard to one milligram gradually over a two-year period, mandate the use of continuous personal dust monitors, address extended work shifts, redefine normal production shifts, require additional medical surveillance examinations for miners, and provide for the use of a single, full-shift sample to determine compliance.

The current respirable coal mine dust exposure standard would be reduced as follows:
 
 
The current limit would be lowered to 1.7 mg/m3 six months after the final rule's effective date.

 
The limit would be lowered to 1.5 mg/m3 12 months after the final rule's effective date.

 
The limit would be lowered to 1.0 mg/m3 24 months after the final rule's effective date.

 
The limit for miners who show evidence of developing pneumoconiosis would be reduced to 0.5 mg/m3 six months after the final rule's effective date.

 
Additionally, the limit for intake air at underground mines would be reduced to 0.5 mg/m3 six months after the final rule's effective date.
 
The PR1 would phase in the required use of the Continuous Personal Dust Monitor (“CPDM”).  The CPDMs would electronically store all respirable dust sampling data collected during a shift and would be sent to MSHA electronically.  The CPDMs would be optional for surface coal mines and for non-production areas of underground coal mines (such as outby areas).
 
Other changes include: requiring sampling of extended work shifts to account for occupational exposures of greater than eight hours per shift; requiring sampling when production is equivalent to or greater than the level of average production level over the last 30 production shifts; requiring spirometry testing, occupational history and symptom assessment to be implemented, in addition to the chest x-ray exam currently required for underground coal miners and medical surveillance; and finally, a single, full-shift sample collected by MSHA or the mine operator would be used to determine compliance rather than averaging multiple dust samples of different miners’ exposures per the current requirements.

The PR1 is out for comment until May 2, 2011.

On September 23, 2010, MSHA promulgated an Emergency Temporary Standard (“ETS”) requiring that the total incombustible content (“TIC”) of the combined coal, rock and other dusts in underground coal mines be at least 80%. 75 Fed. Reg. 57849 (Sept. 23, 2010). In addition, the ETS requires that where methane is present in any ventilating current, the TIC of such combined dust shall be increased 0.4% for each 0.1% of methane. The ETS revised the existing standard, 30 C.F.R. § 75.403, which permitted TIC of combined dusts to be 65% in areas of a mine other than return air courses.
 
The ETS serves as an emergency temporary final rule with immediate effect and provides for an opportunity for notice and comment, after which MSHA will issue a new final standard. The new final standard must be issued within nine months of the promulgation of the ETS and may differ from the ETS.
 
On February 2, 2011, MSHA published proposed changes to 30 C.F.R. Part 104 regarding the Pattern of Violations (“POV”) program (“PR2”).  Under the PR2, MSHA will consider all significant and substantial (“S&S”) citations and orders issued, including non-final citations and orders, when determining POV status.  The existing initial screening criteria found at 30 C.F.R. § 104.2 will be eliminated.  Additionally, the PR2 removes the potential POV notice and instead will post the pattern criteria online so that operators can track their status.  MSHA will also post compliance data that the agency will use on its website and provide access to mine operators in a searchable form.  Finally, mines will be reviewed at least twice annually for POV status under the PR2.  The new POV status will utilize similar criteria as to what is currently set forth in 30 C.F.R. § 104.3, including the history of S&S violations, § 104(b) failure to abate orders for S&S violations, § 104(d) citations and orders for an unwarrantable failure to comply, § 107(a) imminent danger orders, § 104(g) orders for untrained miner withdrawal orders, and other information “that demonstrates a serious safety or health management problem at the mine, such as accident, injury and illness records.”  Mitigating circumstances will also be considered, including changes in ownership, however, it is unclear at what point in the process the mine operator may offer such information to MSHA.
 
 
9

 
 
The PR2 is out for comment until April 4, 2011. 
 
On December 27, 2010, MSHA issued a proposed rule, 75 Fed. Reg. 81165 (“PR3”), to revise the requirements for pre-shift, supplemental, on-shift and weekly examinations of underground coal mines.  The PR3 would add the requirement that operators identify violations of mandatory health or safety standards and would also require the mine operator to record and correct these violations, note the actions taken to correct the conditions and review with mine examiners (e.g., the mine foreman, assistant mine foreman or other certified persons) on a quarterly basis all citations and orders issued in areas where pre-shift, supplemental, on-shift and weekly examinations are required.
 
The PR3 is out for comment until February 25, 2011.

Kentucky, the state in which we operate, has state programs for mine safety and health regulation and enforcement.  Collectively, federal and state safety and health regulation in the coal mining industry is perhaps the most comprehensive and pervasive system for protection of employee health and safety affecting any segment of industry in the United States.  While regulation has a significant effect on our operating costs, our United States competitors are subject to the same regulation.

Safety performance is measured in a variety of different ways, including through accident and violation experience expressed in terms of Non-Fatal Days Lost (NFDL) injury incident rates, Total Reported Incident Rates (TRIR) and Violations per Inspection Day (VPID).  The NFDL incident rate represents the number of non-fatal injuries that result in days away from work, statutory days charged, or days of restricted work activity annually per 100 employees.  The TRIR represents the number of NFDL injuries, injuries requiring medical treatment and fatalities occurring annually per 100 employees.  The VPID measure represents the average number of violations issued by MSHA per inspection day (each day constitutes 5 on-site inspection hours).

We have hired White Star Mining as our operator to conduct all of our mining operations.   This third party operator hires its own employees for the mining operations.  Our third party contractor keeps their own records regarding the safety performance of their company and their employees.  We cannot provide the NFDL and TRIR information for that of our third party contractor.

In addition, our third party operator is responsible for any and all violations issued by MSHA or other regulatory agencies regarding their mining operations.  We do not have access to the records of our third party contractor for their VPIP statistics.

Black Lung.  Under federal black lung benefits legislation, each coal mine operator is required to make payments of black lung benefits or contributions to: (i) current and former coal miners totally disabled from black lung disease; and (ii) certain survivors of a miner who dies from black lung disease.  The Black Lung Disability Trust Fund, to which we must make certain tax payments based on tonnage sold, provides for the payment of medical expenses to claimants whose last mine employment was before January 1, 1970 and to claimants employed after such date, where no responsible coal mine operator has been identified for claims or where the responsible coal mine operator has defaulted on the payment of such benefits.  In addition to federal acts, we are also liable under various state statutes for black lung claims.  Federal benefits are offset by any state benefits paid.
 
Coal Industry Retiree Health Benefit Act of 1992 and Tax Relief and Retiree Health Care Act of 2006.  The Coal Industry Retiree Health Benefit Act of 1992 (“Coal Act”) provides for the funding of health benefits for certain UMWA retirees.  The Coal Act established the Combined Benefit Fund (“CBF”) into which “signatory operators” and “related persons” are obligated to pay annual premiums for covered beneficiaries.  The Coal Act also created a second benefit fund, the 1992 Benefit Plan, for miners who retired between July 21, 1992 and September 30, 1994 and whose former employers are no longer in business.  On December 20, 2006, President Bush signed the Tax Relief and Retiree Health Care Act of 2006.  This legislation includes important changes to the Coal Act that impacts all companies required to contribute to the CBF.  Effective October 1, 2007, the SSA revoked all beneficiary assignments made to companies that did not sign a 1988 UMWA contract (“reachback companies”), but phased-in their premium relief.  Effective October 1, 2007, reachback companies will pay only 55% of their plan year 2008 assessed premiums, 40% of their plan year 2009 assessed premiums, and 15% of their plan year 2010 assessed premiums.  General United States Treasury money will be transferred to the CBF to make up the difference.  After 2010, reachback companies will have no further obligations to the CBF, and transfers from the United States Treasury will cover all of the health care costs for retirees and dependents previously assigned to reachback companies.
 
 
10

 
 
Environmental Laws

Surface Mining Control and Reclamation Act.  The Surface Mining Control and Reclamation Act, (“SMCRA”), which is administered by the Office of Surface Mining Reclamation and Enforcement (“OSM”), establishes mining, environmental protection, and reclamation standards for all aspects of surface mining as well as many aspects of deep mining.  The SMCRA and similar state statutes require, among other things, the restoration of mined property in accordance with specified standards and an approved reclamation plan.  In addition, the Abandoned Mine Land Fund, which is part of the SMCRA, imposes a fee on all current mining operations, the proceeds of which are used to restore mines closed before 1977.  The maximum tax is $0.315 per ton on surface-mined coal and $0.135 per ton on deep-mined coal.  A mine operator must submit a bond or otherwise secure the performance of its reclamation obligations.  Mine operators must receive permits and permit renewals for surface mining operations from the OSM or, where state regulatory agencies have adopted federally approved state programs under the act, the appropriate state regulatory authority.  We accrue for reclamation and mine-closing liabilities in accordance with Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) Topic 410-20, “Asset Retirement and Environmental Obligations” (“ASC 410-20”).
 
Clean Water Act.  Section 301 of the Clean Water Act prohibits the discharge of a pollutant from a point source into navigable waters of the United States except in accordance with a permit issued under either Section 402 or Section 404 of the Clean Water Act.  Navigable waters are broadly defined to include streams, even those that are not navigable in fact, and may include wetlands.  All mining operations in Appalachia generate excess material, which are typically placed in fills in adjacent valleys and hollows.  Likewise, coal refuse disposal areas and coal processing slurry impoundments are located in valleys and hollows.  These areas frequently contain intermittent or perennial streams, which are considered navigable waters under the Clean Water Act.  An operator must secure a Clean Water Act permit before filling such streams.  For approximately the past twenty-five years, operators have secured Section 404 fill permits that authorize the filling of navigable waters with material from various forms of coal mining.  Operators have also obtained permits under Section 404 for the construction of slurry impoundments.  Discharges from these structures require permits under Section 402 of the Clean Water Act. Section 402 discharge permits are generally not suitable for authorizing the construction of fills in navigable waters.
 
Clean Air Act.  Coal contains impurities, including sulfur, mercury, chlorine, nitrogen oxide and other elements or compounds, many of which are released into the air when coal is burned.  The Clean Air Act and corresponding state laws extensively regulate emissions into the air of particulate matter and other substances, including sulfur dioxide, nitrogen oxide and mercury.  Although these regulations apply directly to impose certain requirements for the permitting and operation of our mining facilities, by far their greatest impact on us and the coal industry generally is the effect of emission limitations on utilities and other customers.  Owners of coal-fired power plants and industrial boilers have been required to expend considerable resources to comply with these air pollution standards.  The United States Environmental Protection Agency (“EPA”) has imposed or attempted to impose tighter emission restrictions in a number of areas, some of which are currently subject to litigation.  The general effect of such tighter restrictions could be to reduce demand for coal.  This in turn may result in decreased production and a corresponding decrease in revenue and profits.  

National Ambient Air Quality Standards.  Ozone is produced by a combination of two precursor pollutants: volatile organic compounds and nitrogen oxide, a by-product of coal combustion.  Particulate matter is emitted by sources burning coal as fuel, including coal fired power plants.  States are required to submit to EPA revisions to their State Implementation Plans (“SIPs”) that demonstrate the manner in which the states will attain National Ambient Air Quality Standards (“NAAQS”) every time a NAAQS is revised by EPA.  In 2006, EPA adopted a new NAAQS for fine particulate matter, which a number of states and environmental advocacy groups challenged as not sufficiently stringent to satisfy Clean Air Act requirements.  In February 2009, the United States Court of Appeals for the District of Columbia Circuit agreed that EPA had inadequately explained its decision regarding several aspects of the NAAQS and remanded those to EPA for reconsideration, a process that could lead to more stringent NAAQS for fine particulate matter.  EPA also adopted a more stringent ozone NAAQS on March 27, 2008.  Revised SIPs for both ozone and fine particulates could require electric power generators to further reduce particulate, nitrogen oxide, and sulfur dioxide emissions.  In addition to the SIP process, the Clean Air Act permits states to assert claims against sources in other “upwind” states alleging that emission sources including coal fired power plants in the upwind states are preventing the “downwind” states from attaining a NAAQS.  The new NAAQS for ozone and fine particulates, as well as claims by affected states, could result in additional controls being required of coal fired power plants and we are unable to predict the effect on markets for our coal. 
 
 
11

 
 
Acid Rain Control Provisions.  The acid rain control provisions promulgated as part of the Clean Air Act Amendments of 1990 in Title IV of the Clean Air Act (“Acid Rain program”) required reductions of sulfur dioxide emissions from power plants.  The Acid Rain program is now a mature program and we believe that any market impacts of the required controls have likely been factored into the price of coal in the national coal market.
 
Regional Haze Program.  EPA promulgated a regional haze program designed to protect and to improve visibility at and around so-called Class I Areas, which are generally National Parks, National Wilderness Areas and International Parks.  This program may restrict the construction of new coal-fired power plants whose operation may impair visibility at and around the Class I Areas.  Moreover, the program requires certain existing coal-fired power plants to install additional control measures designed to limit haze-causing emissions, such as sulfur dioxide, nitrogen oxide and particulate matter.  States were required to submit Regional Haze SIPs to EPA by December 17, 2007.  Many states did not meet the December 17, 2007, deadline and we are unable to predict the impact on the coal market of the failure to submit Regional Haze SIPs by the deadline or of any subsequent submissions deadlines.
 
New Source Review Program.  Under the Clean Air Act, new and modified sources of air pollution must meet certain new source standards (“New Source Review Program”).  In the late 1990s, EPA filed lawsuits against many coal-fired plants in the eastern United States alleging that the owners performed non-routine maintenance, causing increased emissions that should have triggered the application of these new source standards.  Some of these lawsuits have been settled, with the owners agreeing to install additional pollution control devices in their coal-fired plants.  The remaining litigation and the uncertainty around the New Source Review Program rules could adversely impact utilities’ demand for coal in general or coal with certain specifications, including the coal we produce.
 
Multi-Pollutant Strategies.  In March 2005, EPA issued two closely related rules designed to significantly reduce levels of sulfur dioxide, nitrogen oxide and mercury: the Clean Air Interstate Rule (“CAIR”) and the Clean Air Mercury Rule (“CAMR”).  CAIR sets a “cap-and-trade” program in 28 states and the District of Columbia to establish emissions limits for sulfur dioxide and nitrogen oxide, by allowing utilities to buy and sell credits to assist in achieving compliance with the NAAQS for 8-hour ozone and fine particulates.  CAMR as promulgated will cut mercury emissions nearly 70% by 2018 through a “cap-and-trade” program.  Both rules were challenged in numerous lawsuits and the United States Court of Appeals for the District of Columbia Circuit vacated CAMR and remanded it to EPA for reconsideration on February 8, 2008.  In February 2009, EPA announced its intention to develop a technology-based standard under Section 112 of the Clean Air Act to address mercury emissions rather than pursue the “cap-and-trade” approach of CAMR.  The same court vacated the CAIR on July 11, 2008, but subsequently revised its remedy to a remand to EPA for reconsideration on December 23, 2008.  EPA is preparing its response to the remand, but the court did not impose a response date.  Regardless of the outcome of litigation on either rule, stricter controls on emissions of SO2, NOX and mercury are likely in some form.  Any such controls may have an impact on the demand for our coal.
 
Global Climate Change
 
The United States has not implemented the 1992 Framework Convention on Global Climate Change (“Kyoto Protocol”), which became effective for many countries on February 16, 2005.  The Kyoto Protocol was intended to limit or reduce emissions of greenhouse gases, such as carbon dioxide.  The United States has not ratified the emission targets of the Kyoto Protocol or any other greenhouse gas agreement among parties.

Nevertheless, global climate change continues to attract considerable public and scientific attention and a considerable amount of legislative attention in the United States is being paid to global climate change and the reduction of greenhouse gas emissions, particularly from coal combustion by power plants.  Enactment of laws and passage of regulations regarding greenhouse gas emissions by the United States or some of its states, or other actions to limit carbon dioxide emissions, could result in electric generators switching from coal to other fuel sources.
 
 
12

 
 
Comprehensive Environmental Response, Compensation and Liability Act

The Comprehensive Environmental Response, Compensation and Liability Act (“CERCLA”), and similar state laws affect coal mining operations by, among other things, imposing cleanup requirements for threatened or actual releases of hazardous substances that may endanger public health or welfare or the environment.  Under CERCLA and similar state laws, joint and several liability may be imposed on waste generators, site owners and lessees and others regardless of fault or the legality of the original disposal activity.  Although EPA excludes most wastes generated by coal mining and processing operations from the hazardous waste laws, such wastes can, in certain circumstances, constitute hazardous substances for the purposes of CERCLA.  In addition, the disposal, release, or spilling of some products used by coal companies in operations, such as chemicals, could implicate the liability provisions of the statute.  Under EPA’s Toxic Release Inventory process, companies are required annually to report the use, manufacture, or processing of listed toxic materials that exceed defined thresholds, including chemicals used in equipment maintenance, reclamation, water treatment and ash received for mine placement from power generation customers.  Our current and former coal mining operations incur, and will continue to incur, expenditures associated with the investigation and remediation of facilities and environmental conditions under CERCLA.

Endangered Species Act
 
The federal Endangered Species Act and counterpart state legislation protect species threatened with possible extinction.  Protection of endangered species may have the effect of prohibiting or delaying us from obtaining mining permits and may include restrictions on timber harvesting, road building, and other mining or agricultural activities in areas containing the affected species.  Based on the species that have been identified on our properties to date and the current application of applicable laws and regulations, we do not believe there are any species protected under the Endangered Species Act that would materially and adversely affect our ability to mine coal from our properties in accordance with current mining plans.

           Operations - Permitting; Compliance.  We have obtained all the permits required for its current operations under the SMCRA, the Clean Water Act, the Clean Air Act, and corresponding state laws.  We are currently, and intend to remain in compliance in all material respects with such permits and intend to routinely correct in a timely fashion violations of which it receives notice in the normal course of operations.  The expiration dates of the permits are largely immaterial as the law provides for a right of successive renewal.  The cost of obtaining surface mining, clean water, and air permits can vary widely depending on the scientific and technical demonstrations that must be made to obtain the permits.  However, the cost of obtaining a permit is rarely more than $500,000 and of obtaining a renewal is rarely more than $5,000.  It is impossible to predict the full impact of future judicial, legislative, or regulatory developments on our operations because the standards to be met, as well as the technology and length of time available to meet those standards, continue to develop and change.

The imposition of more stringent requirements under environmental laws or regulations, new developments or changes regarding site cleanup costs or the allocation of such costs among potentially responsible parties, or a determination that we are potentially responsible for the release of hazardous substances at sites other than those currently identified, could result in additional expenditures or the provision of additional accruals in expectation of such expenditures.

Coal Reserves

We estimate that, as of December 31, 2010, we have total reserves of approximately 9.8 million tons, of proven/probable reserves.  “Reserves” are defined by Securities and Exchange Commission Industry Guide 7 as that part of a mineral deposit, which could be economically and legally extracted or produced at the time of the reserve determination.  “Recoverable” reserves mean coal that is economically recoverable using existing equipment and methods under federal and state laws currently in effect.  “Proven (Measured) Reserves” are defined by Securities and Exchange Commission Industry Guide 7 as reserves for which (a) quantity is computed from dimensions revealed in outcrops, trenches, workings or drill holes; grade and/or quality are computed from the results of detailed sampling and (b) the sites for inspection, sampling and measurement are spaced so closely and the geologic character is so well defined that size, shape, depth and mineral content of reserves are well-established.  “Probable reserves” are defined by Securities and Exchange Commission Industry Guide 7 as reserves for which quantity and grade and/or quality are computed from information similar to that used for proven (measured) reserves, but the sites for inspection, sampling, and measurement are farther apart or are otherwise less adequately spaced.  The degree of assurance, although lower than that for proven (measured) reserves, is high enough to assume continuity between points of observation.  At this time, we cannot readily define the difference of assurance between “proven” and “probable” reserves.
 
 
13

 
 
The table below summarizes our reserves for each of our mines:

SEAM
TONS
CLASS
GRADE*
OWNED
LEASED
           
Winifede
214,650
Proven/Probable
STEAM
0
214,650
Taylor
1,783,500
Proven/Probable
STEAM
0
1,783,650
Cedar Grove
3,702,600
Proven/Probable
STEAM/NEAR MET
0
3,702,600
Pond Creek
4,027,762
Proven/Probable
STEAM/NEAR MET
0
4,027,762
           
TOTALS
9,728,512
       


*--Commonly known information in the general area of the reserve

Information about our reserves consists of estimates based on engineering, economic, and geological data assembled and analyzed by its contracted engineers, geologists, and finance associates.  Reserve estimates are updated as deemed necessary by management using geologic data taken from drill holes, adjacent mine workings, outcrop prospect openings and other sources.  Coal tonnages are categorized according to coal quality, seam thickness, mineability, and location relative to existing mines and infrastructure.  In accordance with applicable industry standards, proven reserves are those for which reliable data points are spaced no more than 2,700 feet apart.  Probable reserves are those for which reliable data points are spaced 2,700 feet to 7,900 feet apart.  Further scrutiny is applied using geological criteria and other factors related to profitable extraction of the coal.  These criteria include seam height, roof and floor conditions, yield, and marketability.

As with most coal-producing companies in Central Appalachia, all of our coal reserves are controlled pursuant to leases from third party landowners.  These leases convey mining rights to the coal producer in exchange for a royalty payment to the lessor based on either a fixed amount per ton of coal mined or a percentage of gross sales price of coal mined.  All of our leases have automatic renewal provisions.  The royalties for coal reserves to landowners from our producing properties was approximately $303,467 for the year ended December 31, 2010 and $110,000 for the year ended December 31, 2009.

So long as the leases are maintained, we intend to mine all of the coal on the properties covering the leases, in large part due to the automatic renewal provisions.  Should we receive a significant capital infusion allowing us to run full time continuous mining operations for all properties, we would expect to complete mining production in approximately 10 years.  However, if we are unable to maintain our leases, we would be unable to maintain this production schedule.  As of the date of this report, we have no mines open and are conducting no mining operations.  Accordingly, we have no current scheduled production.  Upon receipt of additional requisite funding, we plan to resume mining operations.

Our wholly-owned subsidiary, Gwenco, Inc., obtained Title Reports from an established  law firm with offices in Kentucky and West Virginia with respect to the title to the real property subject to the Company’s leases and the rights described therein.  Furthermore, we have obtained supplemental title reports from Appalachian Title Research, Inc. with respect to the title to real property subject to certain of our leases and the rights described therein.
 
 
14

 

The categorization of the “quality” (i.e., sulfur content, Btu, coal type, etc.) of coal reserves is as follows as of December 31, 2010:
 
         
Recoverable Reserves (1)
Sulfur Content
       
Seam
 
Recoverable
Reserves
      +1% (2)      
-1% (2)
   
Compliance
(2)
   
Avg. Btu
as
Received (3)
 
Winifrede
    214,650       0       100 %     100 %     12,000-12,500  
Taylor
    1,783,650       0       100 %     100 %     12,000-12,500  
Cedar Grove
    3,702,600       0       100 %     100 %     12,000-12,500  
Pond Creek
    4,027,762       0       100 %     100 %     12,000-12,500  
 
[Missing Graphic Reference]
(1)
The reserve numbers of each Seam contain a moisture factor specific to the particular reserves of that Seam. The moisture factor represents the average moisture present in our delivered coal.
(2)
+1% or -1% refers to sulfur content as a percentage in coal by weight. Compliance coal is less than 1% sulfur content by weight and is included in the -1% column.
(3)
Represents an estimate of the average Btu per pound present in our coal, as it is received by the customer.
   

Compliance compared to non-compliance coal

Coals are sometimes characterized as compliance or non-compliance coal. The phrase compliance coal, as it is commonly used in the coal industry, refers to compliance only with sulfur dioxide emissions standards imposed by Title IV of the Clean Air Act and indicates that when burned, the coal will produce emissions that will meet the current standard without further cleanup. A coal that is considered a compliance coal for meeting sulfur dioxide standards may not meet an emission standard for a different pollutant such as mercury. Moreover, the term compliance coal is always used with reference to the then current regulatory limit. Clean air regulations that further restrict sulfur dioxide emissions will likely reduce significantly the amount of coal that can be labeled compliance. Currently, coal classified as compliance coal will meet the power plant emission standard of 1.2 pounds of sulfur dioxide per million Btu’s of fuel consumed. At December 31, 2010, all of our coal reserves met the current standard as compliance coal.

Attached below is a table showing production results for the last three years for the Slater’s Branch location on our Pond Creek seam.  We have done any drilling on the Cedar Grove, Winifrede or Taylor seams and as such we have no production rates for each of those seams.
 
Year
Clean Tons Severed
Clean tons sold
Weighted Average
 Price per ton ($)(1)
2010
32,898
32,898
73
2009
24,222.15
24,222.15
66.57
2008
7,686.68
7,686.68
97.15
(1)  
The weighted average calculation is the sum of the daily tonnage sold multiplied by the average daily vender price per ton divided by annual tonnage results.
 
 
15

 
 
Our Slater’s Branch location at Pond Creek has road access and can be reached on trucks.  The minable coal thickness is 29” to 49”.  We run a continuous mining operation using shuttle cars, conveyer belts and continuous miners.  We have contracted White Star Mining to conduct all mining operations at this location.  This mine is currently closed.  We intend to reopen upon receiving the requisite additional funds.

Employees

We currently employ one person, our President, Eugene Chiaramonte, Jr.  All other personnel who provide services for us, whether in administration or in mining operations, either work on an independent contractor basis or work for White Star Mining under a contract mining arrangement.  None of our employees are represented by a labor union, and we have not entered into a collective bargaining agreement with any union.  We have not experienced any work stoppages and believe that it has good relations with its employees.
 
 
Business Development of Kentucky

Quest Minerals (Nevada), was organized on November 19, 2003 to acquire and operate privately held coal mining companies in the southeast United States.

Reverse Merger. We were incorporated on November 21, 1985 in the State of Utah under the name “Sabre, Inc.”  It subsequently changed its name to Tillman International, Inc., or Tillman.  On February 9, 2004, Quest Minerals (Nevada) completed a “reverse merger” with Tillman.  On April 8, 2004, Tillman changed its name to “Quest Minerals & Mining Corp.”

Gwenco Acquisition.  Effective April 28, 2004, Quest Minerals (Nevada) acquired 100% of the outstanding capital stock of Gwenco in exchange for 1,386,275 shares of Series B preferred stock of Quest Minerals (Nevada) and the assumption of up to $1,700,000 in debt.  Each share of Series B preferred stock carries a liquidation preference of $2.50 per share and is convertible into shares of Quest’s common stock.
  
 
16

 
 
Item 1A.  RISK FACTORS AND CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING INFORMATION

An investment in our common stock involves a high degree of risk.  You should carefully consider the following risk factors and the other information in this report before investing in our common stock.  Our business and results of operations could be seriously harmed by any of the following risks.  The trading price of our common stock could decline due to any of these risks, and you may lose part or all of your investment.

We have received a notice from our secured lender under our exit facility alleging defaults thereunder who could seek liquidation of our assets.  On June 14, 2010, our secured lender under the exit facility, delivered a notice of default relating to that certain Loan and Security Agreement dated March 8, 2010.  Under the notice, our alleged an Event of Default under the Loan Agreement occurred and was continuing pursuant to Section 8.21 thereunder as they allegedly deemed itself “insecure” under the Loan Agreement.  We have denied our secured allegation of an Event of Default under the Loan Agreement and contend that no such Event of Default under the Loan Agreement has occurred or is continuing.   On June 17, 2010, Gwenco and our secured lender entered into an agreement pursuant to which, among other things, our secured lender  agreed to forbear under the Loan Agreement for a period of 90 days.  On November 4, 2010, our secured lender delivered another notice of default relating to the Loan and Security Agreement, realleging that an Event of Default under Loan Agreement occurred and was continuing.  We deny the allegations under all notices of an Event of Default under the Loan Agreement and contend that no such Event of Default under the Loan Agreement has occurred or is continuing.   We continue to contend that no default under the exit facility has occurred. To date, our secured lender has not commenced any legal proceedings against us.  However, if our secured lender were to commence litigation and was successful proving a default thereunder, they could seek to liquidate our assets.

Our wholly owned subsidiary, Gwenco, Inc., is emerging from bankruptcy protection; however, it is still possible that its assets may be liquidated in the future.   On March 2, 2007, our wholly owned subsidiary, Gwenco, Inc., filed a voluntary petition for reorganization under Chapter 11 of the U.S. Bankruptcy Code with the United States Bankruptcy Court for the Eastern District of Kentucky.  Prior to October 12, 2009, Gwenco oversaw its operations as a debtor in possession, subject to court approval of matters outside the ordinary course of business.  In 2007, the Bankruptcy Court approved Gwenco’s request for debtor-in-possession financing in an amount of up to $2,000,000 from holders of Gwenco’s existing debt obligations in order to fund operating expenses.  Under Chapter 11, all claims against Gwenco in existence prior to the filing of the petitions for reorganization relief under the federal bankruptcy laws were stayed while Gwenco was in bankruptcy.  On September 30, 2009, the Bankruptcy Court confirmed Gwenco’s Plan of Reorganization (the “Plan”).  Secured and non-priority unsecured classes of creditors voted to approve the Plan, with over 80% of the unsecured claims in dollar amount voting for the plan, and over 90% of responding lessors supporting it.   The Plan became effective on October 12, 2009. 

Even though the Bankruptcy Court has confirmed the Plan, it is still possible that the Bankruptcy Court could convert Gwenco’s case to Chapter 7 and liquidate all of Gwenco’s assets if the Court determines that Gwenco is unable to perform under the Plan.  The Court could make such a determination upon motion of any creditor, other party to the action, or on its own motion.  In the case of a Chapter 7 conversion, the Company would be materially impacted and could lose all of its working assets and have only unpaid liabilities.  In addition, the Company might be forced to file for protection under Chapter 11 as it is the primary guarantor on a number of Gwenco’s contracts.

Equipment breakdowns and a shortage of supplies have caused significant work stoppages.  Unless we receive significant additional working capital, it is likely that these breakdowns and shortages will continue.  During the past two fiscal years, we have been forced to suspend its mining operations for approximately two out of five days, on average, due to either breakdowns in equipment or a lack of necessary supplies.  We require significant additional working capital to maintain, repair, or replace its equipment and to maintain adequate inventories of supplies in order to significantly reduce these work stoppages.  It is possible that we may not be able to obtain such additional working capital in the amounts necessary to reduce these work stoppages.  If we are unable to obtain such working capital, significant work stoppages are to likely to continue.

We have issued a substantial number of securities convertible into shares of our common stock which will result in substantial dilution to the ownership interests of our existing stockholders. As of April 12, 2011, approximately 45,589,707,032 shares of our common stock were required for issuance upon exercise or conversion of the following securities (without regard to any limitations on conversion): (i) 45,307,529,032 shares representing shares of common stock issuable upon conversion in full of our outstanding convertible promissory notes or claims with conversion options (without regard to any limitations on conversion); (ii) 32,178,000 shares of common stock issuable upon conversion of our Series A Preferred (without regard to any limitations on conversion) and (iii) 250,000,000 shares were reserved for exercise of outstanding options.  The exercise or conversion of these securities will result in a significant increase in the number of outstanding shares and substantially dilute the ownership interests of our existing shareholders.  In addition, any decrease in our stock price will result in additional shares of common stock required for issuance upon exercise or conversion of the securities set forth above.  Furthermore, the conversion prices set in many of our convertible securities do not adjust in the event of a stock split or reverse stock split.
 
 
17

 
 
The issuance of shares upon conversion of our convertible securities may cause immediate and substantial dilution to our existing stockholders. The issuance of shares upon conversion of our outstanding convertible notes or Series A Preferred Stock may result in substantial dilution to the interests of other stockholders since the selling stockholders may ultimately convert and sell the full amount issuable on conversion.  Although the selling stockholders may not convert their convertible notes if such conversion would cause them to own more than 4.99% of our outstanding common stock, this restriction does not prevent the selling stockholders from converting some of their holdings and then converting the rest of their holdings. In this way, the selling stockholders could sell more than this limit while never holding more than this limit. There only upper limit on the number of shares that may be issued is the number of shares of common stock authorized for issuance under our articles of incorporation. The issuance of shares upon conversion of the convertible notes will have the effect of further diluting the proportionate equity interest and voting power of holders of our common stock.  Furthermore, the conversion prices set in many of our convertible securities do not adjust in the event of a stock split or reverse stock split.

The issuance of shares of common stock to consultants may cause immediate and substantial dilution to our existing stockholders.  We have established, and my establish in the future additional, stock incentive plans under which we may issue various types of awards, including common stock awards.  We currently pay certain consultants and are likely to continue to pay consultants in the future with stock awards under these plans.  The issuance of stock awards to consultants will have the effect of further diluting the proportionate equity interest and voting power of holders of our common stock.

We may need to continue to finance its operations through additional borrowings or other capital financings, and if it is unable to obtain additional capital, it may not be able to continue as a going concern.  We have a working capital deficit as of December 31, 2010.  While we and Gwenco submitted financial projections to the Bankruptcy Court that forecast that Gwenco will generate positive cash flow, to date, Gwenco has unable to meet those projections and has not generated negative cash flow.  While management believes that it will be able to perform according to the projections, it cannot currently estimate when that may occur, if at all.  As such, we are unable to forecast whether it will be able to fund its operations, working capital requirements, and debt service requirements over the fiscal year 2010 through cash flows generated from operations.  So long as Gwenco is not generating positive cash flow, we will need to continue to finance its operations through additional borrowings or other capital financings.  Our collateral may not be sufficient to borrow additional amounts at such time.  We may also seek equity financing in the form of a private placement or a public offering.  Such additional financing may not be available to us, when and if needed, on acceptable terms or at all.  If we are unable to obtain additional financing in sufficient amounts or on acceptable terms, its operating results and prospects could be further adversely affected.

We have substantial indebtedness outstanding, and its operations are significantly leveraged.   In order to finance our operations, we have incurred substantial indebtedness.  Our subsidiary, Gwenco, Inc., has already filed for protection under Chapter 11 of the U.S. Bankruptcy Code.  On September 30, 2009, the Bankruptcy Court confirmed Gwenco’s Plan of Reorganization (the “Plan”).  Secured and non-priority unsecured classes of creditors voted to approve the plan, with over 80% of the unsecured claims in dollar amount voting for the plan, and over 90% of responding lessors supporting it.   The Plan became effective on October 12, 2009.  Even though the Bankruptcy Court has confirmed the Plan, it is still possible that the Bankruptcy Court could convert Gwenco’s case to Chapter 7 and liquidate all of Gwenco’s assets if the Court determines that Gwenco is unable to perform under the Plan.  Gwenco is not currently generating positive cash flows from operations, and as such, it relies on additional financing in order to supplement its current cash flows from operations in order service its debt and other obligations under the Plan.  In the case of a Chapter 7 conversion, the Company would be materially impacted and could lose all of its working assets and have only unpaid liabilities.  In addition, the Company might be forced to file for protection under Chapter 11 as it is the primary guarantor on a number of Gwenco’s contracts.
 
 
18

 
 
We may be unable to continue as a going concern, in which case its securities will have little or no value.  Our independent auditor has noted in its report concerning our financial statements as of December 31, 2010 that it has incurred recurring losses from operations and has a working capital deficiency, which raises substantial doubt about its ability to continue as a going concern.  As shown in the consolidated financial statements included in this report, we have incurred recurring losses from operations in 2010 and 2009, and have an accumulated deficit and a working capital deficit as of December 31, 2010.  These conditions raise substantial doubt as to our ability to continue as a going concern.  It is possible that we will not achieve operating profits in the future.

The level of our indebtedness could adversely affect its ability to grow and compete and prevent it from fulfilling its obligations under its contracts and agreements.  We have significant debt, lease, and royalty obligations.  Its ability to satisfy debt service, lease, and royalty obligations and to effect any refinancing of its indebtedness will depend upon future operating performance, which will be affected by prevailing economic conditions in the markets that it serves as well as financial, business and other factors, many of which are beyond its control.  We may be unable to generate sufficient cash flow from operations and future borrowings, or other financings may be unavailable in an amount sufficient to enable it to fund its debt service, lease, and royalty payment obligations or its other liquidity needs.   Our relative amount of debt could have material consequences to its business, including, but not limited to, the following: (i) making it more difficult to satisfy debt covenants and debt service, lease payment, and other obligations; (ii) increasing its vulnerability to general adverse economic and industry conditions; (iii) limiting its ability to obtain additional financing to fund future acquisitions, working capital, capital expenditures, or other general corporate requirements; (iv) reducing the availability of cash flows from operations to fund acquisitions, working capital, capital expenditures, or other general corporate purposes; (v) limiting its flexibility in planning for, or reacting to, changes in its business and the industry in which it competes; or (vi) placing it at a competitive disadvantage when compared to competitors with less relative amounts of debt.

If transportation for our coal becomes unavailable or uneconomic for its customers, our ability to sell coal could suffer.  Transportation costs represent a significant portion of the total cost of coal and, as a result, the cost of transportation is a critical factor in a customer’s purchasing decision.  Increases in transportation costs could make coal a less competitive source of energy or could make some of our operations less competitive than other sources of coal.  Coal producers depend upon rail, barge, trucking, overland conveyor, and other systems to deliver coal to markets.  While U.S. coal customers typically arrange and pay for transportation of coal from the mine to the point of use, disruption of these transportation services because of weather-related problems, strikes, lock-outs or other events could temporarily impair our ability to supply coal to its customers and thus could adversely affect our results of operations.  For example, the high volume of coal shipped from one region of mines could create temporary congestion on the rail systems servicing that region.

Risks inherent to mining could increase the cost of operating our business.  Our mining operations are subject to conditions beyond its control that can delay coal deliveries or increase the cost of mining at particular mines for varying lengths of time.  These conditions include weather and natural disasters, unexpected maintenance problems, key equipment failures, variations in coal seam thickness, variations in the amount of rock and soil overlying the coal deposit, variations in rock, and other natural materials and variations in geologic conditions.  In addition, the United States and over 160 other nations are signatories to the 1992 Framework Convention on Climate Change, which is intended to limit emissions of greenhouse gases, such as carbon dioxide.  In December 1997, in Kyoto, Japan, the signatories to the convention established a binding set of emission targets for developed nations.  Although the specific emission targets vary from country to country, the United States would be required to reduce emissions to 93% of 1990 levels over a five-year budget period from 2008 through 2012.  Although the United States has not ratified the emission targets and no comprehensive regulations focusing on U.S. greenhouse gas emissions are in place, these restrictions, whether through ratification of the emission targets or other efforts to stabilize or reduce greenhouse gas emissions, could adversely impact the price of and demand for coal.  According to the Energy Information Administration’s Emissions of Greenhouse Gases in the United States 2002, coal accounts for 30% of greenhouse gas emissions in the United States, and efforts to control greenhouse gas emissions could result in reduced use of coal if electricity generators switch to sources of fuel with lower carbon dioxide emissions.  Further developments in connection with regulations or other limits on carbon dioxide emissions could have a material adverse effect on our financial condition or results of operations.
 
 
19

 
 
Our future success depends upon its ability to continue acquiring and developing coal reserves that are economically recoverable.  Our recoverable reserves decline as it produces coal.  We have not yet applied for the permits required or developed the mines necessary to use all of its reserves.  Furthermore, we may not be able to mine all of its reserves as profitably as it does at its current operations.  Our future success depends upon its conducting successful exploration and development activities or acquiring properties containing economically recoverable reserves.  Our planned mine development projects and acquisition activities may not result in significant additional reserves, and it may not have continuing success developing additional mines.  Most of our mining operations are conducted on properties owned or leased by us.  Because title to most of its leased properties and mineral rights are not thoroughly verified until a permit to mine the property is obtained, our right to mine some of its reserves may be materially adversely affected if defects in title or boundaries exist.  In addition, in order to develop its reserves, we must receive various governmental permits.  We cannot predict whether it will continue to receive the permits necessary for it to operate profitably in the future.  We may not be able to negotiate new leases from the government or from private parties or obtain mining contracts for properties containing additional reserves or maintain its leasehold interest in properties on which mining operations are not commenced during the term of the lease.  From time to time, we have experienced litigation with lessors of our coal properties and with royalty holders.

If the coal industry experiences overcapacity in the future, our profitability could be impaired.  During the mid-1970s and early 1980s, a growing coal market and increased demand for coal attracted new investors to the coal industry, spurred the development of new mines, and resulted in added production capacity throughout the industry, all of which led to increased competition and lower coal prices.  Similarly, an increase in future coal prices could encourage the development of expanded capacity by new or existing coal producers.  Any overcapacity could reduce coal prices in the future.

Our ability to operate effectively could be impaired if it loses key personnel.  We manage our business with a number of key personnel, the loss of a number of whom could have a material adverse effect on us.  In addition, as its business develops and expands, we believe that its future success will depend greatly on its continued ability to attract and retain highly skilled and qualified personnel.  It is possible that key personnel will not continue to be employed by us and that we will be not able to attract and retain qualified personnel in the future. We do not have “key person” life insurance to cover its executive officers. Failure to retain or attract key personnel could have a material adverse effect on us.

Coal markets are highly competitive and affected by factors beyond our control.   We compete with coal producers in various regions of the U.S. for domestic sales and with both domestic and overseas producers for sales to international markets.  Continued domestic demand for our coal and the prices that it will be able to obtain primarily will depend upon coal consumption patterns of the domestic electric utility industry and the domestic steel industry.  Consumption by the domestic utility industry is affected by the demand for electricity, environmental and other governmental regulations, technological developments and the price of competing coal and alternative fuel supplies including nuclear, natural gas, oil and renewable energy sources, including hydroelectric power.  Consumption by the domestic steel industry is primarily affected by the demand for U.S. steel.  Our sales of metallurgical coal are dependent on the continued financial viability of domestic steel companies and their ability to compete with steel producers abroad.  The cost of ocean transportation and the valuation of the U.S. dollar in relation to foreign currencies significantly impact the relative attractiveness of our coal as it competes on price with other foreign coal producing sources.
 
We are subject to being adversely affected by the potential inability to renew or obtain surety bonds.    Federal and state laws require bonds to secure our obligations to reclaim lands used for mining, to pay federal and state workers’ compensation and to satisfy other miscellaneous obligations. These bonds are typically renewable annually. Surety bond issuers and holders may not continue to renew the bonds or may demand additional collateral upon those renewals. We are also subject to increases in the amount of surety bonds required by federal and state laws as these laws change or the interpretation of these laws changes. Our failure to maintain, or inability to acquire, surety bonds that are required by state and federal law would have a material adverse impact on us, possibly by prohibiting us from developing properties that we desire to develop. That failure could result from a variety of factors including the following: (i) lack of availability, higher expense or unfavorable market terms of new bonds; (ii) restrictions on availability of collateral for current and future third-party surety bond issuers under the terms of our senior notes or revolving credit facilities; (iii) our inability to meet certain financial tests with respect to a portion of the post-mining reclamation bonds; and (iv) the exercise by third-party surety bond issuers of their right to refuse to renew or issue new bonds.
 
 
20

 
 
Defects in title or loss of any leasehold interests in our properties could limit its ability to mine its properties or result in significant unanticipated costs.  Substantially all of our mining operations occur on properties that we lease.  Title defects or the loss of leases could adversely affect our ability to mine the reserves covered by those leases.  Our right to mine some of our reserves may be adversely affected if defects in title or boundaries exist.  In order to obtain leases to conduct our mining operations on property where these defects exist, we may have to incur unanticipated costs.  In addition, we may not be able to successfully negotiate new leases for properties containing additional reserves, or maintain our leasehold interests in properties where we have not commenced mining operations during the term of the lease.

Concerns about the environmental impacts of coal combustion, including perceived impacts on global climate change, are resulting in increased regulation of coal combustion in many jurisdictions, and interest in further regulation, which could significantly affect demand for our products.  The Clean Air Act and similar state and local laws extensively regulate the amount of sulfur dioxide, particulate matter, nitrogen oxides and other compounds emitted into the air from electric power plants, which are the largest end-users of our coal. Such regulation may require significant emissions control expenditures for many coal-fired power plants. As a result, the generators may switch to other fuels that generate less of these emissions or install more effective pollution control equipment, possibly reducing future demand for coal and the construction of coal-fired power plants. The majority of our coal supply agreements contain provisions that allow a purchaser to terminate its contract if legislation is passed that either restricts the use or type of coal permissible at the purchaser’s plant or results in specified increases in the cost of coal or its use.

Global climate change continues to attract considerable public and scientific attention. Widely publicized scientific reports, such as the Fourth Assessment Report of the Intergovernmental Panel on Climate Change released in 2007, have also engendered widespread concern about the impacts of human activity, especially fossil fuel combustion, on global climate change. A considerable and increasing amount of attention in the United States is being paid to global climate change and to reducing greenhouse gas emissions, particularly from coal combustion by power plants. According to the EIA report, “Emissions of Greenhouse Gases in the United States 2007,” coal combustion accounts for 30% of man-made greenhouse gas emissions in the United States. Legislation was introduced in Congress in the past several years to reduce greenhouse gas emissions in the United States and, although no bills to reduce such emissions have yet passed either house of Congress, bills to reduce such emissions remain pending and others are likely to be introduced. President Obama campaigned in favor of a “cap-and-trade” program to require mandatory greenhouse gas emissions reductions and since his election has continued to express support for such legislation, contrary to the previous administration. The United States Supreme Court’s 2007 decision in Massachusetts v. Environmental Protection Agency ruled that EPA improperly declined to address carbon dioxide impacts on climate change in a rulemaking related to new motor vehicles. The reasoning of the court decision could affect other federal regulatory programs, including those that directly relate to coal use. In July 2008, EPA published an Advanced Notice of Proposed Rulemaking (ANPR) seeking comments regarding the regulation of greenhouse gas emissions; and in February 2009 the newly appointed administrator of EPA granted a petition by environmental advocacy groups to reconsider an interpretive memorandum by her predecessor in December 2008 that concluded the Clean Air Act’s Prevention of Significant Deterioration program does not extend to carbon dioxide emissions, a decision that could lead to carbon dioxide emissions from coal-fired power plants being a consideration in permitting decisions. In addition, a growing number of states in the United States are taking steps to require greenhouse gas emissions reductions from coal-fired power plants. Enactment of laws and promulgation of regulations regarding greenhouse gas emissions by the United States or some of its states, or other actions to limit carbon dioxide emissions, could result in electric generators switching from coal to other fuel sources.

As part of the United Nations Framework Convention on Climate Change, representatives from 187 nations met in Bali, Indonesia in December 2007 to discuss a program to limit greenhouse gas emissions after 2012. The United States participated in the conference. The convention adopted what is called the “Bali Action Plan.” The Bali Action Plan contains no binding commitments, but concludes that “deep cuts in global emissions will be required” and provides a timetable for two years of talks to shape the first formal addendum to the 1992 United Nations Framework Convention on Climate Change treaty since the Kyoto Protocol. The ultimate outcome of the Bali Action Plan, and any treaty or other arrangement ultimately adopted by the United States may have a material adverse impact on the global supply and demand for coal. This is particularly true if cost effective technology for the capture and sequestration of carbon dioxide is not sufficiently developed. Technologies that may significantly reduce emissions into the atmosphere of greenhouse gases from coal combustion, such as carbon capture and sequestration (which captures carbon dioxide at major sources such as power plants and subsequently stores it in nonatmospheric reservoirs such as depleted oil and gas reservoirs, unmineable coal seams, deep saline formations, or the deep ocean) have attracted and continue to attract the attention of policy makers, industry participants, and the public. For example, in July 2008 EPA proposed rules that would establish, for the first time, requirements specifically for wells used to inject carbon dioxide into geologic formations. Considerable uncertainty remains, not only regarding rules that may become applicable to carbon dioxide injection wells but also concerning liability for potential impacts of injection, such as groundwater contamination or seismic activity. In addition, technical, environmental, economic, or other factors may delay, limit, or preclude large-scale commercial deployment of such technologies, which could ultimately provide little or no significant reduction of greenhouse gas emissions from coal combustion.
 
 
21

 
 
Further developments in connection with legislation, regulations or other limits on greenhouse gas emissions and other environmental impacts from coal combustion, both in the United States could have a material adverse effect on our cash flows, results of operations or financial condition.

Coal prices are affected by a number of factors and may vary dramatically by region.  The two principal components of the price of coal are the price of coal at the mine, which is influenced by mine operating costs and coal quality, and the cost of transporting coal from the mine to the point of use.  The cost of mining the coal is influenced by geologic characteristics such as seam thickness, overburden ratios and depth of underground reserves. Underground mining is generally more expensive than surface mining as a result of high capital costs, including costs for modern mining equipment and construction of extensive ventilation systems and higher labor costs due to lower productivity.  We currently engage in three principal coal mining techniques: underground room and pillar mining, underground longwall mining and highwall mining.  Because underground longwall mining, surface mining, and highwall mining are high-productivity, low-cost mining methods, we seek to increase production from its use of these methods to the extent permissible and cost effective.

We depend on continued demand from its customers.  Reduced demand from our largest customers could have an adverse impact on its ability to achieve its projected revenue.  It is possible that our customers will not continue to purchase the same amount of coal as they have in the past or on terms, including pricing terms, as favorable as under existing purchase terms.  If we enter into long-term contracts with future customers, when those contracts reach expiration, it is possible that that the customers will not extend or enter into new long-term contracts.
 
We face numerous uncertainties in estimating its economically recoverable coal reserves, and inaccuracies in its estimates could result in lower than expected revenues, higher than expected costs and decreased profitability.  There are numerous uncertainties inherent in estimating quantities and values of economically recoverable coal reserves, including many factors beyond our control.  As a result, estimates of economically recoverable coal reserves are by their nature uncertain.  Information about our reserves consists of estimates based on engineering, economic, and geological data assembled and analyzed by our staff.  Some of the factors and assumptions that impact economically recoverable reserve estimates include the following:

 
·
geological conditions;

 
·
historical production from the area compared with production from other producing areas;

 
·
the assumed effects on regulations and taxes by governmental agencies;

 
·
assumptions governing future prices; and

 
·
future operating costs.

Each of these factors may in fact vary considerably from the assumptions used in estimating reserves.  For these reasons, estimates of the economically recoverable quantities of coal attributable to a particular group of properties may vary substantially.  As a result, we estimate may not accurately reflect its actual reserves. Actual production, revenues, and expenditures with respect to its reserves will likely vary from estimates, and these variances may be material.
 
Union represented labor creates an increased risk of work stoppages and higher labor costs.  As of December 31, 2010, none of our workforce was represented by a union.  However, in the event that we are required to hire union labor, there may be an increased risk of strikes and other related work actions, in addition to higher labor costs associated with union labor.  We have experienced some union organizing campaigns at some of its open shop facilities within the past five years.  If some or all of our current open shop operations were to become union represented, we could be subject to additional risk of work stoppages and higher labor costs.  Increased labor costs or work stoppages could adversely affect the stability of production and reduce its net income.
 
 
22

 
 
Severe weather may affect our ability to mine and deliver coal. Severe weather, including flooding and excessive ice or snowfall, when it occurs, can adversely affect our ability to produce, load, and transport coal, and can also result in power outages that create an inability to operate the mines.  We have suffered work stoppages as a result of severe weather conditions, particularly during winter months.
 
Shortages of skilled labor in the Central Appalachian coal industry may pose a risk to achieving high labor productivity and competitive costs.  Coal mining continues to be a labor intensive industry.  In 2001, the coal industry experienced a shortage of trained coal miners in the Central Appalachian region causing many companies to hire mine workers with less experience. While we did not experience a comparable labor shortage in 2003, if another such shortage of skilled labor were to arise, our productivity could decrease and our costs could increase.  Such a lack of skilled miners could have an adverse impact on our labor productivity and costs and its ability to expand production in the event there is an increase in the demand for coal.
 
If the coal industry experiences overcapacity in the future, our profitability could be impaired.  Historically, a growing coal market and increased demand for coal attract new investors to the coal industry, spur the development of new mines and result in added production capacity throughout the industry, all of which can lead to increased competition and lower coal prices.  Similarly, an increase in future coal prices could encourage the development of expanded capacity by new or existing coal producers.  Any overcapacity could reduce coal prices and therefore reduce our revenues.
 
Terrorist attacks and threats, escalation of military activity in response to such attacks, or acts of war may negatively affect our cash flows, results of operations, or financial condition. Terrorist attacks and threats, escalation of military activity in response to such attacks or acts of war may negatively affect our cash flows, results of operations, or financial condition.  Our business is affected by general economic conditions, fluctuations in consumer confidence and spending, and market liquidity, which can decline as a result of numerous factors outside of its control, such as terrorist attacks and acts of war.  Future terrorist attacks against U.S. targets, rumors or threats of war, actual conflicts involving the U.S. or its allies, or military or trade disruptions affecting our customers may materially adversely affect its operations.  As a result, there could be delays or losses in transportation and deliveries of coal to our customers, decreased sales of its coal, and extension of time for payment of accounts receivable from its customers.  Strategic targets such as energy-related assets may be at greater risk of future terrorist attacks than other targets in the U.S.  In addition, disruption or significant increases in energy prices could result in government-imposed price controls.  It is possible that any, or a combination, of these occurrences could have a material impact on our cash flows, results of operations, or financial condition.
 
We may not be able to identify quality strategic acquisition candidates, and if it does make strategic acquisitions, it may not be able to successfully integrate their operations.  We intend to acquire companies in the coal mining industry that offer complementary products and services to its current business operations.  For each acquisition, we will be required to assimilate the operations, products, and personnel of the acquired business and train, retain, and motivate its key personnel.  We may be unable to maintain uniform standards, controls, procedures, and policies if it fails in these efforts.  Similarly, acquisitions may subject us to liabilities and risks that are not known or identifiable at the time of the acquisition or may cause disruptions in its operations and divert management’s attention from day-to-day operations, which could impair our relationships with its current employees, customers, and strategic partners.  We may have to incur debt or issue equity securities to pay for any future acquisitions.  The issuance of equity securities could be substantially dilutive to our stockholders.  In addition, our profitability may suffer because of acquisition related costs.  We currently have no agreements or commitments concerning any such additional acquisitions, and it may not be able to identify any companies that satisfy its acquisition criteria.
 
 
23

 
 
The government extensively regulates our mining operations, which imposes significant costs on us, and future regulations could increase those costs or limit our ability to produce coal.  Federal, state, and local authorities regulate the coal mining industry with respect to matters such as employee health and safety, permitting and licensing requirements, air quality standards, water pollution, plant and wildlife protection, reclamation and restoration of mining properties after mining is completed, the discharge of materials into the environment, surface subsidence from underground mining, and the effects that mining has on groundwater quality and availability.  In addition, significant legislation mandating specified benefits for retired coal miners affects our industry.  Numerous governmental permits and approvals are required for mining operations.  We are required to prepare and present to federal, state, or local authorities data pertaining to the effect or impact that any proposed exploration for or production of coal may have upon the environment.  The costs, liabilities, and requirements associated with these regulations may be costly and time-consuming and may delay commencement or continuation of exploration or production.  The possibility exists that new legislation and/or regulations and orders may be adopted that may materially adversely affect our mining operations, its cost structure, and/or its customers’ ability to use coal.  New legislation or administrative regulations (or judicial interpretations of existing laws and regulations), including proposals related to the protection of the environment that would further regulate and tax the coal industry, may also require us or our customers to change operations significantly or incur increased costs.  The majority of our coal supply agreements contain provisions that allow a purchaser to terminate its contract if legislation is passed that either restricts the use or type of coal permissible at the purchaser’s plant or results in specified increases in the cost of coal or its use.  Further, in light of the recent mine explosion in West Virginia, it is also possible that new legislation and/or regulations and orders may be adopted relating to miners’ health and safety that may material adversely affect our mining operations, its cost structure, and/or its customers’ ability to use coal.  New legislation or administrative regulations (or judicial interpretations of existing laws and regulations), including proposals related to the protection of mine workers’ safety that would further regulate and tax the coal industry may also require us or our customers to change operations significantly or incur increased costs.  These factors and legislation, if enacted, could have a material adverse effect on our financial condition and results of operations.

There is a limited active trading market for our shares.  Our common stock is traded on the “Pink Sheets” under the symbol “QMIN.PK.”  Trading activity in our common stock has fluctuated widely and at times has been limited.  We consider our common stock to be “thinly traded” and any last reported sale prices may not be a true market-based valuation of the common stock.  A consistently active trading market for our stock may not develop at any time in the future.  Stockholders may experience difficulty selling their shares if they choose to do so because of the illiquid market and limited public float for our stock.

Our common stock is considered to be a “penny stock” and, as such, the market for our common stock may be further limited by certain SEC rules applicable to penny stocks.   As long as the price of our common stock remains below $5.00 per share or we have net tangible assets of $2,000,000 or less, our common shares are likely to be subject to certain “penny stock” rules promulgated by the SEC.  Those rules impose certain sales practice requirements on brokers who sell penny stock to persons other than established customers and accredited investors (generally institutions with assets in excess of $5,000,000 or individuals with net worth in excess of $1,000,000).  For transactions covered by the penny stock rules, the broker must make a special suitability determination for the purchaser and receive the purchaser’s written consent to the transaction prior to the sale.  Furthermore, the penny stock rules generally require, among other things, that brokers engaged in secondary trading of penny stocks provide customers with written disclosure documents, monthly statements of the market value of penny stocks, disclosure of the bid and asked prices and disclosure of the compensation to the brokerage firm and disclosure of the sales person working for the brokerage firm.  These rules and regulations make it more difficult for brokers to sell our common shares and limit the liquidity of our securities.

We have no immediate plans to pay dividends.  We have not paid any cash dividends to date and does not expect to pay dividends for the foreseeable future.

Our sole officer controls our voting rights, and as long as he does, he will be able to control the outcome of stockholder voting.  Our sole officer, who is also one of two directors, is the owner of all of the outstanding shares of our Series C Preferred Stock, pursuant to which he holds approximately 99% of the outstanding voting rights for our capital stock.  As long as he controls our voting rights, our other stockholders will generally be unable to affect or change the management or the direction of our company without the support of our officers and directors.  As a result, some investors may be unwilling to purchase our common stock.  If the demand for our common stock is reduced because our officers and directors have significant influence over our company, the price of our common stock could be materially depressed.  Our sole officer will be able to exert significant influence over the outcome of all corporate actions requiring stockholder approval, including the election of directors, amendments to our certificate of incorporation, and approval of significant corporate transactions.
 
 
24

 
 
Our articles of incorporation authorize our board of directors to effectuate forward and reverse stock splits without stockholder approval.  Our board of directors has the authority to effectuate both forward and reverse stock splits of our common stock without any further vote or action by our stockholders.  Although a forward or reverse stock split does not, in and of itself, result in dilution to existing stockholders, forward or reverse stock split may be negatively perceived and may have a negative effect on the market capitalization and relative price per share of our common stock.  Furthermore, the conversion prices set in many of our convertible securities do not adjust in the event of a stock split or reverse stock split.  As a result, some investors may be unwilling to purchase our common stock.

Our articles of incorporation authorize our board of directors to designate and issue preferred stock with rights, preferences and privileges that may be adverse to the rights of the holders of our common stock.  Our board of directors has the authority to issue up to an additional 21,140,000 shares of preferred stock and to determine the price, rights, preferences, and privileges of those shares without any further vote or action by our stockholders.  To date, we have issued 2,000,000 shares of Series A preferred stock, 1,600,000 shares of Series B preferred stock and 260,000 shares of Series C preferred stock.  Any preferred stock issued by our board of directors may, and in certain cases, do contain rights and preferences adverse to the voting power and other rights of the holders of common stock.  As a result, some investors may be unwilling to purchase our common stock.

Cautionary Statement Concerning
Forward-Looking Information

This annual report and the documents to which we refer you and incorporate into this annual report by reference contain forward-looking statements.  In addition, from time to time, we, or our representatives, may make forward-looking statements orally or in writing.  These are statements that relate to future periods and include statements regarding our future strategic, operational and financial plans, potential acquisitions, anticipated or projected revenues, expenses and operational growth, markets and potential customers for our products and services, plans related to sales strategies and efforts, the anticipated benefits of our relationships with strategic partners, growth of its competition, its ability to compete, the adequacy of its current facilities and its ability to obtain additional space, use of future earnings, and the feature, benefits and performance of its current and future products and services.

You can identify forward-looking statements by those that are not historical in nature, particularly those that use terminology such as “may,” “will,” “should,” “expects,” “anticipates,” “contemplates,” “estimates,” “believes,” “plans,” “projected,” “predicts,” “potential,” “seek” or “continue” or the negative of these or similar terms.  In evaluating these forward-looking statements, you should consider various factors.  These factors may cause our actual results to differ materially from any forward-looking statement.  We caution you not to place undue reliance on these forward-looking statements.

We base these forward-looking statements on its expectations and projections about future events, which it derives from the information currently available to it.  Such forward-looking statements relate to future events or future performance.  Forward-looking statements are only predictions.  The forward-looking events discussed in this annual report, the documents to which we refer you and other statements made from time to time by us or our representatives, may not occur, and actual events and results may differ materially and are subject to risks, uncertainties and assumptions about us.  For these statements, we claim the protection of the “bespeaks caution” doctrine.  The forward-looking statements speak only as of the date hereof, and we expressly disclaims any obligation to publicly release the results of any revisions to these forward-looking statements to reflect events or circumstances after the date of this filing.
 
 
25

 
 
Item 1B.   UNRESOLVED STAFF COMMENTS

We are a smaller reporting company as defined by Rule 12b-2 of the Exchange Act and are not required to provide the information required under this item.

Item 2.   PROPERTIES                                           
 
PROPERTIES
 
Our executive offices are located in Paterson, New Jersey and consist of approximately 1,000 square feet of leased space.  We lease this space at the rate of $1,500 per month from a related party corporation.

Gwenco leases over 700 acres of coal mines in Pike County, Kentucky, with approximately 9.8 tons of coal in place in six seams.  Gwenco is required to make annual minimum lease payments of approximately $55,000 per year. Gwenco currently only have 1 mine established, the Slater’s Branch location at Pond Creek.  Our Slater’s Branch location at Pond Creek has road access and can be reached on trucks.  The minable coal thickness is 29” to 49”.  We run a continuous mining operation using shuttle cars, conveyer belts and continuous miners.  We have contracted White Star Mining to conduct all mining operations at this location.  This mine is currently closed.  We intend to reopen upon receiving the requisite additional funds.


All of our current facilities are adequate for its current operations.  We anticipate that additional facilities will be leased or purchased as needed and that sufficient facilities for its needs are readily available.

Item 3.   LEGAL PROCEEDINGS

Litigation

SEC Settlement.  On October 31, 2008, we received a Wells notice (the “Notice”) from the staff of the Salt Lake Regional Office of the Securities and Exchange Commission (the “Commission”) stating that they are recommending an enforcement action be filed against us based on our financial statements and other information contained in reports filed by us with the Commission by us for our 2004 year and thereafter. The Notice states that the Commission anticipates alleging that we have violated Sections 10(b), 13(a) and 13(b)(2) of the Securities Exchange Act of 1934, as amended and Rules 10b-5, 12b-20, 13a-1 and 13a-13 thereunder.

On April 8, 2011, the SEC announced that it has agreed to a settlement with us.  We entered into the settlement without admitting or denying the allegations set forth in the Notice, as is consistent with standard SEC practice.  Under the terms of the settlement, we consented to a cease and desist order from committing or causing any violations and any future violations of Section 13(a) and 13(b)(2)(A) and (B) of the Exchange Act and Rules 12b-20, 12a-1 and 13a-13 thereunder.  In addition, we agreed to perform certain undertakings including maintaining at least two independent director so that not less than 2/3 of our board will be independent directors (ii) employing a chief financial officer qualified to prepare financial statements in accordance with GAAP; (iii) notify the Division of Enforcement if our chief financial officer resigns or is terminated or if one or more board members leave such that the board as a whole is not independent and (iv) adopt a system of written internal controls and identify and implement actions to improve the effectiveness of our disclosure controls, including plans to enhance our resources and training with respect to financial reporting and disclosure responsibilities, and to review such actions with our independent auditors.

Gwenco, Inc. Chapter 11 Reorganization.  On March 2, 2007, our wholly owned subsidiary, Gwenco, Inc., filed a voluntary petition for reorganization under Chapter 11 of the U.S. Bankruptcy Code with the United States Bankruptcy Court for the Eastern District of Kentucky.  Management felt this was a necessary step to further the company’s financial restructuring initiative and to protect Gwenco’s assets from claims, debts, judgments, foreclosures, and forfeitures of those creditors and stakeholders with whom both us and Gwenco were unable to negotiate restructured agreements.  Prior to October 12, 2009, Gwenco oversaw its operations as a debtor in possession, subject to court approval of matters outside the ordinary course of business.  In 2007, the Bankruptcy Court approved Gwenco’s request for debtor-in-possession financing in an amount of up to $2,000,000 from holders of Gwenco’s existing debt obligations in order to fund operating expenses.  Under Chapter 11, all claims against Gwenco in existence prior to the filing of the petitions for reorganization relief under the federal bankruptcy laws were stayed while Gwenco was in bankruptcy.
 
 
26

 
 
On September 30, 2009, the Bankruptcy Court confirmed Gwenco’s Plan of Reorganization (the “Plan”).  Secured and non-priority unsecured classes of creditors voted to approve the Plan, with over 80% of the unsecured claims in dollar amount voting for the plan, and over 90% of responding lessors supporting it.   The Plan became effective on October 12, 2009. 
 
There were 5 classes of Claims under the Plan:  (i)  Class 1—The Interstellar Duke claim, in the aggregate amount of $1,093,771; (ii) Class 2—Priority Claims, in aggregate amount of $391,558; (iii) Class 3—General Unsecured Claims, in the aggregate amount of $1,417,786; (iv) Class 4-Subordinated Claims, consisting of claims of affiliates of the debtor totaling $3,453,996; and (v) Class 5—Equity Holder Interest in the amount of $199,213.

The Class 1 Claim was satisfied by the issuance to Interstellar Holdings, LLC of a 5 year secured convertible promissory note, which note is convertible into common stock of the Company at a rate of the lower of (i) $0.001 per share and (ii) 40% of the average of the three lowest per shares market values of the Company’s common stock during the 10 trading days before a conversion; provided that the holder is prohibited from converting if such conversion would result in it holding more than 4.99% of the Company’s outstanding common stock.  The company and Interstellar formally closed this transaction on March 8, 2010.

The Class 2 Claims were due and payable as of the effective date of the Plan.

The Class 3 Claims will be satisfied by cash payments equal to the value of their claim on the earlier of (i) the 60th month after the effective date of the Plan or (ii) the date on which, in Gwenco’s sole discretion, proceeds from the exit facility are sufficient to satisfy the claims.  Further, Class 3 Claimholders shall receive their pro-rata share of royalty payments to reduce their claims beginning in the month following the Effective Date.  Notwithstanding the foregoing, certain creditors in this Class negotiated settlements as more specifically set forth in the Plan.

The Class 4 Claims will be paid after holders of all allowed claims in other classes have been paid in full.  The Class 5 Claims were deemed unimpaired.

Gwenco, as a reorganized debtor, operates its coal mining business and will use current and future income from operations to meet current and future expenses and to make payments called for under the Plan.  In addition, the Court approved an exit facility under which Interstellar Holdings, LLC will provide up to $2 million in financing to Gwenco.  The exit facility consists of a 5 year secured convertible line of credit note, which note is convertible into common stock of the Company at a rate of the lower of (i) $0.001 per share and (ii) 40% of the average of the three lowest per shares market values of the Company’s common stock during the 10 trading days before a conversion; provided that the holder is prohibited from converting if such conversion would result in it holding more than 4.99% of the Company’s outstanding common stock.  On March 8, 2010, Gwenco and Interstellar formally closed this transaction by, among other things, entering into a Loan and Security Agreement and related transaction documents.  The obligations under the exit facility are secured and guaranteed by the company and Quest (Nevada).

Even though the Bankruptcy Court has confirmed the Plan, it is still possible that the Bankruptcy Court could convert Gwenco’s case to Chapter 7 and liquidate all of Gwenco’s assets if the Court determines that Gwenco is unable to perform under the Plan.  In the case of a Chapter 7 conversion, the Company would be materially impacted and could lose all of its working assets and have only unpaid liabilities.  In addition, the Company might be forced to file for protection under Chapter 11 as it is the primary guarantor on a number of Gwenco’s contracts.

This description of the Plan does not purport to be complete and is qualified in its entirety by reference to such Plan, a copy of which was filed as an exhibit to our Current Report on Form 8-K dated October 2, 2009.

Valley Personnel Services.  On or about August 25, 2004, Valley Personnel Services, Inc. commenced an action in the Circuit Court of Mingo County, West Virginia against our indirect wholly-owned subsidiaries, D&D Contracting, Inc. and Quest Energy, Ltd. for damages in the amount of approximately $150,000, plus pre and post judgment interest as provided by law, costs, and fees.
 
 
27

 
 
Federal Insurance Company.  The Federal Insurance Company, the insurer for Community Trust Bank, commenced an action in Pike County Court, Kentucky against Quest Energy for subrogation of monies it has paid to the bank and repayment of deductibles by Community Trust as a part of an alleged criminal scheme and conspiracy by Mr. Runyon, Ms. Holbrook, Mr. Stollings, and Mr. Wheeler.  The insurer alleged that former employees or associates of Quest Energy, including Mr. Runyon and Mr. Wheeler, were primarily involved in the alleged scheme, that Quest Energy is accordingly responsible for the actions of these former employees and associates, and that Quest Energy obtained a substantial material benefit as a result of this alleged scheme.  Quest Energy has denied these allegations, that it had any involvement with or responsibility for any of the actions alleged by the insurer, and it further denies that it has benefited from any such alleged scheme.  Further, Quest Energy filed a counterclaim against the Federal Insurance Company and Community Trust contending that the negligent actions and inactions by Community Trust caused severe damage and loss to Quest Energy and Quest.  The court granted Community Trust’s motion to dismiss the counterclaim.

Mountain Edge Personnel.  Mountain Edge Personnel commenced an action in the Circuit Court of Mingo County, West Virginia against our now-dissolved indirect wholly-owned subsidiary, J. Taylor Mining, for damages in the amount of approximately $115,000, plus pre and post judgment interest as provided by law, costs, and fees.   This matter was settled in January 2009 for payment of approximately $25,000.

Personal Injury.  An action has been commenced in the Circuit Court of Pike County, Kentucky against us and its indirect, wholly-owned subsidiaries, Gwenco, Inc., Quest Energy, Ltd., and J. Taylor Mining, for unspecified damages resulting from personal injuries suffered while working for Mountain Edge Personnel, an employee leasing agency who leased employees to our subsidiaries.  Quest Energy is actively defending the action.  This action was originally stayed against Gwenco as a result of Gwenco’s Chapter 11 filing. However, in March, 2008, the plaintiff obtained relief from stay and as a result the lawsuit has reopened against Gwenco.

Fidler.  In the fourth quarter of 2008, a former attorney for the Company commenced an action alleging breach of contract for unpaid legal fees.  The Company has denied the allegations and is actively defending the matter.  Furthermore, the Company has filed a counterclaim against the attorney alleging legal malpractice in connection with the attorney’s representation of the Company in several matters.  The matter is currently pending.
  
Item 4.   (REMOVED AND RESERVED).

 
28

 

 
PART II
 
Item 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
 
Our common stock is traded on the Pink Sheets OTC Electronic Market under the symbol “QMIN.”  The following table shows the high and low bid prices for our common stock for each quarter since January 1, 2009 as reported by the either the OTC Bulletin Board or the Pink Sheets OTC Electronic Market.  All share prices have been adjusted to provide for the 1 for 100 reverse stock split effected on August 5, 2009, the 1 for 20 reverse stock split effected on June 16, 2010 and the 1 for 25 reverse stock split effected on February 2, 2011.  We consider our stock to be “thinly traded” and any reported sale prices may not be a true market-based valuation of its stock.  Some of the bid quotations from the OTC Bulletin Board set forth below may reflect inter-dealer prices, without retail mark-up, mark-down or commission and may not represent actual transactions.
 
2010 (OTC Bulletin Board)
 
High Bid
   
Low Bid
 
First quarter
  $ 1.75     $ 0.20  
Second quarter
    0.35       0.05  
Third quarter
    0.0575       0.01  
Fourth quarter
    0.0125       0.0025  
                 
2009 (OTC Bulletin Board)
 
High Bid
   
Low Bid
 
First quarter
  $ 140     $ 20.00  
Second quarter
    90.00       20.00  
Third quarter
    40.00       20.00  
Fourth quarter
    15.50       0.50  

As of April 12, 2011, there were approximately 516 record holders of our common stock.

We have not paid any cash dividends since its inception and does not contemplate paying dividends in the foreseeable future.  It is anticipated that earnings, if any, will be retained for the operation of its business.

Shares eligible for future sale could depress the price of our common stock, thus lowering the value of your investment.  Sales of substantial amounts of our common stock, or the perception that such sales could occur, could adversely affect prevailing market prices for shares of our common stock.

Our revenues and operating results may fluctuate significantly from quarter to quarter, which can lead to significant volatility in the price and volume of its stock.  In addition, stock markets have experienced extreme price and volume volatility in recent years.  This volatility has had a substantial effect on the market prices of securities of many smaller public companies for reasons unrelated or disproportionate to the operating performance of the specific companies.  These broad market fluctuations may adversely affect the market price of our common stock.

Recent Sales of Unregistered Securities

During the quarter ended December 31, 2010, we issued an aggregate of 31,078,867 shares of common stock upon conversions of various convertible notes. The aggregate principal and interest amount of these notes that were converted was $86,136.  The issuances were exempt pursuant to Section 3(a)(9) of the Securities Act as well as Section 4(2) of the Securities Act.

During the quarter ended December 31, 2010, we issued an aggregate of 4,089,511 shares of common stock pursuant to Gwenco’s Plan of Reorganization in partial satisfaction of certain claims against Gwenco in the Gwenco Bankruptcy proceedings.  The aggregate amount of claims satisfied pursuant to these issuances was $45,000.  The issuances were exempt pursuant to Section 1145 of the Bankruptcy Code.

From July 20, 2010 to December 3, 2010, we entered into a series of purchase agreements with unrelated third party investors pursuant to which we issued a series of convertible promissory notes in the aggregate principal amount of $169,500.  The notes bear interest at an annual interest rate of eight percent (8%) and are convertible into shares of the our common stock at a conversion price of forty percent (40%) of the average of the three (3) lowest per share market value during the ten (10) trading days immediately preceding a conversion date.  The proceeds were used for working capital and general corporate proceeds. The issuance was exempt pursuant to Section 4(2) of the Securities Act.
 
 
29

 
 
On October 13, 2010, we entered into a purchase agreement with an unrelated third party where we issued a $20,000 convertible promissory note.  The note bears interest at an annual interest rate of eight percent (8%).  The note is convertible into shares of our common stock at a conversion price of forty percent (50%) of the average of the five (5) trading days immediately preceding a conversion date.  The proceeds were used for working capital and general corporate proceeds. The issuance was exempt pursuant to Section 4(2) of the Securities Act.

On October 22, 2010, we entered into a purchase agreement with an unrelated third party where we issued a $50,000 convertible promissory note.  The note is due October 22, 2012 and bear interest at an annual interest rate of eight percent (8%).  The note is convertible into shares of our common stock at a conversion price of forty percent (30%) of the average of the three (3) lowest per share market value during the five (5) trading days immediately preceding a conversion date.  The proceeds were used for working capital and general corporate proceeds. The issuance was exempt pursuant to Section 4(2) of the Securities Act.

On November 16, 2010, we entered into an agreement with a third party investor where the existing principal and accrued interest of $1,115 were exchanged for a new convertible note with an aggregate principal amount of $11,115.   The note bears interest at an annual rate of eight percent (8%).  The note is convertible into shares of the our common stock at a conversion price of forty percent (40%) of the average of the three (3) lowest per share market values during the ten (10) trading days immediately preceding a conversion date. The issuance was exempt pursuant to Section 3(a)(9) of the Securities Act as well as Section 4(2) of the Securities Act.

On February 10, 2011, we entered into a purchase agreement with an unrelated third party where we issued a $50,000 convertible promissory note.  The note bears interest at an annual interest rate of eight percent (8%).  The note is convertible into shares of our common stock at a conversion price of thirty percent (30%) of the average of the three (3) lowest per share market value during the ten (10) trading days immediately preceding a conversion date. The proceeds were used for working capital and general corporate proceeds. The issuance was exempt pursuant to Section 4(2) of the Securities Act.

On February 15, 2011, we  entered into a purchase agreement with an unrelated third party where we issued a $50,000 convertible promissory note.  The note bears interest at an annual interest rate of eight percent (8%).  The note is convertible into shares of our  common stock at a conversion price of forty five percent (45%) of the average of the three (3) lowest per share market value during the ten (10) trading days immediately preceding a conversion date. The proceeds were used for working capital and general corporate proceeds. The issuance was exempt pursuant to Section 4(2) of the Securities Act.
 
Item 6.     SELECTED FINANCIAL DATA
 
           We are a smaller reporting company as defined by Rule 12b-2 of the Exchange Act and are not required to provide the information required under this item.
 
 
30

 
 
Item 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OR PLAN OF OPERATIONS

The following discussion and analysis should be read in conjunction with our financial statements and related notes included in this report.  This report contains “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995.  The statements contained in this report that are not historic in nature, particularly those that utilize terminology such as “may,” “will,” “should,” “expects,” “anticipates,” “estimates,” “believes,” or “plans” or comparable terminology are forward-looking statements based on current expectations and assumptions.  Various risks and uncertainties could cause actual results to differ materially from those expressed in forward-looking statements.  Please refer to the Risk Factors section of this report for a description of these risks and uncertainties.

All forward-looking statements in this document are based on information currently available to us as of the date of this report, and we assume no obligation to update any forward-looking statements.  Forward-looking statements involve known and unknown risks, uncertainties and other factors that may cause the actual results to differ materially from any future results, performance or achievements expressed or implied by such forward-looking statements.

General

We acquire and operate energy and mineral related properties in the southeastern part of the United States.  We focus our efforts on properties that produce quality compliance blend coal.

We are a holding company for Quest Minerals & Mining, Ltd., a Nevada corporation, or Quest (Nevada), which in turn is a holding company for Quest Energy, Ltd., a Kentucky corporation, or Quest Energy, and of Gwenco, Inc., a Kentucky corporation, or Gwenco.  Quest Energy is the parent corporation of E-Z Mining Co., Inc, a Kentucky corporation, or E-Z Mining, and of Quest Marine Terminal, Ltd., a Kentucky corporation, or Quest Marine.

Gwenco leases over 700 acres of coal mines, with approximately 9.8 tons of coal in place in six seams.  In 2004, Gwenco had reopened Gwenco’s two former drift mines at Pond Creek and Lower Cedar Grove, and had begun production at the Pond Creek seam.  This seam of high quality compliance coal is located at Slater’s Branch, South Williamson, Kentucky.

Fiscal 2010 and First Quarter 2011 Developments

SEC Settlement.  On October 31, 2008, we received a Wells notice (the “Notice”) from the staff of the Salt Lake Regional Office of the Securities and Exchange Commission (the “Commission”) stating that they are recommending an enforcement action be filed against us based on our financial statements and other information contained in reports filed by us with the Commission by us for our 2004 year and thereafter. The Notice states that the Commission anticipates alleging that we have violated Sections 10(b), 13(a) and 13(b)(2) of the Securities Exchange Act of 1934, as amended and Rules 10b-5, 12b-20, 13a-1 and 13a-13 thereunder.

On April 8, 2011, the SEC announced that it has agreed to a settlement with us.  We entered into the settlement without admitting or denying the allegations set forth in the Notice, as is consistent with standard SEC practice.  Under the terms of the settlement, we consented to a cease and desist order from committing or causing any violations and any future violations of Section 13(a) and 13(b)(2)(A) and (B) of the Exchange Act and Rules 12b-20, 12a-1 and 13a-13 thereunder.  In addition, we agreed to perform certain undertakings including (i) maintaining at least two independent director so that not less than 2/3 of our board will be independent directors (ii) employing a chief financial officer qualified to prepare financial statements in accordance with GAAP; (iii) notify the Division of Enforcement if our chief financial officer resigns or is terminated or if one or more board members leave such that the board as a whole is not independent and (iv) adopt a system of written internal controls and identify and implement actions to improve the effectiveness of our disclosure controls, including plans to enhance our resources and training with respect to financial reporting and disclosure responsibilities, and to review such actions with our independent auditors.

Termination of Letter of Intent.  On February 8, 2011, we announced the signing of a letter of intent to sell our coal mining operation.  As of the date of this report, the purchaser under such letter of intent has not consummated the acquisition within the exclusivity period set forth in the letter of intent.  As such, we intend to resume discussions with other prospective purchasers who have expressed an interest in acquiring our mining assets.  In addition, we are currently seeking a larger credit facility that would allow us to make the necessary capital expenditures and provide sufficient working capital in order to accelerate our desired revenue growth.
 
 
31

 
 
Operations Overview.  In the year ended 2010, we continued to conduct mining operations.  We generated coal revenues of approximately $2.4 million for the year ended 2010, compared to approximately $1.6 million for the year ended 2009.  Other than with respect to the West Virginia explosion discussed below, we did not have to shut down our operations during the year ended 2010.  However, we did encounter temporary delays and stoppages, due to either breakdowns in equipment, a lack of necessary supplies, weather-related production issues, or regulatory inspections.  We continue to encounter thicker coal seams as we advance further into the mine.

While certain general business conditions continue to improve, the continued effects of the recent recession, credit crisis, and related turmoil in the global financial system has had and may continue to have a negative impact on our business, financial condition, and liquidity.  We may face significant future challenges if conditions in the financial markets do not continue to improve.  Worldwide demand for coal has been adversely impacted by the global recession, but the steel industry and the global metallurgical coal markets have shown signs of improvement.   If this trend continues, coal demand should increase and improve our opportunities to sell our coal products at higher prices. 

West Virginia Explosion.  On April 5, 2010, an explosion occurred at the Upper Big Branch mine in Montcoal, West Virginia, operated by Performance Coal Company, a subsidiary of Massey Energy, which resulted in 29 fatalities.  In response to this tragedy, the Federal Mine Safety and Health Administration (“MSHA”) conducted inspections of most mines in the region, including Pond Creek.  As a result of these inspections, MSHA issued an order to Gwenco to take certain precautionary measures, including upgrades to its ventilation system, CO system, and airlock system.  In addition, MSHA conducted simulated evacuations and conducted underground training seminars.  Gwenco ceased mining operations during this period in order to allow the inspections, implement the precautionary measures, and conduct the simulations and training.  Gwenco reopened the mining operations approximately two weeks after the inspections commenced.   However, as an ongoing result of the tragedy at UBB, MSHA significantly increased regulatory enforcement in our mines.  The increased regulatory enforcement had a significant negative impact our productivity and operating results for the third quarter of 2010.  We lost a significant number of shifts during the quarter due to regulatory issues, many of which were due to delays in MSHA’s approval process for ventilation or other mine plan changes.  If MSHA continues to order our mines to be temporarily closed or permanently closes such mines, our ability to meet our customers’ demands could be adversely affected.

In September 2010, MSHA revised the federal standard for the incombustible content of coal dust, rock dust and other dust combined in coal mines. The revised standard is effective for new mining as of October 7, 2010, and for previously mined areas by November 22, 2010.  We expect our cost of mining to increase as we comply with the revised standard for additional rock-dusting materials, equipment and labor.

Name Change.  On June 10, 2010, we filed an amendment to our Articles of Incorporation to change corporate name from Quest Minerals & Mining Corp. to “Kentucky Energy, Inc.  The change in corporate name took effect on June 16, 2010.

Drilling Contract.   On July 21, 2010, we entered into an agreement with an unrelated third party to obtain up to 100 drill sites and a 100% working interest of the oil and gas rights on approximately 3,000 acres of property located in Rockcastle County, Kentucky for $50,000.  In addition, the unrelated third party will be retained for day to day management of the property, including drilling operations for additional consideration of $155,000 per well.  This well will be used to test thoroughly the main oil and gas horizons.  On January 15, 2011, we satisfied the initial deposit requirement pursuant to a lease agreement dated July 21, 2010, where we seeking to obtain the working interests for certain oil and gas properties in Rockcastle County, Kentucky. As part of the agreement, 75%  net revenue interest representing a 100% working interest of said leases totaling 4,640 acres of oil and gas exploration property were assigned to the company by a third party leaseholder representative. We have not yet determined when initial drilling will commence.

Critical Accounting Policies

The discussion and analysis of our financial conditions and results of operations is based upon our consolidated financial statements, which have been prepared in accordance with generally accepted accounting principles in the United States.  The preparation of financial statements requires managers to make estimates and disclosures on the date of the financial statements.  On an on-going basis, we evaluate its estimates, including, but not limited to, those related to revenue recognition.  It uses authoritative pronouncements, historical experience, and other assumptions as the basis for making judgments.  Actual results could differ from those estimates.  We believe the following critical accounting policies affect its more significant judgments and estimates in the preparation of our consolidated financial statements.
 
 
32

 
 
Mineral Interests

The purchase acquisition costs of mineral properties are deferred until the properties are placed into production, sold or abandoned.  These deferred costs will be amortized on the unit-of-production basis over the estimated useful life of the properties following the commencement of production or written-off if the properties are sold, allowed to lapse or abandoned.

Mineral property acquisition costs include any cash consideration and the fair market value of common shares and preferred shares, based on the trading price of the shares, or, if no trading price exists, on other indicia of fair market value, issued for mineral property interests, pursuant to the terms of the agreement or based upon an independent appraisal.

Administrative expenditures are expensed in the year incurred.

Coal Acquisition Costs

The costs to obtain coal lease rights are capitalized and amortized primarily by the units-of-production method over the estimated recoverable reserves.  Amortization occurs either as our mines on the property or as others mines on the property through subleasing transactions.

Rights to leased coal lands are often acquired through royalty payments.  As mining occurs on these leases, the accrued royalty is charged to cost of coal sales.

Mining Acquisition Costs

The costs to obtain any interest in third-party mining operations are expensed unless significantly proven reserves can be established for the entity.  At that point, capitalization would occur.

Mining Equipment

Mining equipment is recorded at cost.  Expenditures that extend the useful lives of existing plant and equipment or increase the productivity of the asset are capitalized.  Mining equipment is depreciated principally on the straight-line method over the estimated useful lives of the assets, which range from three to 15 years.

Deferred Mine Equipment

Costs of developing new mines or significantly expanding the capacity of existing mines are capitalized and amortized using the units-of-production method over the estimated recoverable reserves that are associated with the property being benefited.

Asset Impairment

If facts and circumstances suggest that a long-lived asset may be impaired, the carrying value is reviewed.  If the review indicates that the value of the asset will not be recoverable, as determined based on projected undiscounted cash flows related to the asset over its remaining life, then the carrying value of the asset is reduced to its estimated fair value.

Revenue Recognition
 
 
33

 
 
Coal sales revenues are sales to customers of coal produced at our operations.  We recognize revenue from coal sales at the time title passes to the customer.  Under the typical terms of sale, title and risk of loss transfer to the customer at the mine (or dock, or port) where coal is loaded to the truck (or rail, barge, ocean-going vessel, or other transportation source) that serves our mines.

Income Taxes

We provide for the tax effects of transactions reported in the financial statements.  The provision, if any, consists of taxes currently due plus deferred taxes related primarily to differences between the basis of assets and liabilities for financial and income tax reporting.  The deferred tax assets and liabilities, if any, represent the future tax return consequences of those differences, which will either be taxable or deductible when the assets and liabilities are recovered or settled.  As of the year ended December 31, 2010, we have no material current tax liability, deferred tax assets, or liabilities to impact on its financial position because the deferred tax asset related to our net operating loss carry forward was fully offset by a valuation allowance.  

Fair Value

Our financial instruments, as defined by FASB ASC Topic 825-10-50, “Financial Instruments”, include cash, advances to affiliate, trade accounts receivable, accounts payable and accrued expenses and borrowings.  All instruments are accounted for on a historical cost basis, which, due to the short maturity of these financial instruments, approximates fair value as at December 31, 2010.

Earnings loss per share

We adopted FASB ASC Topic 260, “Earnings per Share”, which provides for the calculation of “basic” and “diluted” earnings per share.  Basic earnings per share includes no dilution and is computed by dividing net income available to common stockholders by the weighted average common shares outstanding for the period.  Diluted earnings per share reflect the potential dilution of securities that could share in the earnings similar to fully diluted earnings per share; however, the potential dilution becomes anti-dilutive in the case of a loss and, therefore, basic and fully diluged loss per share are the same.

Stock Split  

All references to common stock and per share date have been retroactively restated to account for the 1 for 100 reverse stock split effectuated on August 4, 2009.

All references to common stock and per share date have been retroactively restated to account for the 1 for 20 reverse stock split effectuated on June 16, 2010.

All references to common stock and per share date have been retroactively restated to account for the 1 for 25 reverse stock split effectuated on February 2, 2011.

Other Recent Accounting Pronouncements

We do not expect that the adoption of other recent pronouncements from the Public Company Oversight Board to have any impact on our consolidated financial statements.
 
 
34

 
 
Results of Operations

Basis of Presentation

The following table sets forth, for the periods indicated, certain audited selected financial data:

   
Year Ended
 
   
December 31,
 
   
2010
   
2009
 
             
Revenues
  $ 2,405,276     $ 1,612,357  
Production costs
    (3,114,283 )     (2,441,756 )
Selling, general and administrative
    (1,505,455 )     (1,717,373 )
Depreciation and Amortization
    (171,142 )     (165,384 )
                 
Operating (loss)
  $ (2,385,604 )   $ (2,712,156 )

Comparison of the year ended December 31, 2010 and 2009

Net sales.  Revenues for us were $2,405,276 for the year ended December 31, 2010, as compared to $1,612,357 for the year ended December 31, 2009, an increase of approximately 49%.  Our increase in revenues was due to our increased level of mining operations in 2010 versus 2009.  This increase resulted from our ability to mine on a more consistent basis.  We added and upgraded equipment which allowed us to be in production more consistently.  In addition, as we advanced further into the mine, the coal seam thickened, which resulted in improved rates of recovery and a higher percentage of coal per gross ton extracted.  Finally, the completion of the Gwenco bankruptcy allowed us to access additional working capital that allowed us to obtain necessary labor and supplies for production.

Production costs.  Production costs were $3,114,283 for the year ended December 31, 2010 as compared to $2,441,756 for the year ended December 31, 2009, an increase of approximately 27%.  As a percentage of sales, our productions cost decreased from 151% to 129%.  In order to increase our mining production, we needed to contract for additional labor, purchase additional supplies, and conduct additional repairs, all of which led to an increase in production costs.  Furthermore, we incurred increased shipping charges, as the shipping distance to our new customers was further than our prior customers.  In addition, we incurred increased royalty expense as we increased mining production and sales.  As a percentage of net sales, our production costs decreased, as our additional cost expenditures resulted in more efficient and productive mining operations.

Selling, general, and administrative.  Selling, general and administrative expenses decreased to $1,505,455 for the year ended December 31, 2010, from $1,717,373 for the year ended December 31, 2009.   

Depreciation and amortization.  Depreciation expense increased to $171,142 for the year ended December 31, 2010, from $165,384 for the year ended December 31, 2009.  The increase results from our putting additional equipment into service in 2010.

Operating loss.  We incurred an operating loss of $2,385,604 for the year ended December 31, 2010 from $2,712,156 for the year ended December 31, 2009.   We had lower operating losses in 2010 as compared to 2009 primarily from increase in coal revenues as well as a decrease in selling, general, and administrative expenses.

Interest.  Interest expense decreased to $1,762,146 for the year ended December 31, 2010 from $2,710,455 for the year ended December 31, 2009.  Our interest expense results from various outstanding debt obligations, including obligations that we assumed in connection with the acquisition of Gwenco and various notes issued in various financings since October 2004.  In addition, it includes expense associated with the issuance of securities with beneficial conversion features.  The decrease results primarily from lower borrowings which occurred in 2010.
 
 
35

 
 
Gain on loan settlements pursuant to plan of reorganization.  As a result of the confirmation of Gwenco’s Plan of Reorganization, we recorded a loss of $11,313 on loan settlements pursuant to the plan of reorganization in the year ended December 31, 2010 as compared to a gain of $2,450,059 in the year ended December 31, 2009  Although the plan of reorganization is a 100% pay out plan, the revised terms of repayment result in a reduction of the present value of certain debt obligations, which in turn resulted in our recognition of a gain on loan settlements in the year ended December 31, 2009.

Loss on restructuring prior to plan of reorganization.  We recognized a loss of $1,201,226 on restructurings prior to the confirmation of Gwenco’s plan of reorganization in the year ended December 31, 2009.  This loss primarily results from negotiated resolution of outstanding contested matter with our largest creditor.

Liquidity and Capital Resources

We have financed its operations, acquisitions, debt service, and capital requirements through cash flows generated from operations and through issuance of debt and equity securities.  Our working capital deficit at December 31, 2010 was $7,062,681.  We had cash of $238 as of December 31, 2010.

We used $636,255 of net cash in operating activities for the year ended December 31, 2010, compared to using $1,019,781 in the year ended December 31, 2009.  Cash used in operating activities for the year ended December 31, 2010 was due to our net loss of $4,159,063, and an increase in accounts payable and accrued expenses of $1,682,781.  This was offset by non-cash expenses of $171,142 in depreciation and amortization, a decrease  in accounts receivable of $112,282, a loss on debt settlement of $11,313 , a decrease in prepaid expenses of $182, $13,004 of stock issued for interest, $303,260 of stock issued for services, $1,126,197 of amortized discount on convertible notes, $2,647 of amortized royalty costs.

Net cash flows used in investing activities was $45,837 for the year ended December 31, 2010, as compared to $18,544 of net cash flows used in investing activities for the comparable period in 2009.  The net cash flows used in investing activities in 2010 resulted from $45,837 in security deposits.

Net cash flows provided by financing activities were $675,076 for the year ended December 31, 2010, compared to net cash flows provided by financing activities of $1,032,140 for the year ended December 31, 2009.  This decrease in net cash provided by financing activities is due to our borrowings of $1,806,486, offset by repayment of $1,131,407 of debt in 2010 whereas we had borrowings of $2,133,483 in 2009 offset by repayment of $1,100,875 of debt in 2009.

Financings and Debt Restructurings

On March 2, 2007, Gwenco filed a voluntary petition for reorganization under Chapter 11 of the U.S. Bankruptcy Code with the United States Bankruptcy Court for the Eastern District of Kentucky.  Management felt this was a necessary step to further the company’s financial restructuring initiative and to protect Gwenco’s assets from claims, debts, judgments, foreclosures, and forfeitures of those creditors and stakeholders with whom both us and Gwenco were unable to negotiate restructured agreements.  Prior to October 12, 2009, Gwenco oversaw its operations as a debtor in possession, subject to court approval of matters outside the ordinary course of business.  In 2007, the Bankruptcy Court approved Gwenco’s request for debtor-in-possession financing in an amount of up to $2,000,000 from holders of Gwenco’s existing debt obligations in order to fund operating expenses.  Under Chapter 11, all claims against Gwenco in existence prior to the filing of the petitions for reorganization relief under the federal bankruptcy laws were stayed while Gwenco was in bankruptcy.

Upon Gwenco’s recommencement of mining operations in the third quarter of 2009, the debtor-in-possession lender required Gwenco to assign all of its accounts receivable to the lender and have all payments on the receivables paid into an escrow account.  The lender had been making advances under the facility to Gwenco against the accounts receivable, and the advances are being repaid as payments are made to the escrow account.  In connection therewith, the Company issued a convertible promissory note to a third party investor for facilitation of the escrow arrangement.  The note is due September 16, 2011 and bears interest at an annual interest rate of eight percent (8%).  The note is convertible into shares of the Company’s common stock at a conversion price of forty five percent (45%) of the average of the five (5) lowest per share market value during the ten (10) trading days immediately preceding a conversion date.  In addition, the third-party investors who facilitated the escrow arrangement received a commission of 2.5% of each advance made.
 
 
36

 
 
On September 30, 2009, the Bankruptcy Court confirmed Gwenco’s Plan of Reorganization (the “Plan”).  The Plan became effective on October 12, 2009.  Under Gwenco’s Plan of Reorganization, the Court approved an exit facility under which Interstellar Holdings LLC will provide up to $2 million in financing to Gwenco.  Gwenco paid off the debtor-in-possession financing with borrowings from the exit facility.  The exit facility consists of a 5 year secured convertible line of credit note, which note is convertible into common stock of the Company at a rate of the lower of (i) $0.001 per share and (ii) 40% of the average of the three lowest per shares market values of the Company’s common stock during the 10 trading days before a conversion; provided that the holder is prohibited from converting if such conversion would result in it holding more than 4.99% of the Company’s outstanding common stock.

A third-party lender advances operational funding to us.  Since there has been no formal agreement regarding the balance owed, we accrue a 5% annual interest on the principal with the intent that a mutual arrangement will be resolved between both parties.  On June 26, 2009, we entered into an exchange agreement with the third party investor, pursuant to which the investor exchanged approximately $1,082,411 of the evidences of indebtedness, along with $ 124,195 of accrued interest thereon, for a new convertible promissory note in the aggregate principal amount of $1,200,000.  The new note is due June 26, 2011 and bears interest at an annual rate of six percent (6%).  The new note is convertible into shares of our common stock at a conversion price of $0.001 per share, subject to adjustment.  As of December 31, 2010, there continues to be no formal agreement regarding the remaining evidences of indebtedness of $130,857, and we continue to accrue 5% annual interest on the principal with the intent that a mutual arrangement will be resolved between both parties.

On August 14, 2008, we issued an 8% $400,000 convertible promissory note to a single accredited investor. The note is due on July 23, 2010 and is convertible into shares of our common stock at a conversion price of sixty percent (60%) of the average of the five (5) lowest per share market value during the ten (10) trading days immediately preceding a conversion date. The proceeds will be used for working capital and general corporate purposes. The holder may not convert any outstanding principal amount of this note or accrued and unpaid interest thereon to the extent such conversion would result in the holder beneficially owning in excess of 4.999% of our then issued and outstanding common shares of Kentucky.  On August 28, 2009, the Company amended the conversion price to be forty five percent (45%) of the average of the five (5) lowest per share market value during the ten (10) trading days immediately preceding a conversion date in connection with the Company’s common stock being removed from quotation from the OTC Bulletin Board.

On August 28, 2009, we borrowed $12,500, and in connection therewith, issued a promissory note that is due on demand and bears interest at an annual interest rate of twelve percent (12%).

On October 23, 2009, we borrowed $50,000 from an investor, and in connection therewith, issued a $50,000 8% convertible promissory note due October 23, 2011.  The note is convertible into shares of the Company’s common stock at a conversion price of forty five percent (45%) of the average of the five (5) lowest per share market values during the ten (10) trading days immediately preceding a conversion date.

From July 20, 2010 to December 3, 2010, we borrowed $169,500 from an investor and in connection therewith, we issued a series of convertible promissory notes which bear interest at an annual interest rate of eight percent (8%) and are convertible into shares of the our common stock at a conversion price of forty percent (40%) of the average of the three (3) lowest per share market value during the ten (10) trading days immediately preceding a conversion date.  

On October 13, 2010, we borrowed $20,000 from an investor and in connection therewith, issued a $20,000 convertible promissory note which bears interest at an annual interest rate of eight percent (8%). And is convertible into shares of our common stock at a conversion price of forty percent (50%) of the average of the five (5) trading days immediately preceding a conversion date.  
 
 
37

 
 
On October 22, 2010, we borrowed $50,000 from an investor and in connection therewith,  we issued a $50,000 convertible promissory note.  The note is due October 22, 2012 and bear interest at an annual interest rate of eight percent (8%).  The note is convertible into shares of our common stock at a conversion price of forty percent (30%) of the average of the three (3) lowest per share market value during the five (5) trading days immediately preceding a conversion date.  

On November 16, 2010, we entered into an agreement with a third party investor where the existing principal and accrued interest of $1,115 were exchanged for a new convertible note with an aggregate principal amount of $11,115.   The note bears interest at an annual rate of eight percent (8%).  The note is convertible into shares of the our common stock at a conversion price of fifty percent (50%) of the average of the five (5) per share market values preceding a conversion date.

On February 10, 2011, we borrowed $50,000 from an investor and in connection therewith, we issued a $50,000 convertible promissory note.  The note bears interest at an annual interest rate of eight percent (8%).  The note is convertible into shares of our common stock at a conversion price of thirty percent (30%) of the average of the three (3) lowest per share market value during the ten (10) trading days immediately preceding a conversion date.

On February 15, 2011, we borrowed $42,500 from an investor and in connection therewith, we issued a $42,500 convertible promissory note.  The note bears interest at an annual interest rate of eight percent (8%).  The note is convertible into shares of our  common stock at a conversion price of forty five percent (45%) of the average of the three (3) lowest per share market value during the ten (10) trading days immediately preceding a conversion date.

Capital Requirements

The report of our independent accountants for the fiscal year ended December 31, 2010 states that we have incurred operating losses since inception and requires additional capital to continue operations, and that these conditions raise substantial doubt about its ability to continue as a going concern. We believe that, as of the date of this report, in order to fund its plan of operations over the next 12 months, it will need to fund its operations out of cash flows generated from operations, to the extent such operations are resumed, and from the sale of additional securities.

We are continuing to seek to fund its capital requirements over the next 12 months from the additional sale of its debt and equity securities. It is possible that we will be unable to obtain sufficient additional capital through the sale of its securities as needed.  We have also obtained exit facility financing through the Gwenco bankruptcy proceedings to fund the capital requirements of Gwenco, Inc.

Part of our growth strategy is to acquire additional coal mining operations. Where appropriate, we will seek to acquire operations located in markets where it currently operates to increase utilization at existing facilities, thereby improving operating efficiencies and more effectively using capital without a proportionate increase in administrative costs. We do not currently have binding agreements or understandings to acquire any other companies.

We intend to retain any future earnings to pay its debts, finance the expansion of its business and any necessary capital expenditures, and for general corporate purposes.

 
38

 
 
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
 

 
To the Board of Directors and Shareholders
Kentucky Energy, Inc. (formerly Quest Minerals & Mining Corp.)
Paterson, New Jersey

 
We have audited the consolidated balance sheets of Kentucky Energy, Inc. (formerly Quest Minerals & Mining Corp.) (the “Company”) and subsidiaries, as of December 31, 2010 and 2009 and the related consolidated statements of operations, changes in deficiency in stockholders' equity and cash flows for each of the years in the two year period ended December 31, 2010. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated 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 consolidated 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 consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Kentucky Energy, Inc. (formerly Quest Minerals & Mining Corp.) and subsidiaries as of December 31, 2010 and 2009 and the results of its consolidated operations and its cash flows for each of the years in the two year period ended December 31, 2010 in conformity with accounting principles generally accepted in the United States of America.
 
As discussed in Note 1 to the financial statements, the Company’s only operating subsidiary, Gwenco, Inc. (“Gwenco”) filed on March 2, 2007, a voluntary petition for reorganization under Chapter 11 of the U.S. Bankruptcy Code with the United States Bankruptcy Court for the Eastern District of Kentucky. Management felt this was a necessary step to further the Company’s financial restructuring initiative and to protect Gwenco’s assets from claims, debts, judgments, foreclosures, and forfeitures of those creditors and stakeholders with whom both the Company and Gwenco were unable to negotiate restructured agreements. On September 30, 2009, the Bankruptcy Court confirmed Gwenco’s Plan of Reorganization (the “Plan”) and the plan became effective on October 12, 2009. Gwenco is currently overseeing its operations as a debtor in possession, subject to court approval of matters outside the ordinary course of business. Even though the Bankruptcy Court has confirmed the Plan, it is still possible that the Bankruptcy Court could convert Gwenco’s case to Chapter 7 and liquidate all of Gwenco’s assets if the court determines that Gwenco is unable to perform under the Plan. In the case of a Chapter 7 conversion, the Company would be materially impacted and could lose all of its working assets and have only unpaid liabilities. In addition, the Company might be forced to file for protection under Chapter 11, as it is the primary guarantor on a number of Gwenco’s contracts.
 
 Additionally, the accompanying consolidated financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Notes 1 and 3 to the consolidated financial statements, the Company has suffered recurring losses from operations and the company’s primary operating subsidiary has filed for reorganization under Chapter 11 of U.S. Bankruptcy Code, this raises substantial doubt about its ability to continue as a going concern. Management's plans in regard to these matters are also described in Notes 1 and 3. The consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty.
 
 
 
/s/ RBSM, LLP

 
New York, New York
April 15, 2011
 
 
 

 

Item 8.  FINANCIAL STATEMENTS
 
KENTUCKY ENERGY, INC.
(formerly Quest Minerals and Mining Corp.)
 
CONSOLIDATED BALANCE SHEETS
 
   
December 31,
   
December 31,
 
ASSETS
 
2010
   
2009
 
             
Current assets:
           
Cash
  $ 238     $ 7,254  
Receivables
    -       112,282  
Prepaid expenses
    8,045       8,227  
Total current assets
    8,283       127,763  
                 
Other assets:
               
Leased Mineral Reserves, net (Note 5)
    5,165,469       5,187,317  
Mine development, net
    -       113,207  
Equipment, net (Note 6)
    97,097       133,184  
Deposits
    94,823       48,986  
                 
Total assets
  $ 5,365,672     $ 5,610,457  
                 
LIABILITIES AND DEFICIENCY IN STOCKHOLDERS' EQUITY
               
                 
Current Liabilities:
               
Accounts payable and accrued expenses (Note 4 and 7)
  $ 4,263,919     $ 3,060,061  
Loans payable-current portion, net (Note 8)
    2,807,045       996,995  
                 
Total current liabilities
    7,070,964       4,057,056  
                 
Long-Term Liabilities:
               
Loans payable-long term portion, net (Notes 8)
    106,922       2,075,927  
Restructured debt - long term portion, net  (Note 8)
    2,035,388       558,833  
Related party loans, net (Note 8)
    523,195       300,468  
                 
Total long-term liabilities
    2,665,505       2,935,228  
                 
Total liabilities
    9,736,469       6,992,284  
                 
Commitments and contingencies (Note 15)
    -       -  
                 
Deficiency in stockholders' equity:
               
Preferred stock, par value $0.001, 25,000,000 shares authorized (Note 10)
               
SERIES A - issued and outstanding 20,726 shares
    21       21  
SERIES B - issued and outstanding 48,284 shares
    48       48  
SERIES C - issued and outstanding 260,000 shares
    260       260  
 
               
Common stock, par value $0.0001, 2,500,000,000 shares authorized (Note 11)
               
issued and outstanding 64,880,004 and 698,290 shares
    6,488       70  
as of December 31, 2010 and December 31, 2009, respectively
               
                 
Common stock to be issued
    -       5,648  
                 
Equity allowance
    (587,500 )     (587,500 )
                 
Paid-in capital
    71,017,334       69,848,012  
Accumulated deficit
    (74,807,449 )     (70,648,386 )
                 
Total deficiency in stockholders' equity
    (4,370,798 )     (1,381,827 )
                 
Total liabilities and deficiency in stockholders' equity
  $ 5,365,671     $ 5,610,457  
 
The accompanying notes are an integral part of these consolidated financial statements
 
 
F-1

 
 
KENTUCKY ENERGY, INC.
(formerly Quest Minerals and Mining Corp.)
 
CONSOLIDATED STATEMENTS OF OPERATIONS
 
               
               
               
     
For the twelve months ended
December 31,
 
               
     
2010
   
2009
 
               
Coal revenues
    $ 2,405,276     $ 1,612,357  
Production costs
      (3,114,283 )     (2,441,756 )
                   
Gross loss
      (709,007 )     (829,399 )
                   
Operating expenses:
                 
Selling, general and administrative
      1,505,455       1,717,373  
Depreciation and amortization
      171,142       165,384  
                   
Total operating expenses
      1,676,597       1,882,757  
                   
Net loss from operations
      (2,385,604 )     (2,712,156 )
                   
Other income (expense):
                 
Gain (loss) on debt settlements
      (11,313 )     2,450,059  
Loss on restructuring prior to plan of reorganization
      -       (1,201,226 )
Interest, net
      (1,762,146 )     (2,710,455 )
                   
Net loss before income taxes
      (4,159,063 )     (4,173,778 )
                   
Provision for income taxes
      -       -  
                   
Net loss
    $ (4,159,063 )   $ (4,173,778 )
                   
                   
Basic and diluted (loss) per common share
    $ (0.2962 )   $ (32.8385 )
                   
                   
Weighted average common shares outstanding
      14,041,462       127,100  
 
The accompanying notes are an integral part of these consolidated financial statements
 
 
F-2

 
 
 
KENTUCKY ENERGY, INC.
(formerly Quest Minerals and Mining Corp.)
CONSOLIDATED STATEMENT OF CHANGES OF DEFICIENCY IN STOCKHOLDER'S EQUITY
For the years ended December 31, 2010 and 2009
 
   
Common Stock
         
Preferred Stock
         
Additional
   
Escrow /
             
                           
Paid-in
   
Adjustments
             
   
Shares
   
Amount
   
Shares
   
Amount
   
Capital
   
Common Stock
   
Deficit
   
Totals
 
                                                 
Balances at January 1, 2009
    5,064     $ 1       333,809     $ 334       63,722,057     $ (581,852 )   $ (66,474,608 )   $ (3,334,068 )
                                                                 
Common Stock issued:
                                                               
     For notes payable and accrued interest
    493,660       49                       1,046,899                       1,046,948  
                                                                 
Common Stock issued as compensation:
                                                               
     For consulting services
    51,070       5                       322,697                       322,702  
     For legal and accounting services
    124,496       12                       590,376                       590,388  
                                                                 
Series A Preferred Conversion
    24,000       2       (4,800 )     (5 )     2                       -  
                                                                 
Debt discount - Beneficial conversion feature on convertible notes
    -       -                       4,165,981                       4,165,981  
                                                                 
Net Loss for the year ended December 31, 2009
                                                    (4,173,778 )     (4,173,778 )
                                                                 
Balances at January 1, 2010
    698,290     $ 70       329,009     $ 329       69,848,012     $ (581,852 )   $ (70,648,386 )   $ (1,381,827 )
                                                                 
Common Stock issued:
                                                               
     For notes payable and accured interest
    50,873,114       5,087                       762,432                       767,519  
                                                                 
Common Stock issued as compensation:
                                                               
     For consulting services
    7,450,000       745                       94,155                       94,900  
     For legal and accounting services
    5,858,600       586                       207,774                       208,360  
                                                                 
Employee Stock Options
    -       -                       100,000                       100,000  
                                                                 
Expired Warrants
    -       -                       5,648       (5,648 )             -  
                                                                 
Beneficial conversion feature and present value
                                                            -  
adjustments on convertible notes and long term debt
    -       -                       (687 )                     (687 )
                                                                 
Net Loss for the year ended December 31, 2010
                                                    (4,159,063 )     (4,159,063 )
                                                                 
Balances at December 31, 2010
    64,880,004     $ 6,488       329,009     $ 329       71,017,334     $ (587,500 )   $ (74,807,449 )   $ (4,370,798 )
 
The accompanying notes are an integral part of these consolidated financial statements
 
 
F-3

 
 
KENTUCKY ENERGY, INC.
(formerly Quest Minerals and Mining Corp.)
 
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE TWELVE MONTHS ENDED DECEMBER 31, 2010 AND 2009
 
             
             
   
2010
   
2009
 
             
Operating Activities
           
Net loss
 
$
(4,159,063
)
 
$
(4,173,778
)
Adjustments to reconcile net loss to net cash    
               
used in operating activities:
               
Depreciation and amortization
   
171,142
     
165,384
 
Stock issued for interest
   
13,004
     
36,226
 
Stock issued for services
   
303,260
     
913,089
 
Stock compensation
   
100,000
     
-
 
Loss (gain) on debt settlements
   
11,313
     
(1,248,833
)
Amortization of discount on convertible notes
   
1,126,197
     
292,532
 
Amortization of deferred issuance costs
   
-
     
226
 
Amortization of royalty costs
   
2,647
     
16,702
 
Changes in operating assets and liabilities:
               
Decrease (Increase) in receivables
   
112,282
     
(111,052
)
Decrease (Increase) in prepaid expenses
   
182
     
(6,234
)
Decrease (Increase) in restricted cash
   
-
     
12,395
 
Increase (Decrease) in accounts payable and accrued expenses
   
1,682,781
     
3,083,562
 
Net cash used in operating activities
   
(636,255
)
   
(1,019,781
)
                 
Investing Activities
               
Mine development
   
-
     
-
 
Equipment purchased
   
-
     
(12,000
)
Restricted cash
   
-
     
-
 
Security deposits
   
(45,837
)
   
(6,544
)
Net cash used in investing activities
   
(45,837
)
   
(18,544
)
                 
Financing  Activities
               
Repayment of borrowings
   
(1,131,407
)
   
(1,100,875
)
Proceeds from borrowings
   
1,806,483
     
2,133,015
 
Net cash provided by financing activities
   
675,076
     
1,032,140
 
                 
Increase (decrease) in cash
   
(7,016
)
   
(6,185
)
Cash at beginning of year
   
7,254
     
13,439
 
Cash at end of year
 
$
238
   
$
7,254
 
                 
Supplemental Disclosures of Cash Flow Information
               
Cash paid during the year:
               
Interest
 
$
-
   
$
22,477
 
                 
Income taxes
 
$
-
   
$
-
 
                 
Non-cash financing activites:
               
Conversions of note principal and interest
 
$
767,520
   
$
1,046,948
 
 
The accompanying notes are an integral part of these consolidated financial statements

 
 
F-4

 
 
KENTUCKY ENERGY, INC.
(formerly Quest Minerals and Mining Corp.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2010 AND 2009
 
NOTE 1 –  
ORGANIZATION & OPERATIONS

Kentucky Energy, Inc. (formerly Quest Minerals & Mining Corp.the “Registrant,” or the “Company”) was incorporated in Utah on November 21, 1985.  The Company has leasehold interests in certain properties in Eastern Kentucky, is seeking to re-commence full coal mining operations on these properties, and is looking to acquire additional coal properties.

The Company ’s subsidiary, Gwenco, Inc. (“Gwenco”), leases over 700 acres of coal mines, with approximately 9.8 million tons of coal in place in six seams.  In 2004, Gwenco had reopened Gwenco’s two former drift mines at Pond Creek and Lower Cedar Grove, and had begun production at the Pond Creek seam.  This seam of high quality compliance coal is located at Slater’s Branch, South Williamson, Kentucky.

On March 2, 2007, Gwenco filed a voluntary petition for reorganization under Chapter 11 of the U.S. Bankruptcy Code with the United States Bankruptcy Court for the Eastern District of Kentucky.  Management felt this was a necessary step to further the Company’s financial restructuring initiative and to protect Gwenco’s assets from claims, debts, judgments, foreclosures, and forfeitures of those creditors and stakeholders with whom both the Companyt and Gwenco were unable to negotiate restructured agreements.  Prior to October 12, 2009, Gwenco oversaw its operations as a debtor in possession, subject to court approval of matters outside the ordinary course of business.  In 2007, the Bankruptcy Court approved Gwenco’s request for debtor-in-possession financing in an amount of up to $2,000,000 from holders of Gwenco’s existing debt obligations in order to fund operating expenses.  Under Chapter 11, all claims against Gwenco in existence prior to the filing of the petitions for reorganization relief under the federal bankruptcy laws were stayed while Gwenco was in bankruptcy.

On September 30, 2009, the Bankruptcy Court confirmed Gwenco’s Plan of Reorganization (the “Plan”).  Secured and non-priority unsecured classes of creditors voted to approve the Plan, with over 80% of the unsecured claims in dollar amount voting for the plan, and over 90% of responding lessors supporting it.   The Plan became effective on October 12, 2009. 

Even though the Bankruptcy Court has confirmed the Plan, it is still possible that the Bankruptcy Court could convert Gwenco’s case to Chapter 7 and liquidate all of Gwenco’s assets if the Court determines that Gwenco is unable to perform under the Plan.  In the case of a Chapter 7 conversion, the Company would be materially impacted and could lose all of its working assets and have only unpaid liabilities.  In addition, the Company might be forced to file for protection under Chapter 11 as it is the primary guarantor on a number of Gwenco’s contracts.
 
NOTE 2 –  
SIGNIFICANT ACCOUNTING POLICIES
 
Principles of Consolidation

The audited consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries, Quest Mineral & Mining, Ltd., Quest Energy, Ltd., and Gwenco, Inc. (collectively, the “Company”).  All significant intercompany transactions and balances have been eliminated in consolidation.

 
F-5

 

KENTUCKY ENERGY, INC.
(formerly Quest Minerals and Mining Corp.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2010 AND 2009

Management Estimates

The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period.  Actual results could differ from those estimates.  Critical estimates include amortization of intangible assets, depreciation, and the fair value of options and warrants included in the determination of debt discounts and share-based compensation.

Major Customers and Suppliers

The Company had two customers who accounted for 81% and 12%, respectively of total revenues in 2010 and three customers who accounted for 53%, 20%, and 27%, respectively of revenues in 2009.

Costs of the Company’s one major vendor, who provided contract mining services, accounted for 67% of the Company’s production costs for the year ended December 31, 2010 and 71% of the Company’s production costs for the year ended December 31, 2009.

Dependency on Key Management

The future success or failure of the Company is dependent primarily upon the efforts of the Company’s President, director, and controlling stockholder.  The Company does not have insurance covering such officer’s liability and term life insurance.  The Company entered into a five-year employment contract with the President in 2005. The Company and the President informally agreed to extend the employment agreement on substantially the terms set forth in the original agreement

Mineral Interests

The purchase acquisition costs of mineral properties are deferred until the properties are placed into production, sold, or abandoned.  These deferred costs will be amortized on the unit-of-production basis over the estimated useful life of the properties following the commencement of production or written-off if the properties are sold, allowed to lapse, or abandoned.

Mineral property acquisition costs include any cash consideration and the fair market value of common shares and preferred shares, based on the trading price of the shares, or, if no trading price exists, on other indicia of fair market value, issued for mineral property interests, pursuant to the terms of the agreement or based upon an independent appraisal.

Administrative expenditures are expensed in the year incurred.

Since the Company’s continuation as a going concern is dependent upon its ability to obtain adequate financing (see Note 3), the carrying value of the mineral rights does not necessarily represent liquidation value if the Company were force to sell the mineral rights in liquidation in a liquidation proceeding under Chapter 7 of the Bankruptcy Code.

 
F-6

 

KENTUCKY ENERGY, INC.
(formerly Quest Minerals and Mining Corp.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2010 AND 2009

Coal Acquisition Costs

The costs to obtain coal lease rights are capitalized and amortized primarily by the units-of-production method over the estimated recoverable reserves.  Amortization occurs either as the Company mines on the property or as others mine on the property through subleasing transactions.

Rights to leased coal lands are often acquired through royalty payments.  As mining occurs on these leases, the accrued royalty is charged to cost of coal sales.


Mining Acquisition Costs

The costs to obtain any interest in third-party mining operations are expensed unless significantly proven reserves can be established for the entity.  At that point, capitalization would occur.

Mining Equipment

Mining equipment is recorded at cost.  Expenditures that extend the useful lives of existing plant and equipment or increase the productivity of the asset are capitalized.  Mining equipment is depreciated principally on the straight-line method over the estimated useful lives of the assets, which range from 3 to 15 years.

Deferred Mine Expense

Costs of developing new mines or significantly expanding the capacity of existing mines are capitalized and amortized using the units-of-production method over the estimated recoverable reserves that are associated with the property being benefited.

Asset Impairment

If facts and circumstances suggest that a long-lived asset may be impaired, the carrying value is reviewed under the guidance of ASC 360-10, “Accounting for the Impairment or Disposal of Long-Lived Assets.”  If the review indicates that the value of the asset will not be recoverable, as determined based on projected undiscounted cash flows related to the asset over its remaining life, then the carrying value of the asset is reduced to its estimated fair value.

Revenue Recognition

Coal sales revenues are sales to customers of coal produced at the Company’s operations.  The Company recognizes revenue from coal sales at the time title passes to the customer.  Under the typical terms of sale, title and risk of loss transfer to the customer at the mine (or dock, or port) where coal is loaded to the truck (or rail, barge, ocean-going vessel, or other transportation source) that serves the Company’s mines.

 
F-7

 

KENTUCKY ENERGY, INC.
(formerly Quest Minerals and Mining Corp.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2010 AND 2009
Stock-Based Compensation

The Company records  compensation expense associated with stock options and other forms of equity compensation in accordance with FASB ASC 718 “Stock Compensation”.  The Company had adopted the modified prospective transition method provided for ASC 718-10, and, consequently, has not retroactively adjusted results from prior periods.

In 2009, the 50,000 options held by the Company’s President were exchanged and cancelled for a new option grant of equal value, which was  consummated upon the Company’s adoption of a new stock incentive plan.  On November 4, 2009, 264,773 options were issued at an exercise price of $2.20 to complete this exchange.  On April 15, 2010, all parties agreed to rescind and cancel the options effective November 4, 2009. See Note 12 for details.  There were 250,000,000 options issued to the Company’s President in year ended December 31, 2010, which options had an exercise price of $0.0004.


Income Taxes

The Company provides for the tax effects of transactions reported in the consolidated financial statements.  The provision, if any, consists of taxes currently due plus deferred taxes related primarily to differences between the basis of assets and liabilities for financial and income tax reporting.  The deferred tax assets and liabilities, if any, represent the future tax return consequences of those differences, which will either be taxable or deductible when the assets and liabilities are recovered or settled.  As of December 31, 2010 and 2009, the Company had no material current tax liability, deferred tax assets, or liabilities to impact on the Company’s financial position because the deferred tax asset related to the Company’s net operating loss carry forward was fully offset by a valuation allowance.

Fair Value

The FASB issued ASC 820-10, “Fair Value Measurements,” which defines fair value, establishes a framework for measuring fair value and expands disclosures about fair value measurements.  ASC 820-10 applies to other accounting pronouncements that require or permit fair value measurements, but does not require any new fair value measurements.  ASC 820-10 is effective for financial statements issued for fiscal years beginning after November 15, 2007 and interim periods within those fiscal years, with the exception of all non-financial assets and liabilities, which will be effective for years beginning after November 15, 2008.  The Company adopted the required provisions of ASC 820-10 that became effective in its first quarter of 2008.  The adoption of these provisions did not have a material impact on the Company’s consolidated financial statements.  In February 2008, the FASB issued ASC 820-10-15, “Effective Date of FASB ASC 820-10.”  ASC 820-10-15 delays the effective date of ASC 820-10 for nonfinancial assets and nonfinancial liabilities, except for certain items that are recognized or disclosed at fair value in the financial statements on a recurring basis (at least annually).  In October 2008, the FASB issued ASC 820-10-35, “Determining the Fair Value of a Financial Asset When the Market for That Asset Is Not Active.”  ASC 820-10-35 applies to financial assets within the scope of accounting pronouncements that require or permit fair value measurements in accordance with ASC 820-10.  This ASC clarifies the application of ASC 820-10 in determining the fair values of assets or liabilities in a market that is not active.  In April 2009, the FASB issued ASC 820-10-65, “Determining Fair Value When the Volume and Level of Activity for the Asset or Liability Have Significantly Decreased and Identifying Transactions That Are Not Orderly.”  ASC 820-10-65 does not change the definition of fair value as detailed in ASC 820-10, but provides additional guidance for estimating fair value in accordance with ASC 820-10 when the volume and level of activity for the asset or liability have significantly decreased.  The provisions of ASC 820-10-65 are effective for interim and annual reporting periods ending after June 15, 2009, with early adoption permitted for periods ending after March 15, 2009.  If early adoption is elected for either ASC 320-10 or ASC 825-10 and ASC 270-10, ASC 820-10-65 must also be adopted early.
 
 
 
F-8

 
 
KENTUCKY ENERGY, INC.
(formerly Quest Minerals and Mining Corp.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2010 AND 2009
 
ASC 820-10 defines fair value as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date.  ASC 820-10 requires that valuation techniques maximize the use of observable inputs and minimize the use of unobservable inputs.  ASC 820-10 also establishes a fair value hierarchy, which prioritizes the valuation inputs into three broad levels.


The Company’s financial assets and liabilities are valued using either level 1 inputs based on unadjusted quoted market prices within active markets or using level 2 inputs based primarily on quoted prices for similar assets or liabilities in active or inactive markets.  For certain debt, fair value is based on present value techniques using inputs derived principally or corroborated from market data.  Using level 3 inputs using management’s assumptions about the assumptions market participants would utilize in pricing the asset or liability.  In the Company’s case, this entailed assumptions used in pricing models for note discounts.  Valuation techniques utilized to determine fair value are consistently applied.

As of December 31, 2010, the Company does not carry on a recurring basis any assets or liabilities at fair value.

Earnings (loss) per share

The Company adopted ASC 260, which provides for the calculation of “basic” and “diluted” earnings per share.  Basic earnings per share includes no dilution and is computed by dividing net income available to common stockholders by the weighted average common shares outstanding for the period; after provisions for cumulative dividends on Series A preferred stock.  Diluted earnings per share reflect the potential dilution of securities that could share in the earnings similar to fully diluted earnings per share.  The assumed exercise of outstanding stock options and warrants and the conversion of convertible securities were not included in the computation of diluted loss per share because the assumed exercises and conversions would be anti-dilutive for the periods presented.
 
 
F-9

 
 
KENTUCKY ENERGY, INC.
(formerly Quest Minerals and Mining Corp.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2010 AND 2009
 
Stock Split

All references to common stock and per share data have been retroactively restated once more to the earliest period presented to account for the 1 for 100 reverse stock split effectuated on August 4, 2009.  See Note 11 for details.

All references to common stock and per share data have been retroactively restated once more to the earliest period presented to account for the 1 for 20 reverse stock split effectuated on June 16, 2010.  See Note 11 for details.

All references to common stock and per share data have been retroactively restated once more to the earliest period presented to account for the 1 for 25 reverse stock split effectuated on February 2, 2011.  See Note 11 for details.


Articles of Incorporation Amendment

All references to common stock and per share par value data have been retroactively restated to the earliest period presented to account for the amended par value from $.001 to $.0001 effectuated on November 23, 2009.  See Note 11 for details.

 
F-10

 
 
KENTUCKY ENERGY, INC.
(formerly Quest Minerals and Mining Corp.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2010 AND 2009
 
Recently Adopted Accounting Principles

In August 2009, FASB Accounting Standards Update 2009-05 included amendments to Subtopic 820-10, Fair Value Measurements and Disclosures—Overall, for the fair value measurement of liabilities and provides clarification that in circumstances in which a quoted price in an active market for the identical liability is not available, a reporting entity is required to measure fair value using one or more of the techniques provided for in this update.  This update also clarifies that when estimating the fair value of a liability, a reporting entity is not required to include a separate input or adjustment to other inputs relating to the existence of a restriction that prevents the transfer of a liability and that both a quoted price in an active market for the identical liability at the measurement date and the quoted price for the identical liability when traded as an asset in an active market when no adjustments to the quoted price of the asset are required are Level 1 fair value measurements.  The adoption of this update did not have a material impact on the Company’s consolidated financial statements.
 
In July 2009, the FASB issued ASC 105-10, “Generally Accepted Accounting Principles.”  ASC 105-10 established the FASB Accounting Standards Codification as the single source of authoritative U.S. generally accepted accounting principles (“U.S. GAAP”) recognized by the FASB to be applied by nongovernmental entities.  ASC 105-10 will supersede all existing non-SEC accounting and reporting standards.  All other nongrandfathered non-SEC accounting literature not included in ASC 105-10 will become nonauthoritative.  Following ASC 105-10, the FASB will not issue new standards in the form of Statements, FASB Staff Positions, or Emerging Issues Task Force Abstracts.  Instead, the FASB will issue Accounting Standards Updates, which will serve only to: (a) update the Codification; (b) provide background information about the guidance; and (c) provide the bases for conclusions on the change(s) in the Codification.  ASC 105-10 and the Codification are effective for financial statements issued for interim and annual periods ending after September 15, 2009.  The adoption of ASC 105-10 did not have a material impact on the Company’s consolidated financial statements.
 
The FASB has issued ASC 855-10, “Subsequent Events.”  ASC 855-10 established general standards of accounting for and disclosures of events that occur after the balance sheet date but before financial statements are issued or are available to be issued.  Specifically, ASC 855-10 provides (a) the period after the balance sheet date during which management of a reporting entity should evaluate events or transactions that may occur for potential recognition or disclosure in the financial statements; (b) the circumstances under which an entity should recognize events or transactions occurring after the balance sheet date in its financial statements; and (c) the disclosures that an entity should make about events or transactions that occurred after the balance sheet date.  ASC 855-10 is effective for interim or annual financial periods ending after June 15, 2009, and shall be applied prospectively.  The adoption of this ASC did not have a material impact on the Company’s consolidated financial statements.
 
The FASB has issued ASC 825-10-65, “Interim Disclosures about Fair Value of Financial Instruments.”  ASC 825-10-65 amends ASC 825-10-50, Disclosures About Fair Value of Financial Instrument, to require disclosures about fair value of financial instruments for interim reporting periods of publicly traded companies as well as in annual financial statements.  ASC 825-10-65 also amends ASC 270-10, Interim Financial Reporting, to require those disclosures in summarized financial information at interim reporting periods.  ASC 825-10-65 is effective for interim reporting periods ending after June 15, 2009, with early adoption permitted for periods ending after March 15, 2009.  ASC 825-10-65 does not require disclosures for earlier periods presented for comparative purposes at initial adoption. In periods after initial adoption, ASC 825-10-65 requires comparative disclosures only for periods ending after initial adoption.  The adoption of this ASC did not have a material impact on the Company’s consolidated financial statements.
 
 
F-11

 
 
KENTUCKY ENERGY, INC.
(formerly Quest Minerals and Mining Corp.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2010 AND 2009
 
The FASB has issued ASC 805-10, “Accounting for Assets Acquired and Liabilities assumed in a Business Combination That Arise from Contingencies —an amendment of FASB Statement No. 141 (Revised December 2007), Business Combinations.”  ASC 805-10 addresses application issues raised by preparers, auditors, and members of the legal profession on initial recognition and measurement, subsequent measurement and accounting, and disclosure of assets and liabilities arising from contingencies in a business combination.  ASC 805-10 is effective for assets or liabilities arising from contingencies in business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2008.  ASC 805-10 will have an impact on the Company’s accounting for any future acquisitions and its consolidated financial statements.

The FASB has issued ASC 350-10, “Determination of the Useful Life of Intangible Assets.”  ASC 350-10 amends the factors that should be considered in developing renewal or extension assumptions used to determine the useful life of a recognized intangible asset under ASC 350-10, “Goodwill and Other Intangible Assets.”  ASC No. 350-10 is effective for fiscal years beginning after December 15, 2008.  The adoption of this ASC did not have a material impact on the Company’s consolidated financial statements.

 The FASB has issued ASC 815-10, “Disclosures about Derivative Instruments and Hedging Activities — an amendment of FASB Statement No. 133.”  ASC 815-10 requires enhanced disclosures regarding derivatives and hedging activities, including: (a) the manner in which an entity uses derivative instruments; (b) the manner in which derivative instruments and related hedged items are accounted for under Accounting Standards Codification 815-10, “Accounting for Derivative Instruments and Hedging Activities;” and (c) the effect of derivative instruments and related hedged items on an entity’s financial position, financial performance, and cash flows.  ASC 815-10 is effective for financial statements issued for fiscal years and interim periods beginning after November 15, 2008.  The Company adopted ASC 815-10 effective January 1, 2009 and the adoption had no material impact on the Company’s consolidated financial statements and disclosures.

The FASB has issued ASC 810-10-65-1, “Non-controlling Interests in Consolidated Financial Statements—an amendment of ARB No. 51” (“SFAS No. 160”).  In ASC 810-10-65-1, the FASB established accounting and reporting standards that require non-controlling interests to be reported as a component of equity, changes in a parent’s ownership interest while the parent retains its controlling interest to be accounted for as equity transactions, and any retained non-controlling equity investment upon the deconsolidation of a subsidiary to be initially measured at fair value.  ASC 810-10-65-1 is effective for annual periods beginning on or after December 15, 2008.  Retroactive application of ASC810-10-65-1 is prohibited.  The Company adopted ASC 810-10-65-1   effective January 1, 2009 and the adoption had no material impact on the Company’s consolidated financial statements and disclosures.

The FASB has issued ASC 808-10, “Accounting for Collaborative Arrangements.”  ASC 808-10 prescribes the accounting for parties of a collaborative arrangement to present the results of activities for the party acting as the principal on a gross basis and report any payments received from (made to) other collaborators based on other applicable GAAP or, in the absence of other applicable GAAP, based on analogy to authoritative accounting literature or a reasonable, rational, and consistently applied accounting policy election.  Further, ASC 808-10 clarified the determination of whether transactions within a collaborative arrangement are part of a vendor-customer (or analogous) relationship subject to Issue No. 01-9, “Accounting for Consideration Given by a Vendor to a Customer.”  ASC 808-10 is effective for collaborative arrangements that exist on January 1, 2009 and application is retrospective.  The Company adopted ASC 808-10 effective January 1, 2009 and the adoption had no material effect on the Company’s financial position or results of operations.
 
 
F-12

 
 
KENTUCKY ENERGY, INC.
(formerly Quest Minerals and Mining Corp.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2010 AND 2009
 
The FASB issued ASC 815-40-15, “Determining Whether an Instrument (or Embedded Feature) Is Indexed to an Entity’s Own Stock.”  ASC 815-40-15 provides that an entity should use a two-step approach to evaluate whether an equity-linked financial instrument (or embedded feature) is indexed to its own stock, including evaluating the instrument’s contingent exercise and settlement provisions.  It also clarifies the impact of foreign currency denominated strike prices and market-based employee stock option valuation instruments on the evaluation.  ASC 815-40-15 is effective for fiscal years beginning after December 15, 2008.  The Company adopted ASC 815-40-15 effective January 1, 2009, and the adoption had no material effect on the Company’s financial position or results of operations.

In January 2010, the FASB issued an accounting standard update, amending disclosure requirements related to Fair Value Measurements and Disclosures, as follows:

 
1.
Significant transfers between Level 1 and 2 shall be disclosed separately, including the reasons for the transfers; and
 
2.
Information about purchases, sales, issuances and settlements shall be disclosed separately in the reconciliation of activity in Level 3 fair value measurements.

This accounting standard update is effective for interim and annual reporting periods beginning after December 15, 2009, except for the disclosures about purchases, sales, issuances and settlements in the reconciliation of activity in Level 3 fair value measurements, which are effective for interim and annual reporting periods beginning after December 15, 2010.  The adoption of this accounting standard update did not have a material impact on our financial position or results of operations.

In January and April 2010, respectively, the FASB issued ASU 2010-03, Extractive Activities-Oil and Gas (Topic 932) and 2010-14, Accounting for Extractive Activities-Oil & Gas.  The objective of these updates is to align the oil and gas accounting and reserve estimation and disclosure requirements of Extractive Activities-Oil & Gas (Topic 932) with the requirements of the Securities and Exchange Commission’s (SEC) Release 33-8895, Modernization of Oil and Gas Reporting, which became effective for registration statements filed beginning January 1, 2010 and for annual reports for years ending on or after December 31, 2009.  SEC Release 33-8895 was issued to provide investors with more meaningful information on which to base their evaluations of oil and gas companies, taking into account the significant technological advances that have occurred since the original SEC rules were issued some three decades ago.  The Company is applying the requirements of Release 33-8895, though it has not yet reported information regarding reserves in its annual reports.

In January 2010, the FASB issued Update No. 2010-05 “Compensation—Stock Compensation—Escrowed Share Arrangements and Presumption of Compensation” (“2010-05”).  2010-05 re-asserts that the Staff of the SEC has stated the presumption that for certain shareholders escrowed shares represent a compensatory arrangement.  2010-05 further clarifies the criteria required to be met to establish a position different from the SEC Staff’s position.  The adoption of this accounting standard update did not have a material impact on our financial position or results of operations.
 
 
F-13

 

KENTUCKY ENERGY, INC.
(formerly Quest Minerals and Mining Corp.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2010 AND 2009
 
In January 2010, the FASB issued Update No. 2010-04 “Accounting for Various Topics—Technical Corrections to SEC Paragraphs” (“2010-04”).  2010-04 represents technical corrections to SEC paragraphs within various sections of the Codification.  The adoption of this accounting standard update did not have a material impact on our financial position or results of operations.

In January 2010, the FASB issued Update No. 2010-02 “Accounting and Reporting for Decreases in Ownership of a Subsidiary—a Scope Clarification” (“2010-02”) an update of ASC 810 “Consolidation.”  2010-02 clarifies the scope of ASC 810 with respect to decreases in ownership in a subsidiary to those of a subsidiary or group of assets that are a business or nonprofit, a subsidiary that is transferred to an equity method investee or joint venture, and an exchange of a group of assets that constitutes a business or nonprofit activity to a non-controlling interest including an equity method investee or a joint venture.  The adoption of this accounting standard update did not have a material impact on our financial position or results of operations. Management does not intend to decrease its ownership in any of its wholly-owned subsidiaries.

In January 2010, the FASB issued Update No. 2010-01 “Accounting for Distributions to Shareholders with Components of Stock and Cash—a consensus of the FASB Emerging Issues Task Force” (“2010-03”) an update of ASC 505 “Equity.”  2010-03 clarifies the treatment of stock distributions as dividends to shareholders and their affect on the computation of earnings per shares.  The adoption of this accounting standard update did not have a material impact on our financial position or results of operations.

Other recent accounting pronouncements issued by the FASB (including its Emerging Issues Task Force), the AICPA, and the SEC did not, or are not believed by management to, have a material impact on the Company's present or future consolidated financial statements.
 
NOTE 3 –  
GOING CONCERN
 
The accompanying consolidated financial statements have been prepared on a going concern basis, which contemplates the realization of assets and the satisfaction of liabilities in the normal course of business and does not include any adjustments to reflect the possible future effects on the recoverability and classification of assets or liabilities that might be necessary should the Company be unable to continue as a going concern.   The Company incurred net losses from operations of $2,385,604 and $2,712,156 for the years ended December 31, 2010 and 2009 and had a working capital deficit (current assets lesscurrent liabilities) of $7,062,681 and $3,929,293 at December 31, 2010 and December 31, 2009, respectively.  These factors indicate that the Company’s continuation as a going concern is dependent upon its ability to obtain adequate financing.

The Company will require substantial additional funds to finance its business activities on an ongoing basis and will have a continuing long-term need to obtain additional financing.  The Company’s future capital requirements will depend on numerous factors including, but not limited to, continued progress developing additional mines and increasing mine production.  Currently, the Company is in the process of seeking additional funding to achieve its operational goals.

On March 2, 2007, Gwenco filed a voluntary petition for reorganization under Chapter 11 of the U.S. Bankruptcy Code with the United States Bankruptcy Court for the Eastern District of Kentucky.  Management felt this was a necessary step to further the company’s financial restructuring initiative and to protect Gwenco’s assets from claims, debts, judgments, foreclosures, and forfeitures of those creditors and stakeholders with whom both Quest and Gwenco were unable to negotiate restructured agreements.  Prior to October 12, 2009, Gwenco oversaw its operations as a debtor in possession, subject to court approval of matters outside the ordinary course of business.  In 2007, the Bankruptcy Court approved Gwenco’s request for debtor-in-possession financing in an amount of up to $2,000,000 from holders of Gwenco’s existing debt obligations in order to fund operating expenses.  Under Chapter 11, all claims against Gwenco in existence prior to the filing of the petitions for reorganization relief under the federal bankruptcy laws were stayed while Gwenco was in bankruptcy.
 
 
F-14

 

KENTUCKY ENERGY, INC.
(formerly Quest Minerals and Mining Corp.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2010 AND 2009
 
On September 30, 2009, the Bankruptcy Court confirmed Gwenco’s Plan of Reorganization (the “Plan”).  Secured and non-priority unsecured classes of creditors voted to approve the Plan, with over 80% of the unsecured claims in dollar amount voting for the plan, and over 90% of responding lessors supporting it.   The Plan became effective on October 12, 2009. 

Even though the Bankruptcy Court has confirmed the Plan, it is still possible that the Bankruptcy Court could convert Gwenco’s case to Chapter 7 and liquidate all of Gwenco’s assets if the Court determines that Gwenco is unable to perform under the Plan.  In the case of a Chapter 7 conversion, the Company would be materially impacted and could lose all of its working assets and have only unpaid liabilities.  In addition, the Company might be forced to file for protection under Chapter 11 as it is the primary guarantor on a number of Gwenco’s contracts.
 
Plan of Reorganization

In 2009, the United States Bankruptcy Court for the Eastern District of Kentucky confirmed Gwenco’s Plan of Reorganization (the “Plan”) pursuant to Chapter 11 of the U.S. Bankruptcy Code with the United States Bankruptcy Court for the Eastern District of Kentucky.  The Plan became effective on October 12, 2009.  See Note 16 to our consolidated financial statements as of December 31, 2010 and 2009 and for each of the years then ended for a description of the Plan and its effect on our consolidated financial statements.
 
NOTE 4 –  
LEASEHOLD INTERESTS
 
The Company maintains a number of coal leases with minimum lease or royalty payments that vary by lease as defined in the separate agreements.    Several of the landowners contended that the Company was in default under certain of these leases and that said leases were terminated.  The Company disputed these contentions.   
 
 
F-15

 

KENTUCKY ENERGY, INC.
(formerly Quest Minerals and Mining Corp.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2010 AND 2009
 
On September 30, 2009, the Bankruptcy Court confirmed Gwenco’s Plan, which became effective on October 12, 2009.  As a result of the confirmation of Gwenco’s Plan, Gwenco has assumed all coal leases and is obligated to pay cure claims due under each lease.  Pursuant to the Plan, most of the existing royalties, which accrued up until the effective date, were re-categorized as Cure Claims totaling $199,213.  These claim amounts are now due on or before October 12, 2012.  See Note 16 for the terms and effects of the Plan.

As of December 31, 2010, Gwenco owed approximately $321,933  in current lease and/or royalty payments.
 
NOTE 5 –  
LEASED MINERAL RESERVES
 
All of the Company’s existing reserves remain in Gwenco, Inc., a wholly owned subsidiary.  The total reserves are a combination of several coal seams throughout the spectrum of leased properties.
 
At December 31, 2010, the leased mineral reserves, valued at $5,165,469, net consisted of the following:
 
 
 
 
 
Proven Reserves
 
Seams
 
Tons
 
Winifrede
    214,650  
Taylor
    1,783,500  
Cedar Grove
    3,702,600  
Pond Creek
    4,027,762  
           Total Reserves
    9,728,512  

The Company maintains a number of coal leases with minimum lease or royalty payments that vary by lease as defined in the separate agreements.    Several of the landowners contended that the Company was in default under certain of these leases and that said leases were terminated.  The Company disputed these contentions.     As a result of the confirmation of Gwenco’s Plan, Gwenco has assumed all coal leases and is obligated to pay cure claims due under each lease.  Unless otherwise provided in the Plan, the cure claims are due on or before October 12, 2012.

Pursuant to ASC 360-10, management has reviewed the recoverable value of the Company’s mineral reserves and has determined that no impairment loss has occurred as of December 31, 2010 and 2009.  As long as the recoverable amount continues to exceed its carrying value, amortization will occur based on a proportionate ratio of depleted reserves as a result of future coal mining activity.
 
 
F-16

 
 
KENTUCKY ENERGY, INC.
(formerly Quest Minerals and Mining Corp.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2010 AND 2009
 
NOTE 6 –  
EQUIPMENT
 
Equipment consisted of the following:
 
December 31,
   
December 31,
 
   
2010
   
2009
 
             
Mining equipment
  $ 344,435       344,435  
Less accumulated depreciation
    (247,338 )     (211,251 )
                 
Equipment - net   $ 97,097       133,184  

All of the equipment currently in use by the Company is owned or leased by the Company’s wholly-owned subsidiary, Gwenco, Inc.

The Company depreciates its mining equipment over a 5 year period, while the office equipment is depreciated over a 7 year period.  In both cases, the straight-line method is used.  Depending on the type of equipment needed at any given point in production, the Company will sell existing equipment and replace it with new or used machinery, which can reflect a fluctuation in the asset valuation.  Depreciation charged for the years ended December 31, 2010 and 2009 were $36,087 , respectively.
 
NOTE 7 –  
ACCOUNTS PAYABLE & ACCRUED EXPENSES
 
Accounts payable and accrued expenses consist of the following:
 
December 31,
   
December 31,
 
   
2010
   
2009
 
Accounts payable
  $ 1,812,552       1,074,035  
Accrued royalties payable-operating (a)
    347,478       125,894  
Accrued bank claim (b)
    650,000       650,000  
Accrued taxes
    123,263       87,315  
Accrued interest (c)
    375,054       220,095  
Accrued expenses (d)
    955,572       902,722  
    $ 4,263,919     $ 3,060,061  
 
 
(a)
The Company maintains a number of coal leases with minimum lease or royalty payments that vary by lease as defined in each lease agreement.  As a result of the confirmation of Gwenco’s Plan, Gwenco has assumed all coal leases and is obligated to pay cure claims due under each lease.  In addition, the Company has granted overriding royalties to third parties.  Unless otherwise provided in the Plan, all accrued amounts due under the leases and overriding royalty obligations are due on or before October 12, 2012.   As a result, most of the existing royalties, which accrued up until the effective date, were re-categorized as Cure Claims totaling $199,213.  As of December 31, 2010, the Company owed approximately $321,933 in current lease and/or royalty payments.
 
In addition, the Company accrued $25,544 as an estimated royalty payable in connection with an August 2008 financing.  The debt discount related to the accrued royalty  was  amortized over the life of the underlying note involved in the financing.  (See Note 8
 
 
F-17

 

KENTUCKY ENERGY, INC.
(formerly Quest Minerals and Mining Corp.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2010 AND 2009
 
 
(b)
Community Trust Bank and its insurer, the Federal Insurance Company, commenced an action in Pike County Court, Kentucky against Quest Energy alleging that former employees or associates of Quest Energy engaged in a criminal scheme and conspiracy to defraud Community Trust Bank, that Quest Energy is accordingly responsible for the actions of these former employees and associates, and that Quest Energy obtained a substantial material benefit as a result of this alleged scheme.  Quest Energy has denied these allegations.  As of December 31, 2010, the matter is closed and off the Court’s docket, and no outcome has been determined.  While we believe that this matter will be resolved without a material adverse impact on our cash flows, results of operation, or financial condition, it is reasonably possible that our judgments regarding this matter could change in the future.
 
(c)
Since all of the company’s issued debt transactions do not offer a compounded interest rate, interest charges continue to accrue on principal only.

 
(d)
The Company recorded an accrued liability for indemnification obligations of $390,000 to its current and former officers, which represents the fair value of shares of the Company’s common stock, which the officers pledged as collateral for personal guarantees of a loan to the Company.  The Company defaulted on the loan and the lender foreclosed on the officer’s pledged shares.  In January 2007, the Company satisfied $260,000 of this accrued liability by issuing 260,000 shares of Series C Preferred Stock.  See Note 10. The Company has accrued the remaining $130,000 due to its former officer.   In addition, during the period ended December 31, 2004, the Company had recorded accrued expenses of $468,585 from its subsidiaries, E-Z Mining Co. and Gwenco, Inc. as acquisition for mining expenses recorded on their books and records.  The Company continues to carry these balances until further validity can be determined.  The Company also accrues consulting fees based on contractual agreements with consultants.

 
F-18

 

KENTUCKY ENERGY, INC.
(formerly Quest Minerals and Mining Corp.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2010 AND 2009
 
NOTE 8 –  
NOTES PAYABLE

Notes payable consist of the following:
 
December 31,
   
December 31,
 
   
2010
   
2009
 
Kentucky Energy, Inc.
           
   0% Notes Due on Demand (a).
  $ 202,864     $ 202,864  
   7% Senior Secured Convertible Notes Due 2007 (b).
    25,000       25,000  
   5% Unsecured Advances Due on Demand (c).
    130,857       130,857  
   6% Convertible Notes Due 2011 (c).
    838,515       1,044,580  
   6% Convertible Notes Due 2011 (d).
    1,000,000       1,000,000  
   6% Convertible Notes Due 2011 (e).
    165,700       200,000  
   0% Notes Due on Demand (f).
    498,370       480,434  
   10% Convertible Notes due 2008 (g).
    10,000       10,000  
   6% Convertible Notes due 2010 (h).
    2,300       27,304  
   8% Convertible Notes due 2010 (i).
    3,330       117,010  
   8% Convertible Notes due 2011 (j).
    25,000       25,000  
   5% Convertible Notes due 2014 (k).
    50,400       90,500  
   4% Convertible Notes due 2011 (l).
    -       30,000  
   8% Convertible Notes due 2012 (m).
    1,481       50,000  
   8% Convertible Notes due 2012 (n).
    -       12,500  
   8% Convertible Notes due 2012 (o).
    11,115       10,000  
   5% Convertible Notes due 2012 (p).
    95,000       -  
   8% Convertible Notes due 2012 (q).
    55,000       -  
   8% Convertible Notes due 2011 (r).
    24,500       -  
   8% Convertible Notes due 2011 (s).
    169,500       -  
   8% Convertible Notes due 2012 (t).
    50,000       -  
   8% Convertible Notes due 2012 (u).
    10,700       -  
QUEST ENERGY, LTD.
               
   8% Summary Judgment (w).
    35,000       35,000  
 
GWENCO, INC.: (Restructured Debt)
               
   CLASS 1 – Secured Claim with conversion option (x).
    1,258,942       1,753,377  
   CLASS 1 – Secured claim with conversion option (y).
    2,632,659       3,207,376  
   CLASS 3 – Unsecured Claims (z).
    385,900       413,741  
   CLASS 3 - Unsecured Claims with conversion option (ai).
    319,062       319,062  
   CLASS 5 – Cured Claims (aii).
    199,213       199,213  
 
GWENCO, INC.: (Related-Party Loans)
               
   CLASS 3 - Unsecured Claim with conversion option (aiii).
    501,967       651,967  
Total Debt
    8,702,375