U.S.
Securities and Exchange Commission





Washington,
D. C. 20549





Form
10-K





x ANNUAL REPORT
UNDER  SECTION 13 OR 15(d) OF THE


SECURITIES
EXCHANGE ACT OF 1934


For the
fiscal year ended January 3, 2009





o TRANSITION REPORT UNDER
SECTION 13 OR 15(d) OF THE


SECURITIES
EXCHANGE ACT OF 1934


For the
transition period from ________ to ________





Commission
File Number : 0-26226





ENERGYCONNECT
GROUP, INC.


(Exact
Name of Registrant as Specified in Its Charter)


Oregon
                93-0935149(State
      or other jurisdiction of incorporation or organization)
                (I.
      R. S. Employer Identification
No.)





5335
SW Meadows Rd.


Lake
Oswego, Oregon 97035


(Address
of principal executive offices and zip code)





(503)
419-3580


(Registrant’s
telephone number)





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


Securities
registered under Section 12(g) of the Exchange Act:


Common
Stock





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




Indicate
by check mark if the registrant is not required to file reports pursuant to
Section 13 or Section 15(b) of the Act.   o Yes  xNo





Indicate
by check mark whether the registrant (1) has filed all reports required to be
filed 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 days:          Yes
x    No
o





Indicate
by check mark if disclosure of delinquent filers pursuant to Item 405 of
Regulation S-K is not contained in this form, and no disclosure will be
contained, to the best of Registrant’s knowledge, in definitive proxy or
information statements incorporated by reference in Part III of this Form 10-K
or any amendment to this Form 10-K. x





Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer,  a non-accelerated filer , or a smaller reporting
company . See the definitions of “large accelerated filer, an accelerated
filer,” and “smaller reporting company”  in Rule 12b-2 of the Exchange
Act.  (Check one):





o Large Accelerated
Filer    o Accelerated
Filer   x Non-Accelerated
Filer    o Smaller reporting
company





Indicate
by check mark whether the registrant is a shell company (as defined in Rule
12b-2 of the Act).  o





The
aggregate market value of the voting stock and non-voting common equity held by
non-affiliates (based upon the closing sale price of $0.38 per share on the Over
the Counter Bulletin Board on June 27, 2008) was $36,130,385.





The
number of shares outstanding of the registrant’s Common Stock as of March 1,
2009 was 95,179,961 shares.













ENERGYCONNECTGROUP, INC.


FORM
10-K  INDEX





PART
      IPageItem
      1.
                                Business
                                3Item
      1A.
                                Risk Factors
                                8Item
      1B.
                                Unresolved
      Staff CommentsItem
      2.
                                Properties
                                15Item
      3.
                                Legal Proceedings
                                15Item
      4.
                                Submission of Matters to a Vote of Security
      Holders
                                15PART
      IIItem
      5.
                                Market for Registrant’s Common Equity, Related Stockholder
      Matters and Issuer Repurchases of Equity Securities
                                16Item
      6.
                                Selected Financial Data
                                17Item  7.
                                Management’s Discussion and Analysis of Financial Condition And
      Results of Operations
                                18Item
      7A.
                                Quantitative and Qualitative Disclosures About Market
      Risk
                                26Item
      8.
                                Financial Statements and Supplementary Data
                                27Item
      9.
                                Changes in and Disagreements with Accountants on Accounting and
      Financial Disclosure
                                53Item
      9A.
                                Controls and Procedures
                                53Item
      9B.
                                Other Information
                                54PART
      IIIItem
      10.
                                Directors, Executive Officers, and Corporate
      Governance
                                55Item
      11.
                                Executive Compensation
                                57Item
      12.
                                Security Ownership of Certain Beneficial Owners and Management
      and Related Stockholder Matters
                                60Item
      13.
                                Certain Relationships, Related Transactions and Director
      Independence
                                61Item
      14.
                                Principal Accountant Fees and Services
                                61PART
      IVItem
      15.
                                Exhibits and Financial Statement Schedules
                                62




2
 Index





PARTI





ITEM
1.  BUSINESS





Overview





EnergyConnect
Group, Inc. (the “Company,” “we,” “us,” or “our”) through its subsidiary
EnergyConnect, Inc. (“ECI”) provides a full range of demand response services to
the electric power industry. Our customers are the regional grid operators who
pay us market rates for reductions in electrical demand during periods of high
prices or peak demand and for being available to reduce electric power demand on
request at periods of capacity limitations or in response to grid emergencies.
Our suppliers are large commercial and industrial consumers of electricity who
we pay to shift their demand for electricity from high priced hours in the day
to lower priced hours. We also pay these participating energy consumers to be
available to curtail electric demand on request.





Through
proprietary technology and business processes we automate electric consumer
demand response transactions and the associated measurement, verification, and
support decisions.   These capabilities make it possible and easy
for electric consumers, particularly commercial and industrial facilities, to
shift load from high priced hours to lower priced periods.





Our
services provide market incentives to reduce electric demand during periods of
peak demand or high prices. By shifting load from high demand periods our
services improve the operating efficiency of the electrical grids and improve
grid reliability. By improving grid reliability and efficiency, we also delay
the need for construction of new electrical generating plants. Through higher
efficiencies on the grid, lower cost of generation and improved reliability all
consumers of electricity benefit from our demand response
activities





Our
customers are regional electric grid operators such as PJM, the largest electric
grid in the nation, and selected electric utilities who support and sponsor
demand response.  All of our current operations are in the United
States with services provided in more than 25 states.  Following a
three year testing and pilot period, we began commercial operations in 2005 and
have been growing steadily since then.  Our revenues in 2008 were
$25.8 million.  Our suppliers are commercial and industrial electric
energy consumers who we pay to shift, curtail and in some cases produce electric
energy.




In 2003
we acquired a part of Christenson Electric, Inc. (“CEI”), and in 2005, we
acquired the remainder of CEI and the stock of ECI.  This combined a
60 year old electrical contracting and technology business with a high growth
demand response business.   In 2007 we determined that ECI had
grown to a self sustaining transition point and in November 2007 we agreed to
sell the stock of CEI.  The sale was completed on April 24,
2008.  Our objective is to leverage our unique and proprietary
technologies, business processes, and resources and build a viable, profitable
demand response business servicing wholesale power markets. Financial statements
and accompanying notes included in this report include disclosure of the results
of operations for CEI, for all periods presented, as discontinued
operations.  All significant inter-company accounts and transactions
have been eliminated in consolidation.





The
Company was incorporated in October 1986 as an Oregon Corporation, succeeding
operations that began in October 1984.  The Company’s headquarters are
located in Lake Oswego, Oregon.





Products and
Services





ECI
provides grid operators with products similar to those the grid operator
purchases from electric power generators. Our products can be grouped into three
main categories: energy, capacity and reserves.





Economic, or price based
energy





Electrical
energy consumption has a repeating daily rise and fall with lowest consumption
at night and peak usage in most of the U.S. during the 3:00pm to 7:00pm
timeframe. Our priced based economic product provides reduction in usage during
peak usage or at any time of high prices for electrical energy on the grid. The
grid operator pays EnergyConnect for measured and verified reductions from
baseline usage. Grid operators provide a real time next hour market for
electrical energy and a day-ahead market.





3
 Index





EnergyConnect
provides grid operators with aggregated reductions in usage that are meaningful
to the grid and provides participants with the information, support and
procedures necessary to participate. Building operators in particular benefit
from EnergyConnect procedures that allow buildings to shift electrical energy
consumption while keeping all aspects of the building within
specification.  Products take numerous forms generally in the
following categories:





Real time
response





Participants
reduce usage of electricity based on a schedule created by consumers in response
to estimated prices provided by EnergyConnect. EnergyConnect is paid for the
measured reduction that hour at the same market rate as the grid operator pays
electric power generators less the retail charge from the local utility to the
participating consumers.  This is a payment for service product and
there are generally no penalties or charges for not participating.





Real time
dispatch





Participants
reduce usage of electricity in response to requests by the grid operator.
EnergyConnect is paid for the response to the grid operator request at the same
market price paid to electric power generators in each hour.  This is
a payment for service product and there are generally no penalties or charges
for not participating.





Day
ahead





Some grid
operators establish day-ahead economic markets with forward hourly electricity
prices. Day-ahead forward prices reflect the inherent unpredictability of market
conditions.  Day-ahead prices often track the real time price, but can
deviate substantially.  The price certainty of the day ahead market
provides a known return for pre-cooling buildings in early morning hours to
create subsequent reductions of energy use in the peak afternoon hours.
EnergyConnect provides participating consumers with all the information and
support required to execute pre cooling strategies and schedule into the day
ahead electrical energy market. EnergyConnect is paid for the reduction in
usage.  Reductions in excess of the amount committed to the day ahead
market are generally paid at the prevailing real time rate. Under delivery
generally must be made up by buying energy at the real time rate.





Capacity





The
capacity product is the traditional demand response capability and has been in
use for over 40 years. Regional utilities as well as grid operators sponsor and
purchase this demand response product. Capacity is designed to address the few
times a year that an electrical grid may approach the capacity limits of
electrical generation in the region.  Participants in the program are
generally paid a monthly fee to be on standby to respond on several hours notice
to a request to reduce electrical usage for a four, six or eight hour period.
Each grid operator and or utility may have unique requirements for notification
time, response duration, and performance penalties.





EnergyConnect
is paid monthly by the grid for having stand by capability to reduce usage with
specific timing for response and duration. In PJM, the annual commitment and
registration is done in the spring for the following 12 months, particularly
targeting the summer season.  Payments are made monthly for the 12
month period.  Obligations are for 6 hours duration on between two and
twenty-four hour notice.





Reserves, Ancillary
Services, and Others





Reserve
products address the grid operator’s need to respond to emergencies on the
electrical grid such as a lightening strike, a switch failure, loss of a
tie-line, or sudden loss of a generating plant. Response is generally required
within 10 minutes and response duration generally less than 30
minutes.  EnergyConnect is paid a fee for the period of commitment to
have load reduction or back up generation available on short notice. The amount
of the fee may vary hour by hour and over the year.





Some
grids limit the participation of demand response in these products at this
time.   In the PJM grid, demand response may provide 25% of the
synchronous reserve needs in each area of the region.  Synchronous
reserve is 10 minute response, 30 minute duration maximum.





4
 Index





Electric Power
Industry





While
demand for electricity in North America has contracted lately, constraints
on new generating or transmission infrastructure may move the regional electric
grids closer to capacity limitations. Whether the constraints on new
construction come from “not in my back yard” or environmentalists worried about
global warming or the space limitations of large urban cities the result is
delay in planned electrical generation, transmission, and distribution
capacity.  In this environment demand response can provide the added
buffer to keep grids functioning reliably and to delay the need to build new
infrastructure.





The
electric power industry is in a state of change.  Worldwide
fluctuations in supplies of key materials and fuels, environmental footprint
limits, and public perception are driving change.   Expectations
and pressures for the industry to improve efficient use of fuels and materials,
to improve reliability, and to reduce system losses have increased steadily
during that last two decades.  All of these pressures and changes
support the advancement and development of more and better demand
response.  We are aligned with the changing industry and helps support
the needed changes while concurrently reducing electricity costs.





The
electric utility industry has many stakeholders.  The consumer
ultimately bears the price of delivered electricity that is the result of the
successful coordination of all of these stakeholders.  The industry is
dominated by utilities that generally operate as monopolies in their local
service territories and are regulated at both the state and federal
levels.  For regions serving about two thirds of the consumers in
North America, regional grids have replaced the grid management activities of
vertically integrated utilities that for many years built and operated the power
generating plants and transmission lines that make up the backbone of power
supply.  These regional grids, in addition to operating the
transmission system, operate wholesale electric markets, into which generators
bid to supply power and from which electric utilities and other retail suppliers
bid to purchase power.  These markets are more efficient than the
vertically integrated monopoly model, and have created substantial savings for
consumers.  Introducing demand response in these markets adds a
significant additional level of efficiencies. By providing consumers of
electricity an effective means of responding to grid wholesale prices of
electricity we complete the supply-demand marketplace for electricity and
provide offsetting market forces to electricity generators.  Wholesale
Power Markets are regulated by the Federal Energy Regulatory Commission
(FERC).





Anatomy and Challenges of
Demand Response





The use
of demand response as a large scale tool to defer or reduce the need for peaking
power plants, transmission lines, or electric distribution facilities is in its
infancy.  In the US, less than one percent of the initial target
market has been accessed.  Worldwide the potential is even
greater.  Demand response has the potential to significantly reduce
electric energy line losses and prolong the value of existing transmission lines
by reducing congestion that is reducing electric demand during hours of high
usage. This will also reduce the number of new peaking power plants needed and
shift generation to the most efficient power plants. Demand response can provide
this without significant new capital investment or any invasive facilities in
buildings or industrial sites.





With all
of this potential, the growth of demand response has been limited by technology
and regulation.  Prior to the development of transparent wholesale
electric markets, the internet, and electronic building energy control systems
with internet access, the number of people required to effect substantial demand
response was prohibitive.  Today, by using automated technology to
link wholesale market prices and grid conditions with the status, flexibilities,
and capabilities of buildings and industrial sites, sufficient economic
participation is possible.





Regulatory
Impacts





The
enactment of the New Direction for Energy Independence, National Security and
Consumer Protection Act in December, 2007, (“Energy Act of 2007”) presents
remarkable opportunities for demand response providers to emerge as active
wholesale market resources that are the “green” equivalent to traditional
generation and transmission providers. Demand response is codified in the Energy
Act of 2007 as a necessary and proven resource that will promote energy
conservation, cost savings and energy efficiencies for the emerging “smart grid”
by engaging customers with the intelligence required to actively manage
consumption during peak demand and high prices.





The
Energy Act of 2007’s emphasis on smart grid modernization technologies present
significant opportunities for the core competencies of
EnergyConnect.  Our ability to provide scalable automation of demand
response transactions will increase the price elasticity of demand for
electricity, lower the overall regional market price of energy and improve the
efficiency of electricity grids. In addition to beneficial impacts on regional
energy markets, the participating suppliers of EnergyConnect, Inc. benefit by
maximizing income potential and reducing energy costs.





5
 Index





Pennsylvania,
New Jersey, Maryland Interconnection, LLC (“PJM”)





PJM
changed the landscape and market conditions for ECI activities in
2008.  There were several rule changes in the economic markets which
dramatically changed the scale of and number of revenue
opportunities.  On June 13th, PJM
introduced a rule which changed the method and timeframe for the calculation of
customer baselines.  A baseline is calculated to establish what
consumption would be if there was no reduction by the consumer.  When
entering transactions in the economic markets, the energy consumer needs to
curtail their use below this baseline consumption level.  On November
4, 2008, PJM again introduced rules relating to the economic markets and the
frequency with which companies engage in economic energy
transactions.  These changes to PJM’s rules in the economic markets
reduced the revenue opportunities for the Company both in value realization of
each transaction and value realized by the quantity of economic
transactions.





The PJM
Interconnection Capacity program establishes three-year laddered pricing
structure for demand response participants that is not subject to market
fluctuations.  Each year has a fixed price set three years in advance
and prices can vary by location. Prices through May 31, 2010, are determined and
reveal a general, increasing trend in response to load growth and tightening
supplies of conventional generation.





Customers





Our
customers are the regional grid operators, or alternatively electric utilities,
who pay us market rates for reductions in electrical demand during periods of
high prices or peak demand and for being available to reduce electric power
demand on request at periods of capacity limitations or in response to grid
emergencies.





Sales





Most of
our sales are to large regional electric grid operators, by serving the
wholesale power markets for electricity.  Membership in these regional
grids and participation in the committee decision structures of these
organizations provides the access and advocacy channels needed to implement,
execute, and advance our sales. Regional grid programs tend to be broad based
and target the full spectrum of demand response
potential.    In addition, some of our sales are made
directly to electric utilities that sponsor demand response
programs.   Most utility sales are made by competitive bid and
are often limited to event driven capacity-based programs.  Only a
small portion of our sales force is directed toward the grids and
utilities.





Most of
our sales effort and most of our sales force is focused on bringing electric
consumers into our service offerings.  Each consumer we bring into the
portfolio adds to our capability to serve the needs of the wholesale electric
market.





Competition





Competition
includes public and private companies that provide varying segments of demand
response products and services.  ECI is a full service provider that
uses proprietary technology to engage an electrical energy consumer’s inherent
flexibilities and make it easy to meet the needs of a broad range of services to
the grid.  Our competitors fall into two categories:  (1)
supply only the traditional utility event based capacity products, and (2)
supply traditional and new products and services manually.





In the
first category are utilities and third party curtailment service providers that
contract with utilities to outsource these programs.  This group makes
up the largest part of the demand response market today and reflects the ongoing
demand response activities of the past 40 years.  These programs are
not particularly well received by consumers and tend to be ineffective in
achieving significant amounts of demand response or significant benefits to the
electric system.  More intense concentration on these programs by
public well-financed utilities and third party providers has improved
performance.





6
 Index





In the
second category are two well financed competitors.  We have a
technological advantage at this time because we are able to do with software
what these competitors must do with people.  We expect these
competitors to attempt to duplicate our business plan and we expect to remain
technically ahead for many years.





With so
few pursuing such a large potential market, it is only with a small percentage
of energy consumers that we engage competitors.





Intellectual
Property





Part of
ECI’s value is contained in the proprietary software that we use to manage and
control energy consumption patterns in participant properties and integrate
strategies and transactions that serve the electric grid.  Our
embedded industry knowledge and information base is a unique and valuable
asset.





ECI has
filed for patent and copyright protection of its energy automation
software.  These patents have been filed for but not yet
approved.  We also purchased a significant amount of intangible assets
as a part of the acquisition of ECI.  These intangible assets are
valued annually as to whether they retain their value or have an impairment that
may cause us to write down their value.  At the end of 2008 through
this valuation process, it was determined that the carrying value of goodwill on
the Company’s books was impaired, and a charge was taken to reduce the value of
goodwill.





We
protect our intellectual property rights through a combination of patent,
trademark, trade secret and other intellectual property law, nondisclosure
agreements and other measures. We believe, however, that our financial
performance will depend more upon our service, technical knowledge and
innovative design abilities, than upon such
protection.  Notwithstanding the foregoing, we will strongly defend
all intellectual property rights from infringement.





Government Approval or
Regulations





We are
subject to certain local government regulations. We are subject to and
comply with federal regulations pertaining to health and safety, employment,
privacy, and related regulations pertinent to all public
businesses.  While we are not directly subject to regulation by the
Federal Energy Regulatory Commission (FERC) or state public utility commissions,
these commissions have oversight of regional grids and electric utilities. The
FERC must approve all wholesale products purchased by regional grids, and state
commissions may be involved in approval of transactions with electric
utilities.





Employees





As of
January 3, 2009, we directly employed 43 persons.  None of our
employees are covered by collective bargaining agreements, and we believe our
relations with our employees are good.  In addition, we meet our needs
with contract-to-hire, temporary help, contract service, and by training the
sales force of partners.





Principal
Offices





Our
principal corporate office is located at 5335 SW Meadows Rd., Suite 325, Lake
Oswego, Oregon 97035, and our telephone number is (503) 419-3580. We are an
Oregon corporation. We maintain a website
at  www.energyconnectinc.com. The information contained on this
website is not deemed to be a part of this annual report.





Our
principal operating office is located at 51 E. Campbell Ave., Suite 145,
Campbell, California.  Sales and support offices are located at
additional sites throughout the United States.





Recent Corporate
Developments





New CEO




The
Company appointed Kevin R. Evans President and Chief Executive effective January
5, 2009.  Mr. Evans will also serve as a director on the Company’s
Board of Directors.  It has not yet been determined whether Mr. Evans
will serve on any board committees in his capacity as
director.  During the past five years Mr. Evans has been Senior Vice
President, Chief Business Officer, and Chief Financial Officer of the Electric
Power Research Institute (“EPRI”), a world renowned leader in research and
development in the electricity industry.  While at EPRI, Mr. Evans was
instrumental in building its sales, marketing, planning and regulatory
programs.  Prior to joining EPRI, Mr. Evans was the Chief Financial
Officer of PlaceWare, a leading designer and producer of collaboration and
meeting software.  He helped develop the company through its startup
phase, raised several rounds of capital, and ultimately sold it to
Microsoft.  Prior to PlaceWare, he had substantial banking and
international business experience.  Mr. Evans holds an MBA in finance
from San Diego State University and a dual baccalaureate in Economics and
Management from Sonoma State University.





7
 Index





Pursuant
to an employment agreement, the Company has agreed to pay Mr. Evans an annual
base salary of $300,000.  Mr. Evans also received a grant of four
million stock options, consistent with the Company’s approved stock option plan,
with an exercise price equal to $0.12, the closing price of the Company’s stock
on January 5, 2009.  In addition, and pursuant to a change of control
agreement, the Company has agreed to pay Mr. Evans twelve months of severance
pay upon a change of control of the Company or upon Mr. Evan’s termination
without cause or his resignation for good reason.





Debt
Facility





On
February 26, 2009 we entered into a Business Loan Agreement, a Convertible
Secured Promissory Note and Commercial Security Agreement (collectively the
“Loan Agreements”) with Aequitas Commercial Finance, LLC
(“Aequitas”).  Aequitas is a commercial finance company that provides
loan and lease financing to companies. Aequitas is managed by Aequitas Capital
Management, Inc. (“Aequitas Capital”). Aequitas Capital and its affiliates have
previously provided the Companies with debt and equity
financing.  William C. McCormick, the Chairman of the Board of
Directors of EnergyConnect Group, Inc., is a member of the Advisory Board
of Aequitas Capital.





Pursuant
to the terms and conditions of the Loan Agreements, Aequitas will provide the
Companies with a revolving credit facility enabling the Companies to borrow
money in a maximum principal amount not to exceed $5,000,000.  The
current interest rate for funds borrowed by the Companies in the first twelve
(12) month term is twenty-three percent (23%) with an additional seven percent
(7%) deferred interest per annum.  The accrued deferred interest shall
be added to the then current principal balance of the loan at the end of the
first twelve (12) month term.  The interest rate for funds borrowed in
the second twelve (12) month term is thirty percent (30%).  The loan
matures on January 1, 2011.  As security for this loan, the Companies
granted Aequitas a first priority security interest in the assets of the
Companies.  The Loan Agreements grant Aequitas the right to convert up
to two-thirds (2/3rds) of unpaid principal and interest into shares of ECNG’s
common stock at an exercise price of $0.09.





ITEM1A.  RISK FACTORS





CAUTIONARY
FACTORS THAT MAY AFFECT FUTURE RESULTS





We
provide the following cautionary discussion of risks, uncertainties and possible
inaccurate assumptions relevant to our business and our products. These are
factors that we think could cause our actual results to differ materially from
expected results. Other factors besides those listed here could adversely affect
us. Investors should carefully consider all of such risk factors before making
an investment decision with respect to our Common Stock.





Risks Relating to Our
Industry





Demand
response, as sponsored by grid operators and utilities, is regulated by state
and federal commissions.  Changes in regulations could limit our
ability to deliver our products to electrical grids.   Lack of
change in some regions could restrict the growth of demand
response.





Demand
response is regulated by FERC, the Federal Energy Regulatory Commission and
State Public Utility Commissions.   Recently regulators at the
federal and state level have been supportive of facilitating the demand response
business as an effective way to improve reliability and reduce costs on the
electrical grids. That could change in response to changes in the political
environment.





8
 Index





Regional
grids that have active wholesale markets could revert to vertical control by
utilities limiting our revenue opportunities.





State
regulators could restrict or eliminate wholesale markets for electricity that
are the basis for priced based energy demand response limiting our revenue
opportunities.  Very high prices or lack of generating capacity to
match demand could create political pressure, as happened in California in 2000,
to return to vertical control of generation thru delivery to utilities. This may
reduce the revenue opportunity for demand response.




Regional
grids establish local operating rules for demand response. Regional grids can
and do set rules that limit the product and revenue opportunity for demand
response.





The rules
in regional grids can and do restrict and limit demand response. Grid operating
rules are established thru committee processes and may be subject to FERC
approval. Demand response providers are members of the regional grids and
participate on committees, but other members such as electrical generators and
utilities are much larger and may use their market power to set rules that limit
demand response.





All
regional grids have rules that guide demand response revenue
opportunities.  In 2008 PJM Interconnection introduced new rules that
changed the revenue opportunities, and instituted a screening process that may
limit some participants’ ability or desire to enter the electricity markets.
Rule changes could evolve that restrict or eliminate current demand response
products and revenue.





Increased
infrastructure investment and or lower fuel prices could reduce the cost of
electricity, limiting demand response revenue.





Demand
response revenue is dependent on wholesale electric prices for electricity
during periods of high usage.  Prices are particularly high when
system generating capacity operates near its limits. Although increased
investment in electric facilities generally increases costs, in some scenarios,
increased investment in generating and transmission infrastructure could reduce
prices and limit revenue. Decreases in fuel costs, such as natural gas, could
reduce the price of electricity during peak daily usage and reduce the revenue
opportunity of price-based demand response.





Technological
advances could reduce the cost of electricity, limiting our
revenue.





Technological
advances could increase electrical generating capacity, reduce transmission
losses and reduce the price of electricity. In each case demand response revenue
opportunities would be reduced.





Failure
of other providers of demand response to provide valuable service to the
electrical grids may limit the entire demand response market thru unfavorable
regulation and or operating rules on particular grids.





Failure
or perception of failure to meet expectations could induce operating rules that
limit growth in one or more regional grids.





Risks Relating to Our
Business




We Have a History Of Losses Which May
Continue and Which May Negatively Impact Our Ability to Achieve Our Business
Objectives.




We have
incurred operating losses for the last three years.  We cannot be
certain that we can achieve or sustain profitability on a quarterly or annual
basis in the future. Our operations are subject to the risks and competition
inherent in the establishment of a business enterprise.  Revenues and
profits, if any, will depend upon numerous factors.  If we continue to
incur losses, our accumulated deficit will continue to increase, which may make
it harder for us to obtain financing and achieve our business
objectives.  Failure to achieve such goals would have an adverse
impact which could result in reducing or limiting our operations.




If We Experience Continuing Losses
and Are Unable to Obtain Additional Funding Our Business Operations Will
be Harmed and If We Do
Obtain Additional Financing Our Then Existing Shareholders May Suffer
Dilution.




Additional
capital may be required to effectively support the operations and to otherwise
implement our overall business strategy.  If we receive additional
financing, it may not be sufficient to sustain or expand our business
development operations or continue our business operations.





9
 Index





There can
be no assurance that financing will be available in amounts or on terms
acceptable to us, if at all. The inability to obtain additional capital will
restrict our ability to grow and may reduce our ability to continue to conduct
business operations. If we are unable to obtain additional financing, we will
likely be required to curtail our business development plans. Any additional
equity financing will involve dilution to our then existing
shareholders.




Some of Our Competitors Are Larger
and Have Greater Financial and Other Resources than We Do and Those
Advantages Could Make It Difficult For Us to Compete.




In the
demand response industry segment several companies have achieved substantially
greater market shares than we have, have longer operating histories, have larger
customer bases, and have substantially greater financial, development and
marketing resources than we do.  If overall demand for our products
and services should decrease it could have a materially adverse effect on our
operating results.




Competitors
may develop automated systems and business processes that are equivalent to
ours, limiting or removing our current competitive advantage.




Some of
our competitors are larger and may have the financial resources to develop
automated systems and business processes that would allow them to compete
effectively with our price-based products and strategies.  Competitors
may develop the ability to deliver in volume the same set of products that we
currently provide.  Competitors may choose to provide similar products
at lower margins.




The Failure To Manage Our Growth In
Operations And Acquisitions Of New Product Lines And New Businesses Could Have A
Material Adverse Effect On Us.




The
expected growth of our operations (as to which no representation can be made)
will place a significant strain on our current management resources. To manage
this expected growth, we will need to continue to improve ouroperational and financial
systems,procedures
and controls, andhiring, training and
management of employees.




Our
future growth may be attributable to acquisitions of new product lines and new
businesses. We anticipate that future acquisitions, if successfully consummated,
may create increased working capital requirements, which will likely precede by
several months any material contribution of an acquisition to our net
income.




Our
failure to manage growth or future acquisitions successfully could seriously
harm our operating results. Also, acquisition costs could cause our quarterly
operating results to vary significantly. Furthermore, our stockholders would be
diluted if we financed the acquisitions by incurring convertible debt or issuing
securities.




Although
we currently only have operations within the United States, if we were to
acquire an international operation; we will face additional risks,
including:difficulties in staffing,
managing and integrating international operations due to language, cultural or
other differences;different or conflicting
regulatory or legal requirements;foreign currency
fluctuations; and diversion of significant time and attention of our
management.




If We Are Unable to Retain the
Services of Mr. Evans, or If We Are Unable to Successfully Recruit
Qualified Managerial and Sales Personnel Having Experience in Business, We May
Not Be Able to Continue Our Operations.




Our
success depends to a significant extent upon the continued service of Mr. Kevin
R. Evans, our Chief Executive Officer. We have an employment agreement with Mr.
Evans. Loss of the services of this officer could have a material adverse effect
on our growth, revenues, and prospective business. We do not maintain key-man
insurance on the life of Mr. Evans. We are not aware of any named executive
officer or director who has plans to leave us or retire. In addition, in order
to successfully implement and manage our business plan, we will be dependent
upon, among other things, successfully recruiting qualified managerial and sales
personnel having experience in business. Competition for qualified individuals
is intense. There can be no assurance that we will be able to find, attract and
retain existing employees or that we will be able to find, attract and retain
qualified personnel on acceptable terms.




Our success is dependent on the
growth in energy management and curtailment programs, and to the extent that such
growth slows and the need for services curtail, our business may be
harmed.




The
demand response industry segment is in a fast changing
environment.  While revenue from the energy products we sell have been
growing annually, rules changes within the grids in which we operate may change
from time to time.   It is difficult to predict whether these
changes will result in continued economic improvement in the industries which
our company serves. If the rate of growth should slow, or energy consumers
reduce their participation in these programs, our operating results may decline
or fail to meet growth goals.





10
 Index





Our
success is dependent on the actions of our participants many of which are large
corporations and who may choose to limit their shifting or curtailment of
electrical load.  Non performance to commitments by participants could
subject us to financial penalties.




We are
dependent on the load shifting and curtailment actions of our participants to
generate energy reductions that are valuable to the grid and produce revenue.
Participants may choose to implement other strategies to reduce the cost of
electricity or may focus on other areas of their business to increase income or
reduce costs. In some cases for capacity products, failure to meet committed
reductions in energy usage could expose us to financial penalties that exceed
the revenue opportunity.




Our
success is dependent on the continuous operation of our data
center.  We will lose the ability to track revenue transactions during
a data outage which would result in lost revenue.




Our
business processes are highly automated and require the active operation of our
data center to track and process revenue transactions. We will lose the ability
to track and collect revenue for any period of time that our data center is not
operational.  While highly secure, redundant, and hardened, the
operation of our data center is exposed to the negative effects of prolonged
power outages or natural disasters such as earthquakes.




Payment
for most of our products is dependent on administrative approval of the utility
servicing each participant. If one or more utility chooses to delay our payments
our revenues will be delayed or reduced.




The
regional electrical grids are our customers and pay us for our products, but the
utility servicing each participant approves each transaction and can delay or
object to payment based on the rules of the particular grid. Certain utilities
have delayed payments for prolonged periods. We cannot be sure that we will be
paid for all transactions in the future.




Our
growth is partly dependent on the actions of our business partners, many of whom
are large corporations.  If our large business partners choose not to
focus their actions on demand response our growth may be reduced.




We are
dependent on the actions of our business partners to provide future participants
and our growth may be slowed if one or more partner chooses not to focus
activity on demand response.




Our
growth is dependent on having a broad range of products in each region that we
operate. Restrictions or delays on products that we may provide will reduce or
eliminate our competitive advantage.




Our broad
range of products provides a competitive advantage in the recruitment of
participants. Restrictions on our ability to offer multiple products in a region
or delays in our ability to bring current products to new regions will reduce
our competitive position and delay growth in those regions. We may not be able
to anticipate or control all the rules or regulations that affect each product
in each region.




Our
growth is dependent on the cooperation of other stake holders such as utilities
and electrical generators. To the extent that these stake holders resist change
our growth may be slowed.




Utilities
and electrical generators are the largest members of electrical grids and may
for their own reasons act to slow or prevent the growth of demand response. The
cooperation of all stakeholders is required to facilitate the growth of our
business.




Our
quarterly results fluctuate and may cause our stock price to
decline.




Our
quarterly operating results have fluctuated in the past and will likely
fluctuate in the future.  We believe that period to period comparisons
of our results of operations are not a good indication of our future
performance, but this may not be apparent to all stakeholders. A number of
factors, many of which are outside of our control, are likely to cause these
fluctuations.  The factors outside of our control include:fluctuations in demand for
our services;  length of sales cycles; weather abnormalities;
unexpected price changes; changes in the rules by the electric grid operators
regarding payments for our transactional energy services; while opportunities
for transactional revenue is high in cold weather months,adverse weather
conditions, particularly during the winter season, could affect our ability to
render services in certain regions of the United States; reductions in the
margins of products and services offered by our competitors; costs of
integrating technologies or businesses that we add; and delays in payment
resulting from administrative delays from utilities in processing
settlements.





11
 Index





Factors
substantially within our control include: the timing of expansion
into new markets; costs incurred to support internal growth and acquisitions;
fluctuations in operating results caused by acquisitions; and the timing and
payments associated with possible acquisitions.




Because
our operating results may vary significantly from quarter to quarter, our
operating results may not meet the expectations of securities analysts and
investors, and our common stock could decline significantly which may expose us
to risks of securities litigation, impair our ability to attract and retain
qualified individuals using equity incentives and make it more difficult to
complete acquisitions using equity as consideration.




Failure to keep pace with the latest
technological changes could result in decreased
revenues.




The
market for our services is partially characterized by rapid change and
technological improvements. Failure to respond in a timely and cost-effective
way to these technological developments could result in serious harm to our
business and operating results. We have derived, and we expect to continue to
derive, a significant portion of our revenues from technology based products. As
a result, our success will depend, in part, on our ability to develop and market
product and service offerings that respond in a timely manner to the
technological advances of our customers, evolving industry standards and
changing client preferences.




During the ordinary course of our
business, we may become subject to lawsuits or indemnity claims, which could
materially and adversely affect our business and results of
operations.




We have
in the past been, and may in the future be, named as a defendant in lawsuits,
claims and other legal proceedings during the ordinary course of our business.
These actions may seek, among other things, compensation for alleged personal
injury, workers’ compensation, employment discrimination, breach of contract,
property damage, punitive damages, civil penalties or other losses,
consequential damages or injunctive or declaratory relief. In addition, pursuant
to our service arrangements, we generally indemnify our customers for claims
related to the services we provide thereunder. Furthermore, our electrical,
technology, and transactional services are integral to the operation and
performance of the electric distribution and transmission infrastructure. As a
result, we may become subject to lawsuits or claims for any failure of the
systems that we provide, even if our services are not the cause for such
failures. In addition, we may incur civil and criminal liabilities to the extent
that our services contributed to any property damage or blackout. With respect
to such lawsuits, claims, proceedings and indemnities, we have and will accrue
reserves in accordance with generally accepted accounting principles. In the
event that such actions or indemnities are ultimately resolved unfavorably at
amounts exceeding our accrued reserves, or at material amounts, the outcome
could materially and adversely affect our reputation, business and results of
operations. In addition, payments of significant amounts, even if reserved,
could adversely affect our liquidity position.




Our Intellectual Property Rights May
not be Adequately Protected Outside the United States,
Resulting in Loss of Revenue.




We
believe that our trademarks, whether licensed or owned by us, and other
proprietary rights are important to our success and our competitive position. In
the course of any potential international expansion, we may, however, experience
conflict with various third parties who acquire or claim ownership rights in
certain intellectual property. We cannot assure you that the actions we have
taken to establish and protect this intellectual property and other proprietary
rights will be adequate to prevent imitation of our products by others or to
prevent others from seeking to block sales of our products as a violation of the
proprietary rights of others. Also, we cannot assure you that others will not
assert rights in, or ownership of, proprietary rights of ours or that we will be
able to successfully resolve these types of conflicts to our satisfaction. In
addition, the laws of certain foreign countries may not protect proprietary
rights to the same extent, as do the laws of the United States.




Intellectual
Property Litigation Could Harm Our Business.




Litigation
regarding patents and other intellectual property rights is extensive in the
technology industry. In the event of an intellectual property dispute, we may be
forced to litigate. This litigation could involve proceedings instituted by the
U.S. Patent and Trademark Office or the International Trade Commission, as well
as proceedings brought directly by affected third parties. Intellectual property
litigation can be extremely expensive, and these expenses, as well as the
consequences should we not prevail, could seriously harm our
business.





12
 Index





If a
third party claims an intellectual property right to technology we use, we might
need to discontinue an important product or product line, alter our products and
processes, pay license fees or cease our affected business activities. Although
we might under these circumstances attempt to obtain a license to this
intellectual property, we may not be able to do so on favorable terms, or at
all. We are currently not aware of any intellectual property rights that are
being infringed nor have we received notice from a third party that we may be
infringing on any of their patents.




Furthermore,
a third party may claim that we are using inventions covered by the third
party’s patent rights and may go to court to stop us from engaging in our normal
operations and activities, including making or selling our product candidates.
These lawsuits are costly and could affect our results of operations and divert
the attention of managerial and technical personnel. There is a risk that a
court would decide that we are infringing the third party’s patents and would
order us to stop the activities covered by the patents. In addition, there is a
risk that a court will order us to pay the other party damages for having
violated the other party’s patents. The technology industry has produced a
proliferation of patents, and it is not always clear to industry participants,
including us, which patents cover various types of products or methods of use.
The coverage of patents is subject to interpretation by the courts, and the
interpretation is not always uniform. If we are sued for patent infringement, we
would need to demonstrate that our products or methods of use either do not
infringe the patent claims of the relevant patent and/or that the patent claims
are invalid, and we may not be able to do this. Proving invalidity, in
particular, is difficult since it requires a showing of clear and convincing
evidence to overcome the presumption of validity enjoyed by issued
patents.




Because
some patent applications in the United States may be maintained in secrecy until
the patents are issued, because patent applications in the United States and
many foreign jurisdictions are typically not published until eighteen months
after filing, and because publications in the scientific literature often lag
behind actual discoveries, we cannot be certain that others have not filed
patent applications for technology covered by our licensors’ issued patents or
our pending applications or our licensors’ pending applications or that we or
our licensors were the first to invent the technology. Our competitors may have
filed, and may in the future file, patent applications covering technology
similar to ours. Any such patent application may have priority over our or our
licensors’ patent applications and could further require us to obtain rights to
issued patents covering such technologies. If another party has filed a United
States patent application on inventions similar to ours, we may have to
participate in an interference proceeding declared by the United States Patent
and Trademark Office to determine priority of invention in the United States.
The costs of these proceedings could be substantial, and it is possible that
such efforts would be unsuccessful, resulting in a loss of our United States
patent position with respect to such inventions.




Some of
our competitors may be able to sustain the costs of complex patent litigation
more effectively than we can because they have substantially greater resources.
In addition, any uncertainties resulting from the initiation and continuation of
any litigation could have a material adverse effect on our ability to raise the
funds necessary to continue our operations.





Our
Independent Auditors Have Expressed Substantial Doubt About Our Ability to
Continue As a Going Concern, Which May Hinder Our Ability to Obtain Future
Financing.





In their
report dated March 19, 2009, our independent auditors stated that our financial
statements for the year ended January 3, 2009 were prepared assuming that we
would continue as a going concern, and that they have substantial doubt about
our ability to continue as a going concern.  Our auditors’ doubts are
based on our incurring net losses and deficits in cash flows from
continuing operations.  We continue to experience net operating
losses.  Our ability to continue as a going concern is subject to our
ability to generate a profit and/or obtain necessary funding from outside
sources, including by the sale of our securities, or obtaining loans from
financial institutions, where possible.  Our continued net operating
losses and our auditors’ doubts increase the difficulty of our meeting such
goals and our efforts to continue as a going concern may not prove
successful.





13
 Index





Risks Relating to Our Common
Stock




If We Fail to Remain Current on Our
Reporting Requirements, We Could be Removed From the OTC Bulletin Board Which
Would Limit the Ability of Broker-Dealers to Sell Our Securities and the Ability
of Stockholders to Sell Their Securities in the Secondary
Market.




Companies
trading on the OTC Bulletin Board, such as us, must be reporting issuers under
Section 13 or 15(d) of the Securities Exchange Act of 1934, as amended, and must
be current in their reports under Section 13, in order to maintain price
quotation privileges on the OTC Bulletin Board. If we fail to remain current on
our reporting requirements, we could be removed from the OTC Bulletin Board. As
a result, the market liquidity for our securities could be severely adversely
affected by limiting the ability of broker-dealers to sell our securities and
the ability of stockholders to sell their securities in the secondary market.
There can be no assurance that in the future we will always be current in our
reporting requirements.




Our Common Stock is Subject to the
“Penny Stock” Rules of the SEC and the Trading Market in Our Securities is
Limited, Which Makes Transactions in Our Stock Cumbersome and May Reduce the
Value of an Investment in Our Stock.




The
Securities and Exchange Commission has adopted Rule 15g-9 which establishes the
definition of a “penny stock,” for the purposes relevant to us, as any equity
security that has a market price of less than $5.00 per share or with an
exercise price of less than $5.00 per share, subject to certain exceptions. For
any transaction involving a penny stock, unless exempt, the rules
require:




·
            that
      a broker or dealer approve a person’s account for transactions in penny
      stocks; and




·
            the
      broker or dealer receive from the investor a written agreement to the
      transaction, setting forth the identity and quantity of the penny stock to
      be purchased.




In order
to approve a person’s account for transactions in penny stocks, the broker or
dealer must:




·
            obtain
      financial information and investment experience objectives of the person;
      and




·
            make
      a reasonable determination that the transactions in penny stocks are
      suitable for that person and the person has sufficient knowledge and
      experience in financial matters to be capable of evaluating the risks of
      transactions in penny stocks.




The
broker or dealer must also deliver, prior to any transaction in a penny stock, a
disclosure schedule prescribed by the Commission relating to the penny stock
market, which, in highlight form:




·
            sets
      forth the basis on which the broker or dealer made the suitability
      determination; and




·
            that
      the broker or dealer received a signed, written agreement from the
      investor prior to the transaction.




Generally,
brokers may be less willing to execute transactions in securities subject to the
“penny stock” rules. This may make it more difficult for investors to dispose of
our common stock and cause a decline in the market value of our
stock.




Disclosure
also has to be made about the risks of investing in penny stocks in both public
offerings and in secondary trading and about the commissions payable to both the
broker-dealer and the registered representative, current quotations for the
securities and the rights and remedies available to an investor in cases of
fraud in penny stock transactions. Finally, monthly statements have to be sent
disclosing recent price information for the penny stock held in the account and
information on the limited market in penny stocks.




Potential
Fluctuations in Annual Operating Results





Our
annual operating results may fluctuate significantly in the future as a result
of a variety of factors, most of which are outside our control, including: the
demand for our products and services; seasonal weather trends, price competition
or pricing changes in the market; technical difficulties or system downtime;
general economic conditions and economic conditions specific to the
construction  industry.





Our
annual results may also be significantly impaired by the impact of the
accounting treatment of acquisitions, financing transactions or other matters.
Particularly at our early stage of development, such accounting treatment can
have a material impact on the results for any quarter. Due to the foregoing
factors, among others, it is likely that our operating results may fall below
our expectations or those of investors in some future quarter.





14
 Index





Limitation
of Liability and Indemnification of Officers and Directors





Our
officers and directors are required to exercise good faith and high integrity in
our management affairs. Our Articles of Incorporation provide, however, that our
officers and directors shall have no liability to our shareholders for losses
sustained or liabilities incurred which arise from any transaction in their
respective managerial capacities unless they violated their duty of loyalty, did
not act in good faith, engaged in intentional misconduct or knowingly violated
the law, approved an improper dividend or stock repurchase, or derived an
improper benefit from the transaction. Our Articles and By-Laws also provide for
the indemnification by us of the officers and directors against any losses or
liabilities they may incur as a result of the manner in which they operate our
business or conduct the internal affairs, provided that in connection with these
activities they act in good faith and in a manner that they reasonably believe
to be in, or not opposed to, the best interests of EnergyConnect, and their
conduct does not constitute gross negligence, misconduct or breach of fiduciary
obligations.





Management
of Growth





We may
experience growth, which will place a strain on our managerial, operational and
financial systems resources. To accommodate our current size and manage growth
if it occurs, we must devote management attention and resources to improve our
financial strength and our operational systems. Further, we will need to expand,
train and manage our sales and distribution base. There is no guarantee that we
will be able to effectively manage our existing operations or the growth of our
operations, or that our facilities, systems, procedures or controls will be
adequate to support any future growth. Our ability to manage our operations and
any future growth will have a material effect on our stockholders.








ITEM2.  PROPERTIES





We
lease facilities in Lake Oswego, Oregon, Campbell, California, and
Philadelphia, Pennsylvania.  These facilities consist of approximately
14,000 square feet of office space.  We do not own or lease any
manufacturing space.








ITEM3.  LEGAL PROCEEDINGS





During
2008, we were contacted by FERC and asked to provide information to them as part
of a non-public inquiry on the demand response markets, and our activity in our
markets under the FERC tariffs.  Over a period of 8 months we provided
them with the requested documentation both in paper and electronic form, and
voluntarily provided them with access to certain of our employees in an effort
to answer all questions put forth to us.  Our responses under the
inquiry were completed as of December 31, 2008, and we are currently waiting for
word from FERC as to whether the inquiry is closed, or if they require further
information and assistance from us.  We believe that we have complied
with applicable law, although we cannot provide any assurance
that FERC will not bring formal proceedings against the
Company.





From time
to time, we may become involved in various lawsuits and legal proceedings which
arise in the ordinary course of business. However, litigation is subject to
inherent uncertainties, and an adverse result in these or other matters may
arise from time to time that may harm our business. We are currently not aware
of any such legal proceedings or claims other than those mentioned in this Item
that we believe will have, individually or in the aggregate, a material adverse
affect on our business, financial condition or operating results.








ITEM4.  SUBMISSION OF MATTERS OF A VOTE OF SECURITY
HOLDERS





No
matters were submitted to a vote of our shareholders during the quarter ended
January 3, 2009.





15
 Index





PART
II





ITEM5.  MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED
STOCKHOLDER MATTERS AND ISSUER REPURCHASES OF EQUITY SECURITIES.





Our
common stock is quoted on the Over the Counter Bulletin Board under the symbol
“ECNG.OB.” The following table sets forth the high and low sales prices as
reported by the Over the Counter Bulletin Board for the periods
indicated.





Fiscal 2007First
      Quarter
                      
                      $
                      0.77
                      
                      
                      $
                      0.50Second
      Quarter
                      
                      
                      1.18
                      
                      
                      
                      0.61Third
      Quarter
                      
                      
                      0.97
                      
                      
                      
                      0.68Fourth
      Quarter
                      
                      
                      1.53
                      
                      
                      
                      0.70Fiscal 2008First
      Quarter
                      
                      $
                      0.96
                      
                      
                      $
                      0.43Second
      Quarter
                      
                      
                      0.56
                      
                      
                      
                      0.33Third
      Quarter
                      
                      
                      0.63
                      
                      
                      
                      0.34Fourth
      Quarter
                      
                      
                      0.40
                      
                      
                      
                      0.08





As of
March 5, 2009, we had 207 record holders of our common stock. The number of
record holders was determined from the records of our transfer agent and does
not include beneficial owners of common stock whose shares are held in the names
of various security brokers, dealers, and registered clearing
agencies.  There were no cash dividends declared or paid in fiscal
years 2008 or 2007.





Securities
Authorized for Issuance Under Equity Compensation Plans





The
following equity compensation information, as of January 3, 2009, is presented
in compliance with SEC regulation S-K Item 201(d).





Plan
      category
                          
                          Number
      of Securities to be issued upon exercise of outstanding options and
      warrants
                            (a)
                          
                          
                          Weighted
      average exercise price of outstanding options and warrants
                            (b)
                          
                          
                          Number
      of securities remaining available for future issuance under equity
      compensation plans (excluding securities reflected in column
      (a))
                            (c)Equity
      compensation plans approved by security holders
                          
                          
                          6,078,870
                          
                          
                          $
                          0.81
                          
                          
                          
                          10,627,292Equity
      compensation plans not approved by security holders
                          
                          
                          33,055,055
                          
                          
                          $
                          2.21
                          
                          
                          
                          N/ATotal
                          
                          
                          39,133,925
                          
                          
                          $
                          1.99
                          
                          
                          
                          N/A





16
 Index





ITEM6.  SELECTED FINANCIAL DATA





SELECTED
FINANCIAL DATA




The
following selected consolidated financial data should be read in conjunction
with our consolidated financial statements and related notes and “Management’s
Discussion and Analysis of Financial Condition and Results of Operations”
included elsewhere in this annual report. The statements of operations data for
the twelve months ended January 3, 2009 and December 29, 2007 and the balance
sheet data at January 3, 2009, and December 29, 2007 are derived from our
audited financial statements which are included elsewhere in this annual report.
The statement of operations data for the years ended December 30, 2006, December
31, 2005 and January 1, 2005 and the balance sheet data at December 30, 2006 and
January 1, 2005, are derived from our audited financial statements which are not
included in this annual report. The historical results are not necessarily
indicative of results to be expected for future periods. The following
information is presented in thousands, except per share data.




Fiscal years endedJanuary 3,
                    
                    
                    December 29,
                    
                    
                    December 30,
                    
                    
                    December 31,
                    
                    
                    January 1,2009
                    
                    
                    2007
                    
                    
                    2006
                    
                    
                    2005
                    
                    
                    2005Statements
      of Operations:Sales
                    
                    $
                    25,859
                    
                    
                    $
                    12,626
                    
                    
                    $
                    3,202
                    
                    
                    $
                    1,173
                    
                    
                    $
                    -Cost
      of sales
                    
                    
                    18,420
                    
                    
                    
                    8,788
                    
                    
                    
                    3,032
                    
                    
                    
                    666
                    
                    
                    
                    -Gross
      profit
                    
                    
                    7,439
                    
                    
                    
                    3,837
                    
                    
                    
                    170
                    
                    
                    
                    507
                    
                    
                    
                    -Operating
      expense
                    
                    
                    41,4862
                    
                    
                    
                    8,180
                    
                    
                    
                    6,076
                    
                    
                    
                    78,2151
                    
                    
                    
                    1,023Gain(loss)
      from continuing operations
                    
                    
                    (34,066
                    )
                    
                    
                    (4,341
                    )
                    
                    
                    1,561
                    
                    
                    
                    (78,721
                    )
                    
                    
                    (2,057
                    )Net
      income (loss)
                    
                    
                    (34,077
                    )
                    
                    
                    (14,035
                    )
                    
                    
                    833
                    
                    
                    
                    (77,953
                    )
                    
                    
                    (6,182
                    )Net
      income (loss) per share
                    
                    $
                    (0.37
                    )
                    
                    $
                    (0.17
                    )
                    
                    $
                    0.01
                    
                    
                    $
                    (2.91
                    )
                    
                    $
                    (0.36
                    )Weighted
      average shares
                    
                    
                    91,245
                    
                    
                    
                    82,536
                    
                    
                    
                    71,374
                    
                    
                    
                    27,048
                    
                    
                    
                    17,340Balance
      Sheet Data:Cash,
      including certificates of deposit
                    
                    $
                    710
                    
                    
                    $
                    892
                    
                    
                    $
                    2,545
                    
                    
                    $
                    729
                    
                    
                    $
                    11Total
      assets
                    
                    
                    7,357
                    
                    
                    
                    48,085
                    
                    
                    
                    57,147
                    
                    
                    
                    55,241
                    
                    
                    
                    11,775Total
      liabilities
                    
                    
                    5,361
                    
                    
                    
                    16,828
                    
                    
                    
                    13,019
                    
                    
                    
                    27,337
                    
                    
                    
                    12,334Shareholders’
      equity (deficit)
                    
                    $
                    1,996
                    
                    
                    $
                    31,258
                    
                    
                    $
                    43,616
                    
                    
                    $
                    27,904
                    )
                    
                    $
                    (559
                    )





1
            Includes
      write-off in 2005 of impaired goodwill of $77,191,344 resulting from the
      testing of the carrying value of goodwill purchased in the acquisition of
      ECI in October 2005.




2
            Includes
      write-off in 2008 of impaired goodwill of $29,354,000 resulting from the
      testing of the carrying value of goodwill purchased in the acquisition of
      ECI in October 2005.





17
 Index





ITEM7.  MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS





Some of
the information in this annual report contains forward-looking
statements.  These statements are made pursuant to the safe harbor
provisions of the Private Securities Litigation Reform Act of 1995.
Forward-looking statements inherently involve substantial risks and
uncertainties. One can identify these statements by forward-looking words such
as “may,” “will,” “expect,” “anticipate,” “believe,” “estimate” and “continue,”
or similar words. One should read statements that contain these words carefully
because they:





•
            discuss
      future expectations;





•
            contain
      projections of future results of operations or of financial condition;
      and





•
            state
      other “forward-looking”
information.





We
believe it is important to communicate our expectations. However, there may be
events in the future that we are not able to accurately predict or over which we
have no control. Our actual results and the timing of certain events could
differ materially from those anticipated in these forward-looking statements as
a result of certain factors, including those set forth under “Risk Factors,”
“Business” and elsewhere in this Form 10-K.  See “Risk Factors
beginning on page 9.”





Critical
Accounting Policies





The
discussion and analysis of financial condition and results of operations is
based upon our consolidated financial statements, which have been prepared in
accordance with accounting principles generally accepted in the United States.
The preparation of these financial statements requires us to make estimates and
judgments that affect the reported amounts of assets, liabilities, revenues and
expenses, and related disclosure of contingent assets and liabilities. We
continuously evaluate, our estimates and judgments, including those related to
revenue recognition, sales returns, bad debts, excess inventory, impairment of
goodwill and intangible assets, income taxes, contingencies and litigation. Our
estimates are based on historical experience and assumptions that we believe to
be reasonable under the circumstances, the results of which form the basis for
making judgments about the carrying values of assets and liabilities that are
not readily apparent from other sources. Actual results may differ from these
estimates under different assumptions or conditions.  We discuss the
development and selection of the critical accounting estimates with the Audit
Committee of our Board of Directors on a quarterly basis, and the Audit
Committee has reviewed our related disclosure in this Form 10-K.





We
believe the following critical accounting policies, among others, affect our
more significant judgments and estimates used in the preparation of our
consolidated financial statements:





Revenue
recognition




We
produce revenue through agreements with both building owners and the power grid
operators. Under our agreements with facilities owners, we use electrical and
energy related products that help energy consumers control energy use in their
buildings. In conjunction with this agreement we are members of the power grid
operators and have agreed to provide the grids with energy, capacity, and
related ancillary services during specified times and under specified
conditions. These transactions are summarized at the end of each monthly period
and submitted to the power grids for settlement and approval. While the power
grids are our customers, they are primarily a conduit through which these
electrical curtailment transactions are processed.  The vast majority
of our revenue in 2008 was processed through the PJM Interconnection. PJM serves
as the market for electrical transactions in a specific region in the United
States.   Our agreement with PJM is an ongoing one as we are
members of PJM.  These transactions are initiated by building owners,
who are our participants.  The transactions form the basis for our
revenue.  We have little risk, if any, from the concentration of
revenue through this power grid as it is a not-for-profit organization that
exists to act as the market for electrical transactions.





In 2008,
we revised our accounting for reserves for collections of revenues. The revision
in our reserve accounting is a result of improvements in our ability to
accurately estimate collections, which is based upon historical trends and
timely and accurate information.   Previously the transactions
were recorded as revenue on the settlement date, which typically fall 45-70 days
after the transaction date from which the revenue is derived, because management
believed that without an established history for this source of revenue, and the
potential for disputes, that the settlement date, on which both parties agree to
the amount of revenue to recognize, was the most conservative and appropriate
date to use.  For periods beginning with the first quarter of 2008 and
forward, revenue from these settlements were accrued into the prior month
instead of recognizing revenue as the settlement amounts were
received.  The record of these settlement amounts being realized over
the prior two years had been extremely accurate so that management believed it
was appropriate to accrue the settlement amounts into the prior
month.  This revision in our reserve accounting resulted in an extra
month of revenue being recorded in the first quarter of 2008.  This
first quarter of 2008 contained the payment received in January of 2008 (which
was not accrued into December) and the settlement amounts from the fifth
business day in February, March and April of 2008, each of which was accrued
into the prior months of January, February and March of 2008.





18
 Index





An
additional source of our revenue is derived from agreements with the power grid
operators whereby a monthly reserve fee is paid for our agreement to standby,
ready to provide relief in the form of curtailment of energy usage, in times of
high energy demand.  We record these payments as revenue over the
period during which we’re required to perform under these
programs.  Under certain programs, our obligation to perform may not
coincide with the period over which we receive payments under that
program.  In these cases we record revenue over the mandatory
performance obligation period and record a receivable for the amount of payments
that will be received after that period has been completed.





Accruals
for contingent liabilities





We make
estimates of liabilities that arise from various contingencies for which values
are not fully known at the date of the accrual. These contingencies may include
accruals for reserves for costs and awards involving legal settlements, costs
associated with vacating leased premises or abandoning leased equipment, and
costs involved with the discontinuance of a segment of a business. Events may
occur that are resolved over a period of time or on a specific future date.
Management makes estimates of the potential cost of these occurrences, and
charges them to expense in the appropriate periods. If the ultimate resolution
of any event is different than management’s estimate, compensating entries to
earnings may be required.




Purchase
price allocation and impairment of intangible and long-lived assets





Intangible
and long-lived assets to be held and used are reviewed for impairment whenever
events or changes in circumstances indicate that the carrying amounts of such
assets may not be recoverable. Determination of recoverability is based on an
estimate of undiscounted future cash flows resulting from the use of the asset,
and its eventual disposition. Measurement of an impairment loss for intangible
and long-lived assets that management expects to hold and use is based on the
fair value of the asset as estimated using a discounted cash flow
model.




We
measure the carrying value of goodwill recorded in connection with the
acquisitions for potential impairment in accordance with SFAS No. 142, Goodwill
and Other Intangible Assets.” To apply SFAS 142, a company is divided into
separate “reporting units,” each representing groups of products that are
separately managed. For this purpose, we have one reporting unit. To determine
whether or not goodwill may be impaired, a test is required at least annually,
and more often when there is a change in circumstances that could result in an
impairment of goodwill. If the trading of our common stock is below book value
for a sustained period, or if other negative trends occur in our results of
operations, a goodwill impairment test will be performed by comparing book value
to estimated market value. To the extent goodwill is determined to be impaired,
an impairment charge is recorded in accordance with SFAS 142.





We tested
our intangibles for impairment as of the end of fiscal years 2005 through 2008.
Goodwill of $106,544,871 was recorded upon the acquisition of ECI in October
2005, and represented the excess of the purchase price over the fair value of
the net tangible and intangible assets acquired. At December 31, 2005, it was
determined in an independent valuation that the goodwill generated in this
transaction was impaired. The Company decided to write off approximately
$77,191,344 of this goodwill.  At January 3, 2009, it was determined
that the remaining carrying value of goodwill generated from the 2005
transaction was impaired. The Company decided to write off the remaining
carrying value of goodwill of $29,353,527. The write-off of the goodwill, and
the amortization of the intangible assets are included in operating expenses in
the consolidated statements of operations.  There were no changes in
the carrying value of goodwill at December 30, 2006 and December 29,
2007.





19
 Index




Stock-Based
Compensation




On
January 1, 2006, we adopted Statement of Financial Accounting Standards
No. 123 (revised 2004), “Share-Based Payment,” (“SFAS 123(R)”) which
requires the measurement and recognition of compensation expense for all
share-based payment awards made to employees and directors including employee
stock options based on estimated fair values. SFAS 123(R) supersedes our
previous accounting under Accounting Principles Board Opinion No. 25,
“Accounting for Stock Issued to Employees” (“APB 25”) for periods beginning in
fiscal 2006. In March 2005, the Securities and Exchange Commission issued Staff
Accounting Bulletin No. 107 (“SAB 107”) relating to SFAS 123(R). The
Company has applied the provisions of SAB 107 in its adoption of SFAS
123(R).




We
adopted SFAS 123(R) using the modified prospective transition method, which
requires the application of the accounting standard as of January 1, 2006, the
first day of the Company’s fiscal year 2006. Our Consolidated Financial
Statements for twelve months ended January 3, 2009 reflect the impact of SFAS
123(R). In accordance with the modified prospective transition method, our
Consolidated Financial Statements for prior periods have not been restated to
reflect, and do not include, the impact of SFAS 123(R). Stock-based compensation
expense recognized under SFAS 123(R) for the twelve months ended January 3, 2009
and December 29, 2007 was approximately $870,000 and $921,000,
respectively.





SFAS
123(R) requires companies to estimate the fair value of share-based payment
awards on the date of grant using an option-pricing model. The value of the
portion of the award that is ultimately expected to vest is recognized as
expense over the requisite service periods in our Consolidated Statement of
Operations. Prior to the adoption of SFAS 123(R), we accounted for stock-based
awards to employees and directors using the intrinsic value method in accordance
with APB 25 as allowed under Statement of Financial Accounting Standards
No. 123, “Accounting for Stock-Based Compensation” (“SFAS 123”). Under the
intrinsic value method, no stock-based compensation expense had been recognized
in our Consolidated Statement of Operations because the exercise price of our
stock options granted to employees and directors equaled the fair market value
of the underlying stock at the date of grant.




Stock-based
compensation expense recognized during the period is based on the value of the
portion of share-based payment awards that is ultimately expected to vest during
the period. Stock-based compensation expense recognized in our Consolidated
Statements of Operations for the twelve months ended January 3, 2009 and
December 29, 2007  included compensation expense for share-based
payment awards granted prior to, but not yet vested as of December 31, 2005
based on the grant date fair value estimated in accordance with the pro forma
provisions of SFAS 123 and compensation expense for the share-based payment
awards granted subsequent to December 31, 2005 based on the grant date fair
value estimated in accordance with the provisions of SFAS 123(R). SFAS 123(R)
requires forfeitures to be estimated at the time of grant and revised, if
necessary, in subsequent periods if actual forfeitures differ from those
estimates. In our pro forma information required under SFAS 123 for the periods
prior to fiscal 2006, we accounted for forfeitures as they
occurred.




Upon
adoption of SFAS 123(R), we are using the Black-Scholes option-pricing model as
its method of valuation for share-based awards granted beginning in fiscal 2006,
which was also previously used for our pro forma information required under SFAS
123. Our determination of fair value of share-based payment awards on the date
of grant using an option-pricing model is affected by our stock price as well as
assumptions regarding a number of highly complex and subjective variables. These
variables include, but are not limited to our expected stock price volatility
over the term of the awards, and certain other market variables such as the risk
free interest rate.





Computation of Net Income (Loss) per
Share





Basic
earnings (loss) per common share is computed using the weighted-average number
of common shares outstanding during the period.  Diluted earnings per
common share is computed using the combination of dilutive common share
equivalents, which include convertible preferred shares, options and warrants
and the weighted-average number of common shares outstanding during the
period.  During the years ended January 3, 2009 and December 29, 2007
common stock equivalents are not considered in the calculation of the weighted
average number of common shares outstanding because they would be anti-dilutive,
thereby decreasing the net loss per common share.





Concentrations





Financial
instruments that potentially subject us to concentrations of credit risk consist
primarily of accounts receivable.  During the year ended January 3,
2009, revenue from one major customer approximated $24,730,000 or 95.6% of
sales.  During the year ended December 29, 2007, revenues from one
major customer approximated 98% of sales.  This revenue is the result
of multiple participating electric consumers who each executed myriad energy
transactions that were aggregated and billed to the PJM Interconnection, or
PJM.  The revenue is dependent on actions taken by these third parties
in conjunction with ECI, for which PJM, as our customer remits
payment.  The transactions form the basis for our
revenue.  We have little risk, if any, from the concentration of
revenue through this power grid as it’s a not-for-profit organization that
exists to act as the market for electrical transactions.  Of these
participants, there was one whose transactions resulted in revenue that totaled
10% or more of our revenue in the twelve months ended January 3, 2009 and two
whose transactions resulted in revenue that totaled 10% or more of our revenue
in the twelve months ended December 29, 2007.





20
 Index





At
January 3, 2009 there was one customer whose accounts receivable accounted for
94% of our outstanding trade accounts receivable.  At December 29,
2007 there was one customer whose accounts receivable accounted for more than
10% of total outstanding trade accounts receivable.  We have little
risk, if any, from the concentration of receivables through this power grid as
it’s a not-for-profit organization that exists to act as the market for
electrical transactions.  We perform limited credit evaluations of our
customers and do not require collateral on accounts receivable
balances.  We have not experienced any credit losses for the periods
presented.   The level of revenue resulting from any single
participant’s transactions may vary and the loss of any one of these
participants, or a decrease in the level of revenue from transactions generated
by any one of these participants, could have a material adverse impact on our
financial condition and results of operations.




Fair
Value Measurement
  We
adopted the provisions of SFAS No. 157, “Fair Value Measurements” on
December 30, 2007, the beginning of our 2008 fiscal year. SFAS No. 157 clarifies
the principle that fair value should be based on the assumptions market
participants would use when pricing an asset or liability and establishes a fair
value hierarchy that prioritizes the information used to develop those
assumptions. Under the standard, fair value measurements are separately
disclosed by level within the fair value hierarchy. SFAS No. 157, as originally
issued, was effective for fiscal years beginning after November 15, 2007, with
early adoption permitted. SFAS No. 157 does not require any new fair value
measurements. It only applies to accounting pronouncements that already require
or permit fair value measures, except for standards that relate to share-based
payments (SFAS No. 123R Share Based Payment.)
 
 On
February 12, 2008, the FASB issued FASB Staff Position (“FSP”) FAS 157-2, which
deferred the effective date of SFAS No. 157 for one year, as it relates to
nonfinancial assets and liabilities. Accordingly, our adoption related only to
financial assets and liabilities.
 
 Upon
adoption of SFAS No. 157, there was no cumulative effect adjustment to
beginning retained earnings and no impact on the consolidated financial
statements.
 
 Valuation
techniques considered under SFAS No. 157 techniques are based on observable
and unobservable inputs. The Standard classifies these inputs into the following
hierarchy:
 
 Level 1 inputsare observable
inputs and use quoted prices in active markets for identical assets or
liabilities that the reporting entity has the ability to access at the
measurement date and are deemed to be most reliable measure of fair
value.
 
 Level 2 inputs are observable
inputs and reflect assumptions that market participants would use in pricing the
asset or liability developed based on market data obtained from sources
independent of the reporting entity. Level 2 inputs includes 1) quoted prices
for similar assets or liabilities in active markets, 2) quoted prices for
identical or similar assets or liabilities in markets that are not active, 3)
observable inputs such as interest rates and yield curves observable at commonly
quoted intervals, volatilities, prepayment speeds, credits risks, default rates,
and 4) market-corroborated inputs.
 
 Level 3 inputs are
unobservable inputs and reflect the reporting entity’s own assumptions about the
assumptions market participants would use in pricing the asset or liability
based on the best information available under the circumstances.
 
 In
October 2008, the FASB issued FSP Financial Accounting Standard
No. 157-3, Determining
the Fair Value of a Financial Asset When the Market for That Asset Is Not
Active.  The FSP was effective immediately and clarifies the
application of FASB Statement No. 157, Fair Value Measurements and
provides an example to illustrate key considerations in determining the fair
value of a financial asset when the market for that financial asset is not
active.
 
 We
adopted the provisions of SFAS No. 159, “The Fair Value Option for Financial
Assets and Liabilities – Including an Amendment of FASB Statement No.
115” on December 30, 2007, the beginning of our 2008 fiscal year. SFAS
No. 159 permits us to choose to measure certain financial assets and liabilities
at fair value that are not currently required to be measured at fair value (the
“Fair Value Option”). Election of the Fair Value Option is made on an
instrument-by-instrument basis and is irrevocable. At the adoption date,
unrealized gains and losses on financial assets and liabilities for which the
Fair Value Option has been elected are reported as a cumulative adjustment to
beginning retained earnings. We did not elect the Fair Value Option as we had no
financial assets or liabilities that qualified for this treatment. In the
future, if we elect the Fair Value Option for certain financial assets and
liabilities, we would report unrealized gains and losses due to changes in their
fair value in net income at each subsequent reporting date. The adoption of this
statement had no impact on our consolidated financial statements.
 
 The
carrying value of the Company’s cash and cash equivalents, accounts receivable,
accounts payable, borrowings under the revolving credit facility, and other
current assets and liabilities approximate fair value because of their
short-term maturity.





Recent
Accounting Pronouncements





In March
2008, the FASB issued SFAS No. 161, “Disclosures about Derivative Instruments
and Hedging Activities, an amendment of SFAS No. 133”. SFAS No. 161 amends and
expands the disclosure requirements of SFAS No. 133 for derivative instruments
and hedging activities. SFAS No. 161 requires qualitative disclosure about
objectives and strategies for using derivative and hedging instruments,
quantitative disclosures about fair value amounts of the instruments and gains
and losses on such instruments, as well as disclosures about credit-risk
features in derivative agreements. The Company does not expect the adoption of
SFAS No. 161 to have a significant impact on its consolidated financial
statements.





In April
2008, the FASB issued FSP No. 142-3, “Determination of the Useful Life of
Intangible Assets” (“FSP 142-3”). FSP 142-3 amends the factors an entity should
consider in developing renewal or extension assumptions used in determining the
useful life of recognized intangible assets under FASB Statement No. 142,
“Goodwill and Other Intangible Assets”. This new guidance applies prospectively
to intangible assets that are acquired individually or with a group of other
assets in business combinations and asset acquisitions. FSP 142-3 is effective
for financial statements issued for fiscal years and interim periods beginning
after December 15, 2008. Early adoption is prohibited. The Company does not
expect the adoption of FSP 142-3 to have a significant impact on its
consolidated financial statements.





In May
2008, the FASB issued SFAS No. 162, “The Hierarchy of Generally Accepted
Accounting Principles” (“SFAS 162”). SFAS 162 identifies the sources of
accounting principles and the framework for selecting the principles used in the
preparation of financial statements of nongovernmental entities that are
presented in conformity with generally accepted accounting principles (the GAAP
hierarchy). SFAS 162 will become effective 60 days following the SEC’s approval
of the Public Company Accounting Oversight Board amendments to AU Section 411,
“The Meaning of Present Fairly in Conformity With Generally Accepted Accounting
Principles.” The Company does not expect the adoption of SFAS 162 to have a
material effect on its results of operations and financial
condition.





In May
2008, the FASB issued FSP Accounting Principles Board (“APB”) 14-1 “Accounting
for Convertible Debt instruments That May Be Settled in Cash upon Conversion
(Including Partial Cash Settlement)” (“FSP APB 14-1”). FSP APB 14-1 requires the
issuer of certain convertible debt instruments that may be settled in cash (or
other assets) on conversion to separately account for the liability (debt) and
equity (conversion option) components of the instrument in a manner that
reflects the issuer’s non-convertible debt borrowing rate. FSP APB 14-1 is
effective for fiscal years beginning after December 15, 2008 on a retroactive
basis. The Company does not believe the adoption of FSP APB 14-1 will have
significant effect on its results of operations and financial
condition.





In May
2008, the FASB issued FASB Statement No. 163, “Accounting for Financial
Guarantee Insurance Contracts”, which clarifies how FASB Statement No. 60,
“Accounting and Reporting by Insurance Enterprises”, applies to financial
guarantee insurance contracts issued by insurance enterprises. 
  The standard is effective for financial statements issued for fiscal
years beginning after December 15, 2008, including interim periods in that year.
The Company does not expect the adoption of SFAS 163 to have a material effect
on its consolidated financial statements.





21
 Index





In
June 2008, the FASB issued FSP Emerging Issues Task Force
(EITF) No. 03-6-1, “Determining Whether Instruments Granted in
Share-Based Payment Transactions Are Participating Securities.” Under the FSP,
unvested share-based payment awards that contain rights to receive
nonforfeitable dividends (whether paid or unpaid) are participating securities,
and should be included in the two-class method of computing EPS. The FSP is
effective for fiscal years beginning after December 15, 2008, and interim
periods within those years. The Company does not expect the adoption of FSP EITF
No. 03-6-1 to have a material effect on its consolidated financial
statements.





In
October 2008, the FASB issued FSP SFAS No. 157-3, “Determining the
Fair Value of a Financial Asset When the Market for That Asset Is Not Active.”
This position clarifies the application of SFAS No. 157 in a market
that is not active and provides an example to illustrate key considerations in
determining the fair value of a financial asset when the market for that
financial asset is not active. It also reaffirms the notion of fair value as an
exit price as of the measurement date. This position was effective upon
issuance, including prior periods for which financial statements have not been
issued. The adoption had no impact on the Company’s consolidated financial
statements.





In
December 2008, the FASB issued FSP 132(R)-1, Employers’ Disclosures about
Postretirement Benefit Plan Assets, which is effective for fiscal years ending
after December 15, 2009. FSP 132(R)-1 requires disclosures about fair value
measurements of plan assets that would be similar to the disclosures about fair
value measurements required by SFAS 157. The Company is assessing the potential
effect of the adoption of FSP 132(R)-1 on its consolidated financial
statements.





In
December 2008, the FASB issued FSP SFAS 140-4 and FIN 46(R)-8,
Disclosures about Transfers of Financial Assets and Interests in Variable
Interest Entities. The FSP requires extensive additional disclosure by public
entities with continuing involvement in transfers of financial assets to
special-purpose entities and with variable interest entities (VIEs), including
sponsors that have a variable interest in a VIE. This FSP became effective for
the first reporting period ending after December 15, 2008 and did not have
any material impact on the Company's consolidated financial
statements.





In
January 2009, the FASB issued Financial Statement of Position (“FSP”) Issue
No. EITF 99-20-1, “Amendments to the Impairment Guidance of EITF Issue
No. 99-20” (“FSP EITF No. 99-20-1”). FSP EITF No. 99-20-1 amends
the impairment guidance in EITF Issue No. 99-20, “Recognition of Interest
Income and Impairment on Purchased Beneficial Interests and Beneficial Interests
that Continue to be Held by a Transferor in Securitized Financial Assets” to
achieve more consistent determination of whether an other-than-temporary
impairment has occurred. The Company adopted FSP EITF No. 99-20-1 in
December 2008 and it did not have a material impact on the consolidated
financial statements.




Results
of Operations





The
following table sets forth, as a percentage of sales, certain consolidated
statement of operations data relating to the business for the periods
indicated.





Fiscal 2008*
                    
                    
                    Fiscal 2007Net
      sales
                    
                    
                    100
                    %
                    
                    
                    100
                    %Cost
      of goods sold
                    
                    
                    71
                    
                    
                    
                    70Gross
      profit
                    
                    
                    29
                    
                    
                    
                    30Operating
      expenses
                    
                    
                    47
                    
                    
                    
                    66Loss
      from operations
                    
                    
                    (18
                    )
                    
                    
                    (36
                    )Other
      income (expense)
                    
                    
                    -
                    
                    
                    
                    2Income
      (loss) before income taxes
                    
                    
                    (18
                    )
                    
                    
                    (34
                    )Provision
      for income taxes
                    
                    
                    -
                    
                    
                    
                    -Income
      (loss) from continuing operations
                    
                    
                    (18
                    )
                    
                    
                    (34
                    )Discontinued
      operations
                    
                    
                    
                    
                    
                    
                    (77
                    )Net
      gain (loss)
                    
                    
                    (18
                    )
      %
                    
                    
                    (111
                    )
      %





* This table does not include the
percentage of sales due to the impairment of goodwill of approximately $29
million.  Presentation of this non-cash item would make the comparison
of this year to the other years presented, meaningless.





22
 Index





Sales.  Revenue for
the fiscal year ended January 3, 2009 was $25,859,000 compared to $12,626,000
for the fiscal year ended December 29, 2007.  The increase in revenue
between periods is due to increased wholesale energy market transaction
activities within our participant base as well as transactions from new
participants.  The revenue in the twelve months ended January 3, 2009
consists of thirteen months of revenue due to the change in our policy for
recognizing revenue.  The revenue for the twelve monthly periods ended
January 3, 2009 recognized on the same basis as the revenue for the twelve
months ended December 29, 2007 totaled $24,190,000 compared to $12,626,000,
respectively. We also recorded approximately $8.0 million in 2008 revenue in a
capacity program in PJM, compared to $2.6 million from that same capacity
program in 2007.  There was one participant whose transactions
contributed to revenue from PJM that comprised over 10% of our 2008 consolidated
revenue. The company’s revenue is subject to seasonal influences that affect the
wholesale prices on which the majority of our revenue is derived.  The
Company’s revenue is also subject to changes in tariff rules implemented by PJM
that could adversely affect the Company’s results from operations.





Cost of
Sales.  Cost of sales totaled $18,419,000 (71%) compared to
$8,788,000 (70%) for the fiscal year ended December 29, 2007.  Cost of
sales includes the portion of energy transaction revenue that is paid to
participating energy consumers that initiate revenue generating
transactions.  Also included in cost of sales is amortization of a
developed technology intangible asset that amounted to 1% and 2% for the fiscal
years ended January 3, 2009 and December 29, 2007, respectively.





Gross
Profit.  Gross profit for the fiscal year ended January 3,
2009, was $7,439,000 (29%) compared to $3,837,000 (30%) for the fiscal year
ended December 29, 2007.  This increase in gross profit is due
primarily to the higher levels of revenue generated from participant’s wholesale
energy market transactions.  Future gross profits and gross margins
will depend on the volume and mix of sales of products and services to our
customers.





OperatingExpenses.  Operating
expenses are comprised mainly of payroll costs, outside services, stock-based
compensation and product development.  These expenses for the
fiscal year ended January 3, 2009 were $12,133,000 (excluding
approximately $29 million of goodwill impairment charges) compared to $8,180,000
for the fiscal year ended December 29, 2007.  The increase in
operating expenses is due to the increasing investment underway to build the
sales organization and develop new products in ECI.  We anticipate
decreasing these expenses in the coming periods as we manage our expenses to a
business plan that moves us toward cash flow breakeven.





Write-off of impaired goodwill and
intangibles.  We test our goodwill for potential impairment at
the end of each fiscal year.  This appraisal concluded that there was
an impairment of $29,354,000 to the carrying value of goodwill as of January 3,
2009.  This charge was taken against earnings in
2008.  There was no charge for impairment of goodwill in the fiscal
year ended December 29, 2007.





Interest
Expense.  Interest expense was $69,000 for the year ended
January 3, 2009 compared to $43,000 for the year ended December 29,
2007.  The increase in interest expense was primarily due to a
charge of $57,000 from a penalty imposed as a result of the delayed filing
of the Company’s registration statement associated with the May 2008 private
placement.  According to the registration rights document, the Company
had a total of 120 days to have its initial registration document declared
effective by the SEC.  By the terms of the registration rights
agreement, the Company exceeded that time frame and was obligated to pay a
prorated monthly penalty of 1% of the amount invested in the private
placement.





Gain / Loss From Discontinued
Operations. Discontinued operations for
all years presented contain the operations of Christenson
Electric.  Christenson Electric was sold to a corporation formed by
management of CEI on November 29, 2007.  The shareholders of the
Company voted to approve the transaction at a shareholders’ meeting on March 10,
2008, and it closed on April 24, 2008.  The results of discontinued
operations for the year ended January 3, 2009 included a gain on the sale of
discontinued operations of $135,000, and a loss from discontinued operations of
$146,000 for the 4 months while CEI was part of the consolidated
group.  The loss from discontinued operations for the fiscal year
ended December 29, 2007 was $9,695,000 and included a write off of goodwill and
intangibles of $9,728,000.




23
 Index





Non-cash
Expense Items





We have
entered into several acquisitions, financings, debt conversions and other
transactions where goodwill and amortizable intangible assets were recorded,
and/or common stock or warrants were issued as a part of the
transactions.  Many of the issuances resulted in non-cash charges to
our statement of operations.  Additionally, other transactions and
events occurred in which significant non-cash expense or income arose due to the
nature of those occurrences.  The following table lists these items
and the effect net income or loss in our statements of operations for the fiscal
years ended January 3, 2009, and December 29, 2007.





Year
      ended
                  
                  
                  Year
      endedNon-cash
      expense item description*
                  
                  January
      3, 2009
                  
                  
                  December
      29, 2007Common
      stock issued for services
                  
                  $
                  243,883
                  
                  
                  $
                  118,500Stock-based
      compensation issued for services
                  
                  
                  28,645
                  
                  
                  
                  -Stock-based
      compensation issued to directors and employees
                  
                  
                  841,338
                  
                  
                  
                  920,699Intangible
      amortization
                  
                  
                  239,067
                  
                  
                  
                  239,067Intangible
      amortization (in disc. operations)
                  
                  
                  
                  
                  
                  
                  289,617Write
      down of impaired intangible asset (in disc. operations)
                  
                  
                  -
                  
                  
                  
                  9,728,234Write
      down of goodwill
                  
                  
                  29,353,527
                  
                  
                  
                  -Total
      transactional non-cash expense
                  
                  $
                  30,706,460
                  
                  
                  $
                  11,296,117





*This
table does not include depreciation expense.





Liquidity
and Capital Resources





Since
inception, we have financed our operations and capital expenditures through
public and private sales of equity securities, cash from operations, and
borrowings under operating and revolving lines of credit.  At January
3, 2009, we had negative working capital of approximately $7,560 and our
primary source of liquidity consisted of cash and its operating lines of
credit.





Accounts
receivable increased to $4,374,000 at January 3, 2009 from $1,533,000 at
December 29, 2007.  The increase is due to the larger amount of
deferred payments from a capacity program under which all the revenue was
recorded in the third quarters of 2008 and 2007 which was to be received through
June of the following year. These receivables are not net of any allowances for
doubtful accounts.  Management expects these receivables to increase
in future periods as revenue from this program increases.




Property
and equipment, net of depreciation increased to $299,000 at January 3, 2009
compared to $202,000 at December 29, 2007.  This increase was due to
new computer hardware and software for new employees in ECI, and furniture and
leasehold improvements purchased as a part of the Company’s move to its new
headquarters in 2008.  We do not anticipate spending any material
amounts to acquire fixed assets for the foreseeable future.





We
recorded $106,545,000 in goodwill from the acquisition of ECI in 2005, which
represents the value of the price paid for the stock of ECI over the net asset
value of the assets and liabilities within ECI.  At January 3, 2009,
an impairment test was performed on the value of the goodwill resulting in an
impairment charge of $29,354,000.  This charge is recorded as an
operating expense in the consolidated statement of operations and eliminated the
remaining carrying value of goodwill on the Company’s books.  There
was no write down of goodwill during 2007.





We also
recorded an intangible asset of $2,390,667 at the date of the ECI acquisition
consisting of developed technology that is currently used within
ECI.  The intangible asset acquired has an estimated useful life of
ten years, and as such is being amortized monthly, over that
period.





Accounts
payable increased to $5,116,000 at January 3, 2009 from $2,976,000 at December
29, 2007.  This increase is the result of the increase in participant
payments from higher level of revenue generated in the PJM capacity program in
2008 over that in 2007.  The timing of participant payments also
caused an increase at January 3, 2009.   Payables consist
primarily of the costs of payments for energy automation transactions made by
ECI’s participants and payments due to vendors.  At January 3, 2009
the Company had delayed payments to several of its vendors past normal payment
terms.





24
 Index





We have
one small borrowing facility at January 3, 2009.  The amount
outstanding under this bank line of credit was approximately $117,000 and
$118,000 at January 3, 2009 and December 29, 2007, respectively.  We
are in compliance with all covenants under this loan.





During
the past two years, we have issued common shares in exchange for cash. On May 7,
2008, we issued 9,051,310 shares of our common stock and 4,525,655 warrants to
purchase shares of our common stock, in exchange for $3,512,316 in gross
proceeds and elimination of $103,000 of payables.





In 2008
and 2007, we incurred operating losses of $34,047,000 and $4,343,000,
respectively.  The operating loss in 2008 included a $29,354,000
non-cash loss due to the impairment of the carrying value of
goodwill.  While it is anticipated that we can produce income from
continuing operations, our history of recurring losses and liquidity issues may
recur, in which case we may have to raise additional funds to continue to
operate.  The financial statements do not include any adjustments that
might result from the outcome of this uncertainty.  We may not have
sufficient resources to satisfy cash requirements for the next twelve
months.  We believe we have good relations in the financial community
and are optimistic about our ability to raise additional capital if needed to
support operations.  If during that period or thereafter, we are not
successful in generating sufficient liquidity from operations or in raising
sufficient capital resources, on terms acceptable to us, this could have a
material adverse effect on our business, results of operations liquidity and
financial condition.





While we
have raised capital to meet our working capital and financing needs, additional
financing may be required within the next 12 months in order to meet our current
and projected cash flow deficits from operations and development.





By
adjusting our operations and development to appropriate levels we believe we
have sufficient capital resources to meet projected cash flow deficits. However,
if during that period or thereafter, we are not successful in generating
sufficient liquidity from operations or in raising sufficient capital resources,
on terms acceptable to us, this could have a material adverse effect on our
business, results of operations liquidity and financial condition.





In prior
periods, we generated cash through our discontinued operating subsidiary,
Christenson Electric, Inc.  This subsidiary also held a $10 million
operating line of credit under which we borrowed funds against eligible accounts
receivable.  The funds generated from the discontinued operations and
their debt facility will no longer be available to the continuing
entity.  All future cash will need to be generated from the operations
of EnergyConnect, and from funds raised through future debt and equity
financings should cash generated from operations prove
insufficient.





On
February 26, 2009, the Company entered into a $5 million convertible debt
agreement with a commercial finance company.  The agreement provides
us with a revolving credit facility that enables us to borrow money in a maximum
principal amount not to exceed $5 million.  The current interest rate
for funds borrowed by us in the first 12 month term is 23% with an additional 7%
deferred interest per annum.  The accrued, deferred interest shall be
added to the current principal balance of the loan at the end of the first
twelve month term.  The interest rate for funds borrowed in the second
twelve month term is 30%.  The loan matures on January 1,
2011.  We granted the lender a first priority security interest in all
of our assets.  The lender also has the right to convert up to 2/3 of
unpaid principal and interest into shares of our common stock at an exercise
price of $0.09 per share.  While the Company believes that the
availability of funds from this debt facility, with cash generated from
operations, will be sufficient to meet the Company’s operating capital needs
through 2009, conditions may change in the markets in which the Company operates
that may cause the borrowing capacity under this debt facility to become
limited.  There can be no assurance that funds will be available under
this debt facility





We may
need additional investments in order to continue operations to cash flow break
even. We cannot guarantee that we will be able to obtain such investments.
Financing transactions may include the issuance of equity or debt securities,
obtaining credit facilities, or other financing mechanisms. However, the trading
price of our common stock and the downturn in the U.S. stock and debt markets
could make it more difficult to obtain financing through the issuance of equity
or debt securities. Even if we are able to raise the funds required, it is
possible that we could incur unexpected costs and expenses, fail to collect
significant amounts owed to us, or experience unexpected cash requirements that
would force us to seek alternative financing. Further, if we issue additional
equity or debt securities, stockholders may experience additional dilution or
the new equity securities may have rights, preferences or privileges senior to
those of existing holders of our common stock.




Our
registered independent certified public accountants have stated in their report
dated March 19, 2009 that we have incurred operating losses in the last two
years, and that we are dependent upon management’s ability to develop profitable
operations.  These factors among others may raise substantial doubt
about our ability to continue as a going concern.




We have
no commitments for capital expenditures in material amounts at January 3,
2009.





25
 Index





Inflation





In the
opinion of management, inflation will not have an impact on our financial
condition and results of its operations.





Off-Balance
Sheet Arrangements





We do not
maintain off-balance sheet arrangements nor do we participate in any
non-exchange traded contracts requiring fair value accounting
treatment.





Related
Party Transactions





We, as a
part of the discontinued operations have previously had a number of promissory
notes, lines of credit and lease obligations owing to related
parties.  As of January 3, 2009, as a part of continuing operations,
there are no amounts owing to related parties other than nominal amounts
incurred in the normal course of business and paid from expense
reports.





Contractual
Obligations and Commitments





The
following is a summary of our significant contractual cash obligations for the
periods indicated that existed as of January 3, 2009, and is based on
information appearing in the notes to consolidated financial statements included
elsewhere in this filing.




Total
                    
                    
                    Less
      than
                      1
      Year
                    
                    
                    1-2
                      Years
                    
                    
                    3-5
                      Years
                    
                    
                    More
      than
                      5
      YearsOperating
      Leases
                    
                    $
                    710,300
                    
                    
                    $
                    306,492
                    
                    
                    $
                    255,387
                    
                    
                    $
                    148,421
                    
                    
                    $
                    -Total
      obligations
                    
                    $
                    710,300
                    
                    
                    $
                    306,492
                    
                    
                    $
                    255,387
                    
                    
                    $
                    148,421
                    
                    
                    $
                    -




Recent
Accounting Pronouncements





See
Note 2 of the Consolidated Financial Statements for a full description of
new accounting pronouncements, including the respective expected dates of
adoption and effects on results of operations and financial
condition.




Item7a.  Quantitative and Qualitative Disclosures About
Market Risk





We do not
own or trade any financial instruments about which disclosure of quantitative
and qualitative market risks are required to be disclosed.





26
 Index





ITEM8.  FINANCIAL STATEMENTS





RBSM
LLP


Certified
Public Accountants




REPORT OF INDEPENDENT
REGISTERED PUBLIC ACCOUNTING FIRM








Board of
Directors


EnergyConnect
Group, Inc.


Portland,
Oregon








We have audited the accompanying
consolidated balance sheets of EnergyConnect Group, Inc. and its wholly-owned
subsidiaries (the "Company") as of January 3, 2009 and December 29, 2007 and the
related consolidated statements of operations, stockholders' equity, and cash
flows for each of the two years in the period ended January 3,
2009.  These financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
financial statements based upon our audits.





We conducted our audits in accordance
with standards of the Public Company Accounting Oversight Board (United States
of America).  Those standards require that we plan and perform the
audit to obtain reasonable assurance about whether the financial statements are
free of material misstatements. 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
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements. An audit also includes assessing the
accounting principles used and significant estimates made by management, as well
as evaluating the overall financial statement presentation. We believe 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 financial position of EnergyConnect Group, Inc. and its wholly-owned
subsidiaries as of January 3, 2009 and December 29, 2007, and the consolidated
results of its operations and its cash flows for each of the two years in the
period ended January 3, 2009, in conformity with accounting principles generally
accepted in the United States of America.





The
accompanying consolidated financial statements have been prepared assuming that
the Company will continue as a going concern.  As discussed in Note
16, the Company is experiencing difficulty in generating sufficient cash flow to
meet its obligations and sustain its operations, which raises substantial doubt
about its ability to continue as a going concern.  Management’s plans
in regard to these matters are also described in Note 16.  The
accompanying statements do not include any adjustments that might result from
the outcome of this uncertainty.





/s/RBSM
LLP








McLean,
Virginia


March 19,
2009




27
 Index





ENERGYCONNECT
GROUP, INC.


CONSOLIDATED
BALANCE SHEETS


AS
OF JANUARY 3, 2009 AND DECEMBER 29, 2007





January
      3, 2009
                          
                          
                          December
      29, 2007Current
      assets:Cash
      and cash equivalents
                          
                          $
                          410,101
                          
                          
                          $
                          758,299Certificates
      of deposit
                          
                          
                          300,000
                          
                          
                          
                          133,400Accounts
      receivable, net of allowance of $0 as of January 3, 2009 and December 27,
      2007
                          
                          
                          4,373,818
                          
                          
                          
                          1,532,843Other
      current assets
                          
                          
                          269,144
                          
                          
                          
                          551,601Discontinued
      operations (Note 5)
                          
                          
                          -
                          
                          
                          
                          12,666,606Total
      current assets
                          
                          
                          5,353,063
                          
                          
                          
                          15,642,749Property
      and equipment, net (Note 3)
                          
                          
                          299,263
                          
                          
                          
                          202,487Other
      assets
                          
                          
                          70,876
                          
                          
                          
                          43,175Intangible
      assets, net (Note 4 and 6)
                          
                          
                          1,633,622
                          
                          
                          
                          1,872,689Goodwill
      (Note 4 and 6)
                          
                          
                          -
                          
                          
                          
                          29,353,527Discontinued
      operations (Note 5)
                          
                          
                          -
                          
                          
                          
                          971,017Total
      Assets
                          
                          $
                          7,356,824
                          
                          
                          $
                          48,085,644Current
      liabilities:Accounts
      payable
                          
                          $
                          5,116,296
                          
                          
                          $
                          2,975,847Accrued
      expenses
                          
                          
                          127,016
                          
                          
                          
                          118,148Bank
      line of credit (Note 10)
                          
                          
                          117,257
                          
                          
                          
                          118,456Other
      current liabilities
                          
                          
                          -
                          
                          
                          
                          4,504Discontinued
      operations (Note 5)
                          
                          
                          -
                          
                          
                          
                          13,549,408Total
      current liabilities
                          
                          
                          5,360,569
                          
                          
                          
                          16,766,363Long-term
      liabilities:Discontinued
      operations
                          
                          
                          -
                          
                          
                          
                          61,327Total
      long-term liabilities
                          
                          
                          -
                          
                          
                          
                          61,327Commitments
      and contingencies (Note 14)
                          
                          
                          
                          
                          
                          
                          -Shareholders’
      equity:Common
      stock, no par value, 225,000,000 shares authorized, 95,179,961 and
      83,569,416 shares issued and outstanding, respectively
                          
                          
                          120,671,694
                          
                          
                          
                          115,776,415Common
      stock warrants (Note 9)
                          
                          
                          36,098,289
                          
                          
                          
                          36,178,218Accumulated
      deficit
                          
                          
                          (154,773,728
                          )
                          
                          
                          (120,696,679
                          )Total
      shareholders’ equity
                          
                          
                          1,996,255
                          
                          
                          
                          31,257,954Total
      liabilities and shareholders’ equity
                          
                          $
                          7,356,824
                          
                          
                          $
                          48,085,644






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





28
 Index





ENERGYCONNECT
GROUP, INC.


CONSOLIDATED
STATEMENTS OF OPERATIONS


FOR
THE YEARS ENDED JANUARY 3, 2009 AND DECEMBER 29, 2007




January
      3, 2009
                      
                      
                      December
      29, 2007Sales
                      
                      $
                      25,858,704
                      
                      
                      $
                      12,625,654Cost
      of goods sold
                      
                      
                      18,419,335
                      
                      
                      
                      8,788,454Gross
      profit
                      
                      
                      7,439,369
                      
                      
                      
                      3,837,200Operating
      expensesSales,
      general and administrative
                      
                      
                      12,132,761
                      
                      
                      
                      8,180,188Goodwill
      impairment (Note 6)
                      
                      
                      29,353,527
                      
                      
                      
                      -Total
      operating expenses
                      
                      
                      41,486,288
                      
                      
                      
                      8,180,188Loss
      from operations
                      
                      
                      (34,046,919
                      )
                      
                      
                      (4,342,988
                      )Other
      income (expense)Interest
      income
                      
                      
                      49,736
                      
                      
                      
                      45,324Interest
      expense
                      
                      
                      (68,586
                      )
                      
                      
                      (43,115
                      )Total
      other income (expense)
                      
                      
                      (18,850
                      )
                      
                      
                      2,209Loss
      before provision for income taxes
                      
                      
                      (34,065,769
                      )
                      
                      
                      (4,340,779
                      )Provision
      for income taxes (Note 12)
                      
                      
                      -
                      
                      
                      
                      -Loss
      from continuing operations
                      
                      
                      (34,065,769
                      )
                      
                      
                      (4,340,779
                      )Discontinued
      operations:Loss
      on discontinued operations - Christenson Electric (Note 5)
                      
                      
                      (11,281
                      )
                      
                      
                      (9,694,727
                      )Net
      loss
                      
                      $
                      (34,077,050
                      )
                      
                      $
                      (14,035,506
                      )Basic
      and diluted net loss per share from continuing operations (Note
      13)
                      
                      $
                      (0.37
                      )
                      
                      $
                      (0.05
                      )Basic
      and diluted net loss per share from discontinued operations (Note
      13)
                      
                      $
                      (0.00
                      )
                      
                      $
                      (0.12
                      )Basic
      and diluted net loss per share (Note 13)
                      
                      $
                      (0.37
                      )
                      
                      $
                      (0.17
                      )Weighted
      average shares used in per share calculations:Basic
                      
                      
                      91,245,072
                      
                      
                      
                      82,536,027Diluted
                      
                      
                      91,245,072
                      
                      
                      
                      82,536,027








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





29
 Index





EnergyConnect
Group, Inc.


Statement
of Changes in Shareholders’ Equity


Fiscal
Years Ended January 3, 2009 and December 29, 2007





Convertible
      Series 3
                              Preferred
      Stock
                            
                            
                            Convertible
      Series 4
                              Preferred
      Stock
                            
                            
                            Common
      Stock
                            
                            
                            Common
      Stock Warrants
                            
                            
                            Accumulated
      Deficit
                            
                            
                            Total
      Shareholders’ Equity (Deficit)Shares
                            
                            
                            Amount
                            
                            
                            Shares
                            
                            
                            Amount
                            
                            
                            Shares
                            
                            
                            Amount
                            
                            
                            Warrants
                            
                            
                            AmountBalance
      December 30, 2006
                            
                            
                            2,039.688
                            
                            
                            $
                            856,670
                            
                            
                            
                            526.317
                            
                            
                            $
                            174,423
                            
                            
                            
                            79,023,905
                            
                            
                            $
                            113,067,867
                            
                            
                            
                            28,549,182
                            
                            
                            $
                            36,178,218
                            
                            
                            $
                            (106,661,173
                            )
                            
                            $
                            43,616,005Common
      shares issued to outside consultants
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            150,000
                            
                            
                            
                            118,500
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            118,500Stock
      options issued to employees and directors
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            920,699
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            920,699Common
      shares issued  upon conversion of preferred
    shares
                            
                            
                            (2,039.688
                            )
                            
                            
                            (856,670
                            )
                            
                            
                            (526.317
                            )
                            
                            
                            (174,423
                            )
                            
                            
                            2,566,005
                            
                            
                            
                            1,031,093
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            -Common
      shares issued upon  exercise of options
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            1,829,507
                            
                            
                            
                            638,256
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            638,256Net
      loss
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            (14,035,506
                            )
                            
                            
                            (14,035,506
                            )Balance
      December 29, 2007
                            
                            
                            -
                            
                            
                            $
                            -
                            
                            
                            
                            -
                            
                            
                            $
                            -
                            
                            
                            
                            83,569,417
                            
                            
                            $
                            115,776,415
                            
                            
                            
                            28,549,182
                            
                            
                            $
                            36,178,218
                            
                            
                            $
                            (120,696,679
                            )
                            
                            $
                            31,257,954Common
      shares issued to outside consultants
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            455,438
                            
                            
                            
                            243,883
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            243,883Stock
      options issued to employees and directors
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            869,983
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            869,983Common
      shares issued upon  exercise
    of  options
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            2,069,329
                            
                            
                            
                            703,729
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            703,729Common
      shares issued upon  exercise of warrants
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            34,467
                            
                            
                            
                            31,694
                            
                            
                            
                            (34,467
                            )
                            
                            
                            (17,218
                            )
                            
                            
                            
                            
                            
                            
                            14,476Common
      shares and warrants  issued in private placement
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            9,051,310
                            
                            
                            
                            3,256,434
                            
                            
                            
                            4,665,874
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            3,256,434




30
 Index




Convertible
      Series 3
                Preferred
      Stock
              
              
              Convertible
      Series 4
                Preferred
      Stock
              
              
              Common
      Stock
              
              
              Common
      Stock Warrants
              
              
              Accumulated
      Deficit
              
              
              Total
      Shareholders’ Equity (Deficit)Shares
              
              
              Amount
              
              
              Shares
              
              
              Amount
              
              
              Shares
              
              
              Amount
              
              
              Warrants
              
              
              Amount0Reclassification
      of Notes Receivable from employees
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              (264,384
              )
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              (264,384
              )Expiration
      and forfeiture of warrants
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              62,711
              
              
              
              (125,534
              )
              
              
              (62,711
              )
              
              
              
              
              
              
              -Reclassification
      of  amounts upon sale of Christenson Electric,
    Inc.
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              (8,771
              )
              
              
              
              
              
              
              
              
              
              
              1
              
              
              
              (8,770
              )Net
      loss
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              (34,077,050
              )
              
              
              (34,077,050
              )Balance
      January 3, 2009
              
              
              -
              
              
              $
              -
              
              
              
              -
              
              
              $
              -
              
              
              
              95,179,961
              
              
              $
              120,671,694
              
              
              
              33,055,055
              
              
              $
              36,098,289
              
              
              $
              (154,773,728
              )
              
              $
              1,996,255








Each
share of Series 3 and Series 4 preferred stock was converted into one thousand
shares of the Company’s common stock.








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





31
 Index





ENERGYCONNECT
GROUP, INC.


CONSOLIDATED
STATEMENTS OF CASH FLOWS


FOR
THE YEARS ENDED JANUARY 3, 2009, AND DECEMBER 29, 2007





January
      3, 2009
                                    
                                    
                                    December
      29, 2007Cash
      Flows From Operating Activities:Net
      loss
                                    
                                    $
                                    (34,077,050
                                    )
                                    
                                    $
                                    (14,035,506
                                    )Add  (deduct):Loss
      on discontinued operations
                                    
                                    
                                    11,282
                                    
                                    
                                    
                                    9,694,727Loss
      from continuing operations
                                    
                                    
                                    (34,065,768
                                    )
                                    
                                    
                                    (4,340,779
                                    )Depreciation
      of equipment
                                    
                                    
                                    126,028
                                    
                                    
                                    
                                    37,071Amortization
      of intangible assets
                                    
                                    
                                    239,067
                                    
                                    
                                    
                                    239,067Option
      vesting valuation
                                    
                                    
                                    869,983
                                    
                                    
                                    
                                    920,699Loss
      on disposal of fixed assets
                                    
                                    
                                    3,200
                                    
                                    
                                    
                                    -Common
      stock issued for services
                                    
                                    
                                    243,883
                                    
                                    
                                    
                                    118,500Impairment
      of intangibles
                                    
                                    
                                    29,353,527
                                    
                                    
                                    
                                    -Changes
      in current assets and liabilities:Restricted
      cash
                                    
                                    
                                    (166,600
                                    )
                                    
                                    
                                    (133,400
                                    )Accounts
      receivable
                                    
                                    
                                    (2,840,975
                                    )
                                    
                                    
                                    (1,434,150
                                    )Other
      current assets
                                    
                                    
                                    (359,248
                                    )
                                    
                                    
                                    (502,755
                                    )Other
      assets
                                    
                                    
                                    (27,701
                                    )
                                    
                                    
                                    (33,174
                                    )Accounts
      payable
                                    
                                    
                                    2,140,448
                                    
                                    
                                    
                                    1,555,175Other
      current liabilities
                                    
                                    
                                    4,364
                                    
                                    
                                    
                                    (160,520
                                    )Net
      cash used by continuing operations
                                    
                                    
                                    (4,479,792
                                    )
                                    
                                    
                                    (3,734,266
                                    )Net
      cash provided by discontinued operations
                                    
                                    
                                    379,319
                                    
                                    
                                    
                                    1,093,837Net
      cash used by operating activities
                                    
                                    
                                    (4,100,473
                                    )
                                    
                                    
                                    (2,640,429
                                    )Cash
      flows from investing activities:Purchases
      of fixed assets
                                    
                                    
                                    (226,004
                                    )
                                    
                                    
                                    (169,043
                                    )Net cash (used) by
      continuing investing activities
                                    
                                    
                                    (226,004
                                    )
                                    
                                    
                                    (169,043
                                    )Net
      cash used by discontinued investing activities
                                    
                                    
                                    (534,325
                                    )
                                    
                                    
                                    (621,721
                                    )Net
      cash used by investing activities
                                    
                                    
                                    (760,329
                                    )
                                    
                                    
                                    (790,764
                                    )Cash
      flows from financing activities:Repayments
      on line of credit
                                    
                                    
                                    (1,198
                                    )
                                    
                                    
                                    (960
                                    )Exercise
      of options and warrants
                                    
                                    
                                    718,205
                                    
                                    
                                    
                                    670,721Proceeds
      from private placement, net of direct costs
                                    
                                    
                                    3,256,434
                                    
                                    
                                    
                                    (39,027
                                    )Net
      cash provided by continuing financing activities
                                    
                                    
                                    3,973,441
                                    
                                    
                                    
                                    630,734Net
      cash provided by discontinued financing activities
                                    
                                    
                                    539,163
                                    
                                    
                                    
                                    1,890,172Net
      cash provided by financing activities
                                    
                                    
                                    4,512,604
                                    
                                    
                                    
                                    2,520,906Net
      (decrease) in cash and cash equivalents
                                    
                                    
                                    (348,198
                                    )
                                    
                                    
                                    (910,287
                                    )Cash
      and cash equivalents (including discontinued operations), beginning of
      period
                                    
                                    
                                    758,299
                                    
                                    
                                    
                                    2,193,308Cash
      and cash equivalents (including discontinued operations), end of
      period
                                    
                                    $
                                    410,101
                                    
                                    
                                    $
                                    1,283,021Supplemental
      information on interest and taxes:Interest
      paid during the year
                                    
                                    $
                                    11,538
                                    
                                    
                                    $
                                    767,901Income
      taxes paid during the year
                                    
                                    $
                                    -
                                    
                                    
                                    $
                                    -








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





32
 Index





ENERGYCONNECT
GROUP, INC.


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS








1.  Description
of the Business





On
September 24, 2008, our shareholders voted to change the name of the Company to
EnergyConnect Group, Inc. from Microfield Group, Inc.  EnergyConnect
Group, Inc. (the “Company,” “EnergyConnect,” “we,” “us,” or “our”) through its
subsidiaries EnergyConnect, Inc. (“ECI”) specializes in transactions involving
integration of consumers of electricity into the wholesale electricity
markets.   The Company’s objective is to leverage our assets and
resources and build a viable, profitable, energy and electrical services
infrastructure business.





The
consolidated financial statements include the accounts of EnergyConnect and its
wholly owned operating subsidiary, EnergyConnect, Inc. (collectively the
"Company"). The sale of Christenson Electric, Inc. closed on April 24, 2008
(Note 5).  Therefore, the operations of CEI are presented as
discontinued operations in the consolidated financial statements.  All
significant inter-company accounts and transactions have been eliminated in
consolidation.





The
Company was incorporated in October 1986 as an Oregon corporation, succeeding
operations that began in October 1984.  The Company’s headquarters are
located in Lake Oswego, Oregon.








2.  Summary
of Significant Accounting Policies





Fiscal Year





The
Company’s fiscal year is the 52- or 53-week period ending on the Saturday
closest to the last day of December.  The Company’s current fiscal
year is the 53-week period ending January 3, 2009.  The Company’s last
fiscal year was the 52-week period ended December 29, 2007.





Principles of
Consolidation





The
Consolidated Statements of Operations presented above, contain revenue and
expense data of EnergyConnect Group, Inc. for the years ended January 3, 2009
and December 29, 2007.  On October 13, 2005, the Company acquired
its wholly-owned subsidiary, EnergyConnect, Inc. (see Note 4).  The
revenue and expense data of ECI is included in the Consolidated Statement of
Operations from the acquisition date to the end of the period
presented.  The sale of Christenson Electric, Inc. closed on April 24,
2008 (Note 5).  Therefore, the operations of CEI are presented as
discontinued operations.  All significant inter-company accounts and
transactions between the Company and its subsidiaries have been eliminated in
consolidation.





Cash and Cash Equivalents





The
Company considers all highly liquid investments with an original maturity or
remaining maturity of three months or less at the date of purchase to be cash
equivalents.  Cash and cash equivalents are primarily maintained at
two financial institutions.





Fair Value of Financial
Instruments





The
carrying value of the Company’s financial instruments, including cash and cash
equivalents, accounts receivable, accounts payable and accrued liabilities are
carried at cost, which approximates fair value due to the relative short
maturities of these instruments. The carrying value of debt, derivatives and the
liability for warrant settlement are recorded at the estimated fair value of
these instruments.





Inventories





Inventories
are stated at the lower of cost or market, using the first-in, first-out
method.  Inventory is comprised almost entirely of the cost of
material.  The Company provides inventory allowances based on
estimates of excess and obsolete inventories.





33
 Index





Advertising Costs





Advertising
and marketing costs of $523,000 and $90,000 were expensed as incurred in each of
the years ended January 3, 2009 and December 29, 2007,
respectively.





Property and Equipment





Property
and equipment are stated at cost less accumulated depreciation and
amortization.  Depreciation of computer equipment and software is
computed using straight line or accelerated declining balance method over the
estimated useful lives of the assets.  Estimated lives of three to
five years are used for computer equipment and software.  The Company
moved to new office space during 2008, and recorded leasehold improvements as a
part of the build out of the new space.  These leasehold improvements
are being amortized over the 36 month life of the office lease.





Concentrations





Financial
instruments that potentially subject us to concentrations of credit risk consist
primarily of accounts receivable.  During the year ended January 3,
2009, revenue from one major customer approximated $24,730,000 or 95.6% of
sales.  During the year ended December 29, 2007, revenues from one
major customer approximated 98% of sales.  This revenue is the result
of multiple participating electric consumers who each executed myriad energy
transactions that were aggregated and billed to the PJM Interconnection, or
PJM.  The revenue is dependent on actions taken by these third parties
in conjunction with ECI, for which PJM, as our customer remits
payment.  The transactions form the basis for our
revenue.  We have little risk, if any, from the concentration of
revenue through this power grid as it’s a not-for-profit organization that
exists to act as the market for electrical transactions.  Of these
participants, there was one whose transactions resulted in revenue that totaled
10% or more of our revenue in the twelve months ended January 3, 2009 and two
whose transactions resulted in revenue that totaled 10% or more of our revenue
in the twelve months ended December 29, 2007.





At
January 3, 2009 there was one customer whose accounts receivable accounted for
94% of our outstanding trade accounts receivable.  At December 29,
2007 there was one customer whose accounts receivable accounted for more than
10% of total outstanding trade accounts receivable.  We have little
risk, if any, from the concentration of receivables through this power grid as
it’s a not-for-profit organization that exists to act as the market for
electrical transactions.  We perform limited credit evaluations of our
customers and do not require collateral on accounts receivable
balances.  We have not experienced any credit losses for the periods
presented.   The level of revenue resulting from any single
participant’s transactions may vary and the loss of any one of these
participants, or a decrease in the level of revenue from transactions generated
by any one of these participants, could have a material adverse impact on our
financial condition and results of operations.





Revenue
recognition




We
produce revenue through agreements with both building owners and the power grid
operators. Under our agreements with facilities owners, we use electrical and
energy related products that help energy consumers control energy use in their
buildings. In conjunction with this agreement we are members of the power grid
operators and have agreed to provide the grids with energy, capacity, and
related ancillary services during specified times and under specified
conditions. These transactions are summarized at the end of each monthly period
and submitted to the power grids for settlement and approval. While the power
grids are our customers, they are primarily a conduit through which these
electrical curtailment transactions are processed.  The vast majority
of our revenue in 2008 was processed through the PJM Interconnection. PJM serves
as the market for electrical transactions in a specific region in the United
States.   Our agreement with PJM is an ongoing one as we are
members of PJM.  These transactions are initiated by building owners,
who are our participants.  The transactions form the basis for our
revenue.  We have little risk, if any, from the concentration of
revenue through this power grid as it is a not-for-profit organization that
exists to act as the market for electrical transactions.





In 2008,
we revised our accounting for reserves for collections of revenues. The revision
in our reserve accounting is a result of improvements in our ability to
accurately estimate collections, which is based upon historical trends and
timely and accurate information.   Previously the transactions
were recorded as revenue on the settlement date, which typically fall 45-70 days
after the transaction date from which the revenue is derived, because management
believed that without an established history for this source of revenue, and the
potential for disputes, that the settlement date, on which both parties agree to
the amount of revenue to recognize, was the most conservative and appropriate
date to use.  For periods beginning with the first quarter of 2008 and
forward, revenue from these settlements were accrued into the prior month
instead of recognizing revenue as the settlement amounts were
received.  The record of these settlement amounts being realized over
the prior two years had been extremely accurate so that management believed it
was appropriate to accrue the settlement amounts into the prior
month.  This revision in our reserve accounting resulted in an extra
month of revenue being recorded in the first quarter of 2008.  This
first quarter of 2008 contained the payment received in January of 2008 (which
was not accrued into December) and the settlement amounts from the fifth
business day in February, March and April of 2008, each of which was accrued
into the prior months of January, February and March of 2008.





34
 Index





An
additional source of our revenue is derived from agreements with the power grid
operators whereby a monthly reserve fee is paid for our agreement to standby,
ready to provide relief in the form of curtailment of energy usage, in times of
high energy demand.  We record these payments as revenue over the
period during which we’re required to perform under these
programs.  Under certain programs, our obligation to perform may not
coincide with the period over which we receive payments under that
program.  In these cases we record revenue over the mandatory
performance obligation period and record a receivable for the amount of payments
that will be received after that period has been completed.





Purchase
price allocation and impairment of intangible and long-lived assets





Intangible
and long-lived assets to be held and used are reviewed for impairment whenever
events or changes in circumstances indicate that the carrying amounts of such
assets may not be recoverable. Determination of recoverability is based on an
estimate of undiscounted future cash flows resulting from the use of the asset,
and its eventual disposition. Measurement of an impairment loss for intangible
and long-lived assets that management expects to hold and use is based on the
fair value of the asset as estimated using a discounted cash flow
model.




We
measure the carrying value of goodwill recorded in connection with the
acquisitions for potential impairment in accordance with SFAS No. 142, Goodwill
and Other Intangible Assets.” To apply SFAS 142, a company is divided into
separate “reporting units,” each representing groups of products that are
separately managed. For this purpose, we have one reporting unit. To determine
whether or not goodwill may be impaired, a test is required at least annually,
and more often when there is a change in circumstances that could result in an
impairment of goodwill. If the trading of our common stock is below book value
for a sustained period, or if other negative trends occur in our results of
operations, a goodwill impairment test will be performed by comparing book value
to estimated market value. To the extent goodwill is determined to be impaired,
an impairment charge is recorded in accordance with SFAS 142.





We tested
our intangibles for impairment as of the end of fiscal years 2005 through 2008.
Goodwill of $106,544,871 was recorded upon the acquisition of ECI in October
2005, and represented the excess of the purchase price over the fair value of
the net tangible and intangible assets acquired. At December 31, 2005, it was
determined in an independent valuation that the goodwill generated in this
transaction was impaired. The Company decided to write off approximately
$77,191,344 of this goodwill.  At January 3, 2009, it was determined
that the remaining carrying value of goodwill generated from the 2005
transaction was impaired. The Company decided to write off the remaining
carrying value of goodwill of $29,353,527. The write-off of the goodwill, and
the amortization of the intangible assets are included in operating expenses in
the consolidated statements of operations.  There were no changes in
the carrying value of goodwill at December 30, 2006 and December 29,
2007.





Income Taxes





The
Company accounts for income taxes using the asset and liability approach in
accordance with Statement of Financial Accounting Standards (SFAS) No. 109,
Accounting for Income Taxes.  The asset and liability approach
requires the recognition of deferred tax liabilities and assets for the expected
future tax consequences of temporary differences between the carrying amounts
and the tax basis of assets and liabilities.  The effect on deferred
taxes of a change in tax rates is recognized in operations in the period that
includes the enactment date.  Due to recurring losses, there has been
no provision for income taxes in the periods presented.





Computation of Net Income (Loss) per
Share





Basic
earnings (loss) per common share is computed using the weighted-average number
of common shares outstanding during the period.  Diluted earnings per
common share is computed using the combination of dilutive common share
equivalents, which include convertible preferred shares, options and warrants
and the weighted-average number of common shares outstanding during the
period.  During the years ended January 3, 2009 and December 29, 2007
common stock equivalents are not considered in the calculation of the weighted
average number of common shares outstanding because they would be anti-dilutive,
thereby decreasing the net loss per common share.





35
 Index





Pension Plan Contributions





The
Company made quarterly matching payments to the Microfield Group, Inc. 401(k)
Retirement plan during 2008.  These payments totaled $194,000 in the
year ended January 3, 2008.  No matching payments were made by the
Company to its employees under this plan in the year ended December 27,
2007.





The
Company, through the discontinued operating subsidiary, CEI, contributed to
several Multi-Employer Pension Benefit Plans on behalf of its employees covered
by a collective bargaining agreement.  During the years ended January
3, 2009 and December 29, 2007, the Company contributed approximately $1,314,000
and $3,943,000 to these plans, respectively, which was expensed as
incurred.





Stock Based Compensation





On
January 1, 2006, we adopted Statement of Financial Accounting Standards
No. 123 (revised 2004), “Share-Based Payment,” (“SFAS 123(R)”) which
requires the measurement and recognition of compensation expense for all
share-based payment awards made to employees and directors including employee
stock options based on estimated fair values. SFAS 123(R) supersedes our
previous accounting under Accounting Principles Board Opinion No. 25,
“Accounting for Stock Issued to Employees” (“APB 25”) for periods beginning in
fiscal 2006. In March 2005, the Securities and Exchange Commission issued Staff
Accounting Bulletin No. 107 (“SAB 107”) relating to SFAS 123(R). The
Company has applied the provisions of SAB 107 in its adoption of SFAS
123(R).




We
adopted SFAS 123(R) using the modified prospective transition method, which
requires the application of the accounting standard as of January 1, 2006, the
first day of the Company’s fiscal year 2006. Our Consolidated Financial
Statements for twelve months ended January 3, 2009 reflect the impact of SFAS
123(R). In accordance with the modified prospective transition method, our
Consolidated Financial Statements for prior periods have not been restated to
reflect, and do not include, the impact of SFAS 123(R). Stock-based compensation
expense recognized under SFAS 123(R) for the twelve months ended January 3, 2009
and December 29, 2007 was approximately $870,000 and $921,000,
respectively.





SFAS
123(R) requires companies to estimate the fair value of share-based payment
awards on the date of grant using an option-pricing model. The value of the
portion of the award that is ultimately expected to vest is recognized as
expense over the requisite service periods in our Consolidated Statement of
Operations. Prior to the adoption of SFAS 123(R), we accounted for stock-based
awards to employees and directors using the intrinsic value method in accordance
with APB 25 as allowed under Statement of Financial Accounting Standards
No. 123, “Accounting for Stock-Based Compensation” (“SFAS 123”). Under the
intrinsic value method, no stock-based compensation expense had been recognized
in our Consolidated Statement of Operations because the exercise price of our
stock options granted to employees and directors equaled the fair market value
of the underlying stock at the date of grant.




Stock-based
compensation expense recognized during the period is based on the value of the
portion of share-based payment awards that is ultimately expected to vest during
the period. Stock-based compensation expense recognized in our Consolidated
Statements of Operations for the twelve months ended January 3, 2009 and
December 29, 2007  included compensation expense for share-based
payment awards granted prior to, but not yet vested as of December 31, 2005
based on the grant date fair value estimated in accordance with the pro forma
provisions of SFAS 123 and compensation expense for the share-based payment
awards granted subsequent to December 31, 2005 based on the grant date fair
value estimated in accordance with the provisions of SFAS 123(R). SFAS 123(R)
requires forfeitures to be estimated at the time of grant and revised, if
necessary, in subsequent periods if actual forfeitures differ from those
estimates. In our pro forma information required under SFAS 123 for the periods
prior to fiscal 2006, we accounted for forfeitures as they
occurred.




Upon
adoption of SFAS 123(R), we are using the Black-Scholes option-pricing model as
its method of valuation for share-based awards granted beginning in fiscal 2006,
which was also previously used for our pro forma information required under SFAS
123. Our determination of fair value of share-based payment awards on the date
of grant using an option-pricing model is affected by our stock price as well as
assumptions regarding a number of highly complex and subjective variables. These
variables include, but are not limited to our expected stock price volatility
over the term of the awards, and certain other market variables such as the risk
free interest rate.





36
 Index





Comprehensive Income





The
Company has no items of other comprehensive income or
expense.  Accordingly, the Company’s comprehensive loss and net loss
are the same for all periods presented.





Use of Estimates





The
preparation of financial statements and related disclosures 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, liabilities, revenues and expenses, and related disclosure of contingent
assets and liabilities. The Company evaluates, on an on-going basis, its
estimates and judgments, including those related to revenue recognition, bad
debts, impairment of goodwill and intangible assets, income taxes, contingencies
and litigation. Its estimates are based on historical experience and assumptions
that we believe to be reasonable under the circumstances, the results of which
form the basis for making judgments about the carrying values of assets and
liabilities that are not readily apparent from other sources. Actual results may
differ from these estimates under different assumptions or
conditions.





Research and Development





The
Company accounts for research and development costs in accordance with the
Financial Accounting Standards Board's Statement of Financial Accounting
Standards No. 2 ("SFAS 2"), "Accounting for Research and Development
Costs".  Under SFAS 2, all research and development costs must be
charged to expense as incurred. Accordingly, internal research and development
costs are expensed as incurred.  Third-party research and developments
costs are expensed when the contracted work has been performed or as milestone
results have been achieved.  Company-sponsored research and
development costs related to both present and future products are expensed in
the period incurred.  The Company incurred $1,702,347 and $267,391 of
expenditures on research and development for the year ended January 3, 2009 and
December 29, 2007, respectively.





Segment Information





Statement
of Financial Accounting Standards No. 131, "Disclosures about Segments of an
Enterprise and Related Information" ("SFAS 131") establishes standards for
reporting information regarding operating segments in annual financial
statements and requires selected information for those segments to be presented
in interim financial reports issued to stockholders. SFAS 131 also establishes
standards for related disclosures about products and services and geographic
areas. Operating segments are identified as components of an enterprise about
which separate discrete financial information is available for evaluation by the
chief operating decision maker, or decision-making group, in making decisions
how to allocate resources and assess performance. The information disclosed
herein materially represents all of the financial information related to the
Company's principal operating segment.





Reclassification





Certain
reclassifications have been made to conform to prior periods’ data to the
current presentation. These reclassifications had no effect on reported
losses.




Fair
Value Measurement
  We
adopted the provisions of SFAS No. 157, “Fair Value Measurements” on
December 30, 2007, the beginning of our 2008 fiscal year. SFAS No. 157 clarifies
the principle that fair value should be based on the assumptions market
participants would use when pricing an asset or liability and establishes a fair
value hierarchy that prioritizes the information used to develop those
assumptions. Under the standard, fair value measurements are separately
disclosed by level within the fair value hierarchy. SFAS No. 157, as originally
issued, was effective for fiscal years beginning after November 15, 2007, with
early adoption permitted. SFAS No. 157 does not require any new fair value
measurements. It only applies to accounting pronouncements that already require
or permit fair value measures, except for standards that relate to share-based
payments (SFAS No. 123R Share Based Payment.)
 
 On
February 12, 2008, the FASB issued FASB Staff Position (“FSP”) FAS 157-2, which
deferred the effective date of SFAS No. 157 for one year, as it relates to
nonfinancial assets and liabilities. Accordingly, our adoption related only to
financial assets and liabilities.
 
 Upon
adoption of SFAS No. 157, there was no cumulative effect adjustment to
beginning retained earnings and no impact on the consolidated financial
statements.
 
 Valuation
techniques considered under SFAS No. 157 techniques are based on observable
and unobservable inputs. The Standard classifies these inputs into the following
hierarchy:
 
 Level 1 inputsare observable
inputs and use quoted prices in active markets for identical assets or
liabilities that the reporting entity has the ability to access at the
measurement date and are deemed to be most reliable measure of fair
value.
 
 Level 2 inputs are observable
inputs and reflect assumptions that market participants would use in pricing the
asset or liability developed based on market data obtained from sources
independent of the reporting entity. Level 2 inputs includes 1) quoted prices
for similar assets or liabilities in active markets, 2) quoted prices for
identical or similar assets or liabilities in markets that are not active, 3)
observable inputs such as interest rates and yield curves observable at commonly
quoted intervals, volatilities, prepayment speeds, credits risks, default rates,
and 4) market-corroborated inputs.
 
 Level 3 inputs are
unobservable inputs and reflect the reporting entity’s own assumptions about the
assumptions market participants would use in pricing the asset or liability
based on the best information available under the circumstances.
 
 In
October 2008, the FASB issued FSP Financial Accounting Standard
No. 157-3, Determining
the Fair Value of a Financial Asset When the Market for That Asset Is Not
Active.  The FSP was effective immediately and clarifies the
application of FASB Statement No. 157, Fair Value Measurements and
provides an example to illustrate key considerations in determining the fair
value of a financial asset when the market for that financial asset is not
active.
 
 We
adopted the provisions of SFAS No. 159, “The Fair Value Option for Financial
Assets and Liabilities – Including an Amendment of FASB Statement No.
115” on December 30, 2007, the beginning of our 2008 fiscal year. SFAS
No. 159 permits us to choose to measure certain financial assets and liabilities
at fair value that are not currently required to be measured at fair value (the
“Fair Value Option”). Election of the Fair Value Option is made on an
instrument-by-instrument basis and is irrevocable. At the adoption date,
unrealized gains and losses on financial assets and liabilities for which the
Fair Value Option has been elected are reported as a cumulative adjustment to
beginning retained earnings. We did not elect the Fair Value Option as we had no
financial assets or liabilities that qualified for this treatment. In the
future, if we elect the Fair Value Option for certain financial assets and
liabilities, we would report unrealized gains and losses due to changes in their
fair value in net income at each subsequent reporting date. The adoption of this
statement had no impact on our consolidated financial statements.
 
 The
carrying value of the Company’s cash and cash equivalents, accounts receivable,
accounts payable, borrowings under the revolving credit facility, and other
current assets and liabilities approximate fair value because of their
short-term maturity.





Recent
Accounting Pronouncements





In March
2008, the FASB issued SFAS No. 161, “Disclosures about Derivative Instruments
and Hedging Activities, an amendment of SFAS No. 133”. SFAS No. 161 amends and
expands the disclosure requirements of SFAS No. 133 for derivative instruments
and hedging activities. SFAS No. 161 requires qualitative disclosure about
objectives and strategies for using derivative and hedging instruments,
quantitative disclosures about fair value amounts of the instruments and gains
and losses on such instruments, as well as disclosures about credit-risk
features in derivative agreements. The Company does not expect the adoption of
SFAS No. 161 to have a significant impact on its consolidated financial
statements.





37
 Index





In April
2008, the FASB issued FSP No. 142-3, “Determination of the Useful Life of
Intangible Assets” (“FSP 142-3”). FSP 142-3 amends the factors an entity should
consider in developing renewal or extension assumptions used in determining the
useful life of recognized intangible assets under FASB Statement No. 142,
“Goodwill and Other Intangible Assets”. This new guidance applies prospectively
to intangible assets that are acquired individually or with a group of other
assets in business combinations and asset acquisitions. FSP 142-3 is effective
for financial statements issued for fiscal years and interim periods beginning
after December 15, 2008. Early adoption is prohibited. The Company does not
expect the adoption of FSP 142-3 to have a significant impact on its
consolidated financial statements.





In May
2008, the FASB issued SFAS No. 162, “The Hierarchy of Generally Accepted
Accounting Principles” (“SFAS 162”). SFAS 162 identifies the sources of
accounting principles and the framework for selecting the principles used in the
preparation of financial statements of nongovernmental entities that are
presented in conformity with generally accepted accounting principles (the GAAP
hierarchy). SFAS 162 will become effective 60 days following the SEC’s approval
of the Public Company Accounting Oversight Board amendments to AU Section 411,
“The Meaning of Present Fairly in Conformity With Generally Accepted Accounting
Principles.” The Company does not expect the adoption of SFAS 162 to have a
material effect on its results of operations and financial
condition.





In May
2008, the FASB issued FSP Accounting Principles Board (“APB”) 14-1 “Accounting
for Convertible Debt instruments That May Be Settled in Cash upon Conversion
(Including Partial Cash Settlement)” (“FSP APB 14-1”). FSP APB 14-1 requires the
issuer of certain convertible debt instruments that may be settled in cash (or
other assets) on conversion to separately account for the liability (debt) and
equity (conversion option) components of the instrument in a manner that
reflects the issuer’s non-convertible debt borrowing rate. FSP APB 14-1 is
effective for fiscal years beginning after December 15, 2008 on a retroactive
basis. The Company does not believe the adoption of FSP APB 14-1 will have
significant effect on its results of operations and financial
condition.





In May
2008, the FASB issued FASB Statement No. 163, “Accounting for Financial
Guarantee Insurance Contracts”, which clarifies how FASB Statement No. 60,
“Accounting and Reporting by Insurance Enterprises”, applies to financial
guarantee insurance contracts issued by insurance enterprises. 
  The standard is effective for financial statements issued for fiscal
years beginning after December 15, 2008, including interim periods in that year.
The Company does not expect the adoption of SFAS 163 to have a material effect
on its consolidated financial statements.





In
June 2008, the FASB issued FSP Emerging Issues Task Force
(EITF) No. 03-6-1, “Determining Whether Instruments Granted in
Share-Based Payment Transactions Are Participating Securities.” Under the FSP,
unvested share-based payment awards that contain rights to receive
nonforfeitable dividends (whether paid or unpaid) are participating securities,
and should be included in the two-class method of computing EPS. The FSP is
effective for fiscal years beginning after December 15, 2008, and interim
periods within those years. The Company does not expect the adoption of FSP EITF
No. 03-6-1 to have a material effect on its consolidated financial
statements.





In
October 2008, the FASB issued FSP SFAS No. 157-3, “Determining the
Fair Value of a Financial Asset When the Market for That Asset Is Not Active.”
This position clarifies the application of SFAS No. 157 in a market
that is not active and provides an example to illustrate key considerations in
determining the fair value of a financial asset when the market for that
financial asset is not active. It also reaffirms the notion of fair value as an
exit price as of the measurement date. This position was effective upon
issuance, including prior periods for which financial statements have not been
issued. The adoption had no impact on the Company’s consolidated financial
statements.





In
December 2008, the FASB issued FSP 132(R)-1, Employers’ Disclosures about
Postretirement Benefit Plan Assets, which is effective for fiscal years ending
after December 15, 2009. FSP 132(R)-1 requires disclosures about fair value
measurements of plan assets that would be similar to the disclosures about fair
value measurements required by SFAS 157. The Company is assessing the potential
effect of the adoption of FSP 132(R)-1 on its consolidated financial
statements.





In
December 2008, the FASB issued FSP SFAS 140-4 and FIN 46(R)-8,
Disclosures about Transfers of Financial Assets and Interests in Variable
Interest Entities. The FSP requires extensive additional disclosure by public
entities with continuing involvement in transfers of financial assets to
special-purpose entities and with variable interest entities (VIEs), including
sponsors that have a variable interest in a VIE. This FSP became effective for
the first reporting period ending after December 15, 2008 and did not have
any material impact on the Company's consolidated financial
statements.





38
 Index





In
January 2009, the FASB issued Financial Statement of Position (“FSP”) Issue
No. EITF 99-20-1, “Amendments to the Impairment Guidance of EITF Issue
No. 99-20” (“FSP EITF No. 99-20-1”). FSP EITF No. 99-20-1 amends
the impairment guidance in EITF Issue No. 99-20, “Recognition of Interest
Income and Impairment on Purchased Beneficial Interests and Beneficial Interests
that Continue to be Held by a Transferor in Securitized Financial Assets” to
achieve more consistent determination of whether an other-than-temporary
impairment has occurred. The Company adopted FSP EITF No. 99-20-1 in
December 2008 and it did not have a material impact on the consolidated
financial statements.








3.  Property
and Equipment





Property
and equipment consist of the following:





January
      3, 2009
                
                
                December
      29, 2007Furniture
      and fixtures
                
                $
                68,371
                
                
                $
                17,475Leasehold
      improvements
                
                
                40,809
                
                
                
                -Software
      and computer equipment
                
                
                365,095
                
                
                
                234,796474,275
                
                
                
                252,271Less
      accumulated depreciation
                
                
                (175,012
                )
                
                
                (49,784
                )$
                299,263
                
                
                $
                202,487





Depreciation
expense included as a charge to income was $126,028 and $37,071 for the years
ended January 3, 2009 and December 29, 2007, respectively.








4.  Acquisition
of EnergyConnect, Inc.





On
October 13, 2005, the Company acquired EnergyConnect, Inc. (ECI) in exchange for
27,365,305 shares of the Company’s common stock, 19,695,432 warrants to purchase
shares of the Company’s common stock and 3,260,940 stock options to purchase the
Company’s common shares.  The shares of common stock issued in
conjunction with the merger were not registered under the Securities Act of
1933. The acquisition of ECI was accounted for using the purchase method in
accordance with SFAS 141, “Business Combinations.”  The results of
operations for ECI have been included in the Consolidated Statements of
Operations since the date of acquisition.





Through
EnergyConnect’s energy automation software systems, we have the capability to
develop and provide solutions and infrastructure for the electric energy supply
chain. ECI’s energy automation is a suite of products that deliver new
energy-related revenues to energy consumers and major benefits to the electric
grid.  It’s anticipated that a portion of ECI’s services will drive
additional growth in CEI.





The value
of the Company’s common stock issued as a part of the acquisition was determined
based on the average price of the Company's common stock for several days before
and after the acquisition of ECI. The fair value of employee stock options
issued in conjunction with this acquisition has been included in the
determination of the purchase price.  The fair value of such options
was determined using the Black-Scholes model.  The components of the
purchase price were as follows:





Common
      stock
                    
                    $
                    64,234,814Warrant
      issuance value
                    
                    
                    36,495,391Stock
      option issuance value
                    
                    
                    6,769,711Direct
      acquisition costs
                    
                    
                    224,374Total
      purchase price
                    
                    $
                    107,724,290





39
 Index





In
accordance with Financial Accounting Standard (SFAS) No. 141, Business
Combinations, the total purchase price was allocated to the estimated fair value
of assets acquired and liabilities assumed. The estimate of fair value of the
assets acquired was based on management’s and an independent appraiser’s
estimates. The total purchase price was allocated to the assets and liabilities
acquired as follows:





Cash
      and other current assets
                    
                    $
                    263,256Equipment
      and other assets
                    
                    
                    35,426Intangible
      asset – Developed technology
                    
                    
                    2,390,667Goodwill
                    
                    
                    106,544,871Current
      liabilities
                    
                    
                    (1,509,930
                    )Total
                    
                    $
                    107,724,290





The
intangible asset of $2,390,667 at the date of acquisition consisted of developed
technology that is currently used within ECI.  The intangible asset
acquired has an estimated useful life of ten years, and as such will be
amortized monthly, over that period.  Goodwill of $106,544,871
represented the excess of the purchase price over the fair value of the net
tangible and intangible assets acquired.  At December 31, 2005, it was
determined in an independent valuation that the goodwill generated in this
transaction was impaired.  The Company decided to write off
approximately $77,191,344 of this goodwill. The write-off of the goodwill and
the amortization of the intangible assets are included in operating expenses in
the consolidated statement of operations.  The Company tested the
value of the goodwill at January 3, 2009 and concluded that there was additional
impairment of the goodwill asset in ECI during the twelve months ended January
3, 2009.  After consideration of the Company’s market capitalization,
a valuation of the assets using a discounted cash flow computation, and other
market data, the decision was made to reduce the carrying value of the goodwill
to zero.  An impairment charge of $29,353,527 was recorded
against operations in the year ended January 3, 2009 (see Note 6).




5.
Sale of Discontinued Operations





On July
20, 2005, the Company acquired Christenson Electric, Inc. (CEI) in exchange for
2,000,000 shares of the Company’s common stock and the assumption of certain
liabilities within CEI.  CEI provides services to utilities and other
energy related companies.  On November 29, 2007, our board of
directors signed an agreement to sell all of the shares of our wholly-owned
subsidiary Christenson Electric, Inc. to a corporation formed by the management
of CEI.  The agreement was approved by our shareholders in a vote on March
10, 2008.  The closing occurred on April 24, 2008.





The
following summarizes the actual results of the disposition of the CEI business
segment.





Debts
      assumed by buyer
                  
                  $
                  12,653,197Net
      assets disposed of
                  
                  
                  (12,149,018
                  )Expenses
      incurred in connection with the transaction
                  
                  
                  (369,404
                  )Net
      gain on disposal of CEI
                  
                  $
                  134,775





40
 Index





The
financial statements reflect the operating results and balance sheet items of
the discontinued operations separately from continuing operations. Prior years
have been restated. Operating results for the discontinued operations for the
years ended January 3, 2009 and December 29, 2007 were:





January
      3, 2009
                        
                        
                        December
      29, 2007Revenue
                        
                        $
                        
                        
                        
                        $
                        56,842,125Costs
      and expenses
                        
                        
                        
                        
                        
                        
                        66,533,852Net
      loss before tax
                        
                        
                        (146,056
                        )
                        
                        
                        (9,694,727
                        )Income
      tax provision (benefit)
                        
                        
                        -
                        
                        
                        
                        -Net
      loss
                        
                        
                        (146,057
                        )
                        
                        
                        (9,694,727
                        )Net
      gain on disposal of CEI before tax
                        
                        
                        134,775
                        
                        
                        
                        -Income
      tax provision (benefit)
                        
                        
                        -
                        
                        
                        
                        -Gain
      on sale, net of tax
                        
                        
                        134,775
                        
                        
                        
                        -Loss
      on discontinued operation, net of tax
                        
                        $
                        (11,281
                        )
                        
                        $
                        (9,694,727
                        )








6.  Intangible
Assets and Goodwill





As a
result of our acquisition of ECI we recorded an intangible asset of $2,390,667
at the date of acquisition representing developed technology that is currently
used within ECI.  The intangible asset acquired has an estimated
useful life of ten years, and as such is being amortized monthly, over that
period.  Goodwill of $106,544,871 represented the excess of the
purchase price over the fair value of the net tangible and intangible assets
acquired.  At December 31, 2005 and January 3, 2009, it was determined
in independent valuations that the goodwill generated in this transaction was
impaired.  The Company decided to write off approximately $77,191,344
and $29,353,527 of this goodwill in the years ended December 31, 2005 and
January 3, 2009, respectively.  The write-off of the goodwill, and the
amortization of the intangible assets are included in operating expenses in the
consolidated statement of operations.





Intangible
assets consist of the following:





January
      3, 2009
                
                
                December
      29, 2007Developed
      technology
                
                $
                2,390,667
                
                
                $
                2,390,6672,390,667
                
                
                
                2,390,667Less
      accumulated depreciation
                
                
                (757,045
                )
                
                
                (517,978
                )$
                1,633,622
                
                
                $
                1,872,689




Amortization
of intangible assets included as a charge to income was $239,067 and $239,067
for the years ended January 3, 2009 and December 29, 2007, respectively.Based on the
Company’s current intangible assets, amortization expense for the five
succeeding years will be as follows:





AmortizationYear
                    
                    Expense2009
                    
                    $
                    239,0672010
                    
                    
                    239,0672011
                    
                    
                    239,0672012
                    
                    
                    239,0672013
      and beyond
                    
                    
                    677,354Total
                    
                    $
                    1,633,622





41
 Index





The
Company does not amortize goodwill.  As a result of the acquisition of
ECI, the Company recorded goodwill in the amount of $106,544,871 during
fiscal year 2005 Note 4). Goodwill of $106,544,871 represented the excess of the
purchase price over the fair value of the net tangible and intangible assets
acquired.  The write-off of the goodwill is included in operating
expenses in the consolidated statement of operations.  There were no
changes in the carrying amount of goodwill for the year ended and December 29,
2007.





Management
judgment is necessary to estimate fair value. We tested the values of our
intangible assets and goodwill, both at the dates of acquisition and at specific
dates annually.  Based on various market factors and projections used
by management, actual results could vary significantly from managements'
estimates.








7.  Capital





Common
Stock




We are
authorized to issue up to 225,000,000 shares of common stock, no par value. At
our shareholders’ meeting in June 2006, the shareholders voted to increase to
total common shares authorized from 125,000,000 to 225,000,000
shares.  As of January 3, 2009 and December 29, 2007, there were
95,179,961 and 83,569,416, shares respectively, of common stock outstanding.
Holders of the common stock are entitled to one vote per share on all matters to
be voted upon by the stockholders. Holders of common stock are entitled to
receive ratably such dividends, if any, as may be declared by the Board of
Directors out of funds legally available therefore. Upon the liquidation,
dissolution, or winding up of our company, the holders of common stock are
entitled to share ratably in all of our assets which are legally available for
distribution after payment of all debts and other liabilities and liquidation
preference of any outstanding common stock. Holders of common stock have no
preemptive, subscription, redemption or conversion rights. The outstanding
shares of common stock are validly issued, fully paid and
non-assessable.





On May 7,
2008, the Company entered into a private placement under which it issued
9,051,310 shares of its common stock in exchange for $3,512,000 of cash and
elimination of $103,000 of payables, before direct expenses.





During
the year ended January 3, 2009 the Company issued 455,438 shares of common stock
to outside consultants for services rendered during 2008.  These
shares were valued at $243,883, which approximated the fair value of the shares
issued during the period services were completed and rendered.





There
were 34,467 warrants and 2,069,329 stock options exercised for common stock in
the current year.





On
October 5, 2007 the Company issued 150,000 shares of common stock to an outside
consultant for services to be rendered in the following six-month
period.





During
the year ended December 29, 2007 several shareholders converted shares of Series
3, and Series 4 preferred stock into 2,566,004 shares of the Company’s common
stock.  The Company issued 1,829,507 shares of common stock in
exchange for stock options exercised at $0.27 to $0.59 per share.





Preferred
Stock




We are
authorized to issue up to 10,000,000 shares of Preferred Stock, no par value.
The 10,000,000 shares of Preferred Stock authorized are undesignated as to
preferences, privileges and restrictions. As the shares are issued, the Board of
Directors must establish a “series” of the shares to be issued and designate the
preferences, privileges and restrictions applicable to that series. As of
January 3, 2009, there were no remaining shares of any Series of preferred
stock.





The terms
of our previously outstanding series’ of preferred stock were as
follows.





42
 Index





Series 3 Preferred
Stock




On April
3, 2004 the Company issued 3,640.803 shares of Series 3 preferred stock at $420
per share in exchange for conversion of $1,529,000 of outstanding debt. During
the year ended January 3, 2009, several of the Series 3 preferred stockholders
converted a total of 2,039.689 shares of Series 3 preferred stock into 2,039,689
shares of common stock.  During the year ended December 29, 2007,
several of the Series 3 preferred stockholders converted a total of 1,445.210
shares of Series 3 preferred stock into 1,445,210 shares of common stock. Each
share of Series 3 preferred stock was convertible into 1,000 shares of the
Company’s common stock. The terms of the Series 3 preferred stock were as
follows.As of
January 3, 2009 and December 29, 2007, all of the shares of Series 3 Preferred
stock had been converted to common.  The terms of the Series 4
preferred stock were as follows.





Dividends. Series 3 preferred
stock issued and outstanding was entitled to receive a cash dividend in the
amount of 6.5% of the issue price per annum. The Series 3 preferred stock
dividends were cumulative and were to be payable in cash, quarterly, subject to
the declaration of the dividend by the board of directors, if and when the board
of directors deems advisable. Any declared but unpaid dividend will not bear
interest and were to be paid out of net profits. If net profits were not
sufficient to pay this dividend, either in whole or in part, then any unpaid
portion of the dividend was to be paid in full out of our net profits in
subsequent quarters before any dividends are paid upon shares of junior
stock.  No dividends were declared on this series of preferred
shares.





Liquidation Preference. In the
event of any liquidation, dissolution or winding up of our company, either
voluntary or involuntary, except in certain circumstances, the holders of each
share of Series 3 preferred stock were entitled to be paid out of our assets
available for distribution to our shareholders, before any declaration and
payment or setting apart for payment of any amount were to be made in respect of
junior stock, an amount equal to the issue price and all accrued but unpaid
dividends.





Conversion. Each holder of any
share(s) of Series 3 preferred stock may, at the holder’s option, convert all or
any part of such share(s) from time to time held by the holder into shares of
common stock at any time after one year from the date of issuance. Each such
share of Series 3 preferred stock shall be convertible into one thousand shares
of fully-paid and non-assessable shares of common stock. Each share of Series 3
preferred stock shall automatically be converted into shares of common stock on
a one-for-one thousand basis immediately upon the consummation of a sale of our
common stock in a bona fide, firm commitment, underwritten public offering under
the Securities Act of 1933, as amended, which results in aggregate cash proceeds
(before underwriters’ commissions and offering expenses) to us of $5,000,000 or
more. In any event, if not converted to common stock, each share of Series 3
preferred stock shall automatically be converted into shares of common stock on
a one-for-one thousand basis immediately upon the third anniversary of the date
of issuance of the Series 3 preferred stock. The Series 3 preferred shares were
originally issued in April 2004.  The Company has recorded a
beneficial conversion feature of $983,017, which represents the difference
between the conversion price and the fair value of the Company’s common stock on
the commitment date, which was also the issuance date.  This
beneficial conversion feature was amortized over the conversion period of one
year.   At January 3, 2009, there was no remaining unamortized
beneficial conversion feature associated with the Series 3 preferred
stock.





Voting Rights.Each holder of Series 3
preferred stock had the right to one vote for each share of Common Stock into
which such Series 3 preferred stock could then be converted.




Series 4 Preferred
Stock




In April
and May 2004, the Company issued 4,605.265 shares of Series 4 preferred stock at
$380 per share in exchange for $1,750,000 in a private placement (Note 10) from
investors, some of which include certain related parties. During the year ended
January 3, 2009, several of the Series 4 preferred stockholders converted a
total of 526.315 shares of Series 4 preferred stock into 526,315 shares of
common stock. During the year ended December 29, 2007, several of the Series 4
preferred stockholders converted a total of 3,865.790 shares of Series 4
preferred stock into 3,865,790 shares of common stock. Each share of Series 4
preferred stock was convertible into 1,000 shares of the Company’s common
stock.   The terms of the Series 4 preferred stock were as
follows. As of
January 3, 2009, all of the shares of Series 4 Preferred stock had been
converted to common.  The terms of the Series 4 preferred stock were
as follows.





Dividends.Series 4 preferred stock
issued and outstanding was entitled to receive a cash dividend in the amount of
6.5% of the issue price per annum. The Series 4 preferred stock dividends were
cumulative and were to be payable in cash, quarterly, subject to the declaration
of the dividend by the board of directors, if and when the board of directors
deems advisable. Any declared but unpaid dividend will not bear interest and
were to be paid out of net profits. If net profits were not sufficient to pay
this dividend, either in whole or in part, then any unpaid portion of the
dividend was to be paid in full out of our net profits in subsequent quarters
before any dividends are paid upon shares of junior stock.  No
dividends were declared on this series of preferred shares.





43
 Index





Liquidation Preference. In the
event of any liquidation, dissolution or winding up of our company, either
voluntary or involuntary, except in certain circumstances, the holders of each
share of Series 4 preferred stock were entitled to be paid out of our assets
available for distribution to our shareholders, before any declaration and
payment or setting apart for payment of any amount were to be made in respect of
junior stock, an amount equal to the issue price and all accrued but unpaid
dividends.




Conversion.Each holder of any share(s)
of Series 4 preferred stock may, at the holder’s option, convert all or any part
of such share(s) from time to time held by the holder into shares of common
stock at any time after one year from the date of issuance. Each such share of
Series 4 preferred stock shall be convertible into one thousand shares of
fully-paid and non-assessable shares of common stock. Each share of Series 4
preferred stock shall automatically be converted into shares of common stock on
a one-for-one thousand basis immediately upon the consummation of a sale of our
common stock in a bona fide, firm commitment, underwritten public offering under
the Securities Act of 1933, as amended, which results in aggregate cash proceeds
(before underwriters’ commissions and offering expenses) to us of $5,000,000 or
more. In any event, if not converted to common stock, each share of Series 4
preferred stock shall automatically be converted into shares of common stock on
a one-for-one thousand basis immediately upon the third anniversary of the date
of issuance of the Series 4 preferred stock. The Series 4 preferred shares were
originally issued in April 2004.  The Company has recorded a
beneficial conversion feature of $598,684, which represents the difference
between the conversion price and the fair value of the Company’s common stock on
the commitment date, which was also the issuance date.  This
beneficial conversion feature was amortized over the conversion period of one
year.  At January 3, 2009, there was no remaining unamortized
beneficial conversion feature associated with the Series 4 preferred
stock.





Voting Rights.Each holder of Series 4
preferred stock had the right to one vote for each share of Common Stock into
which such Series 4 preferred stock could then be converted.







8.  Private
Placements





May
7, 2008 private placement





On May 7,
2008 we closed a private placement in which we issued 9,051,310 shares of common
stock resulting in aggregate gross proceeds of $3,512,000 and elimination of
accounts payable of $103,000.  In conjunction with this private
placement, we also issued 4,525,655 five year warrants exercisable at $0.60 per
share.  The proceeds of this financing were used for general working
capital purposes.





The
registration rights provided for the Company to file a registration statement
with the Securities and Exchange Commission (“SEC”) no later than 60 days
after the closing of the transaction and have it declared effective by the SEC
no later than 120 days after the closing of the transaction. The final
amended registration statement was filed with the SEC on October 23, 2008 and
declared effective on the same day.





The
registration rights agreement had a liquidated damages provision that called for
a cash payment to be issued to the investors in the event that the registration
statement was not filed and declared effective within a certain period of
time.  The registration statement was not declared effective by the
SEC until 49 days later.  In accordance with this liquidated damages
provision the Company has accrued a payable to these investors in the amount of
$57,048.  As of January 3, 2009, this payment had not been
made.








9.  Stock
Options and Warrants





Stock
Incentive  Plan





The
Company has a Stock Incentive Plan (the "Plan").  At January 3, 2009
and December 29, 2007, 6,078,870 and 9,723,750 shares of common stock were
reserved, respectively, for issuance to employees, officers, directors and
outside advisors.  Under the Plan, the options may be granted to
purchase shares of the Company's common stock at fair market value, as
determined by the Company's Board of Directors, at the date of
grant.  The options are exercisable over a period of up to five years
from the date of grant or such shorter term as provided for in the
Plan.  The options become exercisable over periods ranging between one
and four years.





44
 Index





The
following table summarizes the changes in stock options outstanding and the
related prices for the shares of the Company’s common stock issued to employees,
officers and directors of the Company under the Plan.





Options Outstanding
                    
                    
                    Options ExercisableExercise
      Prices
                    
                    
                    Number
      Outstanding
                    
                    
                    Weighted
      Average Remaining Contractual Life
      (Years)
                    
                    
                    Weighted
      Average Exercise Price
                    
                    
                    Number
      Exercisable
                    
                    
                    Weighted
      Average Exercise Price$
                    0.26
      - $0.94
                    
                    
                    
                    5,802,481
                    
                    
                    
                    3.42
                    
                    
                    $
                    0.74
                    
                    
                    
                    3,696,273
                    
                    
                    $
                    0.67$
                    1.76
      - $2.70
                    
                    
                    
                    276,389
                    
                    
                    
                    2.43
                    
                    
                    $
                    2.13
                    
                    
                    
                    198,263
                    
                    
                    $
                    2.186,078,870
                    
                    
                    
                    3.33
                    
                    
                    $
                    0.81
                    
                    
                    
                    3,894,536
                    
                    
                    $
                    0.75





A summary
of the status of the Company’s Stock Incentive Plan as of January 3, 2009 and
December 29, 2007 and for the years then ended is presented below:





January
      3, 2009
                  
                  
                  December
      29, 2007Weighted
                  
                  
                  
                  
                  
                  Weightedaverage
                  
                  
                  
                  
                  
                  averageexercise
                  
                  
                  
                  
                  
                  exerciseShares
                  
                  
                  price
                  
                  
                  Shares
                  
                  
                  priceOutstanding
      at beginning of year
                  
                  
                  9,723,750
                  
                  
                  $
                  0.54
                  
                  
                  
                  9,057,577
                  
                  
                  $
                  0.54Granted
      at market price
                  
                  
                  162,000
                  
                  
                  
                  .042
                  
                  
                  
                  2,707,500
                  
                  
                  
                  .092Granted
      at other than market priceExercised
                  
                  
                  (2,069,331
                  )
                  
                  
                  0.34
                  
                  
                  
                  (1,829,507
                  )
                  
                  
                  0.35Cancelled
                  
                  
                  (1,737,549
                  )
                  
                  
                  0.67
                  
                  
                  
                  (211,820
                  )
                  
                  
                  0.41Outstanding
      at end of year
                  
                  
                  6,078,870
                  
                  
                  $
                  0.81
                  
                  
                  
                  9,723,750
                  
                  
                  $
                  0.69Options
      exercisable at year end
                  
                  
                  3,894,536
                  
                  
                  $
                  0.75
                  
                  
                  
                  5,829,750
                  
                  
                  $
                  0.55





The
Company granted 77,000 and 2,706,000 options to purchase shares of the Company’s
common stock to employees and directors of the Company, during the years ended
January 3, 2009 and December 29, 2007, respectively.  These options
are forfeited if not exercised within periods of five to ten years, and vest
over periods ranging from immediately to forty-eight months starting with the
month of grant.  During 2008 the Company also granted 85,000 options
to purchase shares of the Company’s common stock to outside
consultants.  These options were fully vested upon issuance and have a
five year life.





On
October 13, 2005, in conjunction with the acquisition of EnergyConnect, the
Company granted 3,260,940 options at $0.32 per share to prior holders of options
in the EnergyConnect, Inc. Incentive Stock Option Plan.  These options
were granted with exercise dates of February 5, 2007 and February 5,
2008.  On February 5, 2007 1,342,740 of the 1,534,560 shares eligible
to be exercised, were exercised. The other 191,820 were not exercised, and
therefore were forfeited. Of the remaining 1,726,380 options 1,534,560 were
exercised on February 5, 2008.  The remaining 191,820 were not
exercised and therefore were forfeited.





On April
24, 2008, the Company closed on the agreement to sell the assets of CEI to its
management.  Coincident with that closing, 525,000 options held by CEI
employees and 1,297,500 options held by CEI’s President were subject to
forfeiture within 60 and 90 days of the closing, respectively, if not
exercised.  Before these time periods lapsed, 15,000 options were
exercised by a CEI employee and 428,500 options were exercised by CEI’s
President.





The
weighted average per share value of options granted during the years ended
January 3, 2009 and December 29, 2007 were $0.42 and $0.92
respectively.





45
 Index





The
Company computed the value of all options granted using the Black-Scholes
pricing model as prescribed by SFAS No. 123 and SFAS No. 123(R).  The
following ranges of assumptions were used to calculate the values of options
granted during 2008 and 2007:





January
      3,
                  
                  
                  December
      29,2009
                  
                  
                  2007Risk-free
      interest rate
                  
                  
                  1.72%
      - 3.54
                  %
                  
                  
                  3.42%
      - 4.64
                  %Expected
      dividend yield
                  
                  
                  -
                  
                  
                  
                  -Expected
      lives
                  
                  5
      years
                  
                  
                  5
      yearsExpected
      volatility
                  
                  
                  112%
      - 124
                  %
                  
                  
                  120%
      - 134
                  %





The
Company also granted 85,000 options to an outside consultant for services
rendered in 2008.  Compensation expenses charged to operations for
stock options issued to consultants amounted to approximately $29,000 and $0 for
the years ended January 3, 2009 and December 29, 2007,
respectively.





Common
Stock Warrants




In
connection with an April 2003 common stock private placement, we issued 111,308
warrants to purchase common stock. Each warrant is exercisable into one share of
common stock at $0.40 per share and will expire in 2008. Subsequent to this
private placement, the Company exercised an option to convert $1,400,000 of
outstanding debt into preferred stock that is convertible into shares of common
stock. This exercise, when aggregated with all other outstanding equity
arrangements, resulted in the total number of common shares that could be
required to be delivered to exceed the number of authorized common shares. In
accordance with EITF 00-19, the fair value of the warrants issued in the private
placement must be recorded as a liability in the financial statements using the
Black-Scholes model, and any subsequent changes in the Company’s stock price to
be recorded in earnings. Accordingly, the fair value of these warrants at the
date of issuance was determined to be $19,832. At September 1, 2004, the
Company’s shareholder’s voted to increase the authorized shares available for
issuance or conversion, which cured the situation described above. Accordingly,
the fair value of the warrants on September 1, 2004 was determined to be
$48,976. The warrant liability was reclassified to shareholders’ equity and the
increase from the initial warrant value was recorded in earnings in the fiscal
year ended January 1, 2005. As of December 29, 2007, the warrant holders had
exercised 101,308 warrants in exchange for 101,308 shares of our common
stock.  During 2008, 10,000 warrants issued in this financing were
forfeited and no warrants from this issuance remain outstanding.





In
September 2003, in connection with a preferred stock private placement, we
issued 333,334 warrants to purchase common stock. Each warrant is exercisable
into one share of common stock at $0.42 per share and will expire in 2008. In
September 2003, in connection with a preferred stock private placement, the
Company issued 333,334 warrants to purchase common stock.  Each
warrant is exercisable into one share of common stock at $0.42 per share and
will expire in 2008.  Subsequent to this private placement, the
Company exercised an option to convert $1,400,000 of outstanding debt into
preferred stock that is convertible into shares of common stock.  This
exercise, when aggregated with all other outstanding equity arrangements,
resulted in the total number of common shares that could be required to be
delivered to exceed the number of authorized common shares.  In
accordance with EITF 00-19, the fair value of the warrants issued in the private
placement must be recorded as a liability in the financial statements using the
Black-Scholes model, and any subsequent changes in the Company’s stock price to
be recorded in earnings.  Accordingly, the fair value of these
warrants at the date of issuance was determined to be $64,902.  At
September 1, 2004, the Company’s shareholder’s voted to increase the authorized
shares available for issuance or conversion, which cured the situation described
above.  Accordingly, the fair value of the warrants on September 1,
2004 was determined to be $139,000.  The warrant liability was
reclassified to shareholders’ equity and the increase from the initial warrant
value was recorded in earnings in the fiscal year ended January 1,
2005.  As of December 29, 2007, the warrant holders had exercised
183,333 warrants in exchange for 183,333 shares of our common stock and 150,001
warrants remained outstanding. During the year ended January 3, 2009, the
warrant holders exercised 34,467 warrants in exchange for 34,467 shares of our
common stock.   During 2008, 115,534 warrants issued in this
financing were forfeited and no warrants from this issuance remain
outstanding.





46
 Index





In
connection with the January 22, 2004 debt issuance by Destination Capital, LLC,
the Company was obligated to issue warrants to purchase the Company’s common
stock.  According to the terms of the debt issuance, warrants in the
amount of one percent of the Company’s fully diluted common stock were issued to
the debt holders on the first day of each calendar month that the debt was
outstanding.  The Company repaid this debt in April 2004, and
accordingly issued 1,403,547 warrants, which was equivalent to 4% of the fully
diluted common stock outstanding on that date under the terms outlined in that
agreement.  Each warrant is exercisable into one share of common stock
at $0.31 per share, subject to changes specified in the debt agreement, and will
expire in 2008.  Prior to this debt issuance, the Company exercised an
option to convert $1,400,000 of outstanding debt into preferred stock that is
convertible into shares of common stock.  This exercise, when
aggregated with all other outstanding equity arrangements, resulted in the total
number of common shares that could be required to be delivered to exceed the
number of authorized common shares.  In accordance with EITF 00-19,
the fair value of the warrants issued in connection with the debt issuance must
be recorded as a liability for warrant settlement in the financial statements
using the Black-Scholes model, and any subsequent changes in the Company’s stock
price to be recorded in earnings.  Accordingly, the aggregate fair
value of these warrants, on the date each of the obligations to issue warrants
arose, was determined to be $701,824.  At September 1, 2004, the
Company’s shareholder’s voted to increase the authorized shares available for
issuance or conversion, which cured the situation described
above.  Accordingly, the fair value of the warrants on September 1,
2004 was determined to be $780,373.  The warrant liability was
reclassified to shareholders’ equity and the increase from the initial warrant
value was recorded in earnings in the fiscal year ended January 1,
2005.  As of January 3, 2009 and December 29, 2007, the warrant
holders have exercised 1,403,546 warrants in exchange for 1,226,374 shares of
our common stock and no warrants remain outstanding.





In
connection with the August 24, 2004 debt issuance by Destination Capital, LLC,
the Company was obligated to issue warrants to purchase the Company’s common
stock.  According to the terms of the debt issuance, warrants in the
amount of 12.5% percent of the loan balance, outstanding on the first day of
each month, were issued to the debt holders for each calendar month that the
debt was outstanding.  Each warrant is exercisable into one share of
common stock at the lesser of $0.38 per share or the price applicable to any
shares, warrants or options issued (other than options issued to employees or
directors) while the loan is outstanding, and will expire in
2009.  Prior to this debt issuance, the Company exercised an option to
convert $1,400,000 of outstanding debt into preferred stock that is convertible
into shares of common stock.  This exercise, when aggregated with all
other outstanding equity arrangements, resulted in the total number of common
shares that could be required to be delivered to exceed the number of authorized
common shares.  In accordance with EITF 00-19, the fair value of the
37,500 warrants initially issued in connection with the debt issuance must be
recorded as a liability for warrant settlement in the financial statements using
the Black-Scholes model, and any subsequent changes in the Company’s stock price
to be recorded in earnings.  Accordingly, the aggregate fair value of
these warrants, issued prior to September 1, 2004, was determined to be
$17,513.  At September 1, 2004, the Company’s shareholder’s voted to
increase the authorized shares available for issuance or conversion, which cured
the situation described above.  Accordingly, the fair value of the
warrants on September 1, 2004 was determined to be $20,776.  The
warrant liability was reclassified to shareholders’ equity and the increase from
the initial warrant value was recorded in earnings in the fiscal year ended
January 1, 2005.  As of January 3, 2009 and December 29, 2007, the
warrant holders have exercised 1,309,616 of these warrants in exchange for
1,170,841 shares of our common stock, and 316,426 warrants remain
outstanding.





On
September 10, 2004, the Company entered into a Master Vehicle Lease
Termination Agreement with CLLLC, under which the Company terminated its
previous master vehicle lease agreement with CLLLC. Under the terms of this
termination agreement, the Company was released from its obligation under the
previous master vehicle lease agreement. In consideration for this release the
Company issued 1,000,000 warrants to purchase the Company’s common shares, which
were valued at $515,000 using the Black Scholes model. This warrant value was
recorded in the Company’s consolidated balance sheet as common stock warrants,
with a corresponding expense recorded in the Company’s consolidated statement of
operations in the third quarter of 2004. As of January 3, 2009 and December 29,
2007, the holders of these warrants have exercised 1,000,000 warrants in
exchange for 889,648 shares of the Company’s common stock.





On
October 5, 2005, in conjunction with a private placement which resulted in gross
proceeds of $3,276,000 (Note 8), the Company sold 5,233,603 shares of common
stock at $0.70 per share, and issued warrants to purchase up to 2,944,693 shares
of common stock.  The warrants have a term of five years and an
exercise price of $0.90 per share.  As of January 3, 2009 and December
29, 2007, the warrant holders have exercised 192,370 warrants, for 180,409
shares of our common stock, and 2,752,323 warrants remain
outstanding.





On
October 13, 2005, the Company issued an aggregate of 19,695,432 warrants in
connection with acquisition of acquired EnergyConnect, Inc. The Company valued
the warrants using the Black-Scholes option pricing model, applying a useful
life of 5 years, a risk-free rate of 4.06%, an expected dividend yield of 0%, a
volatility of 129% and a fair value of the common stock of
$2.17.  Total value of the warrants issued amounted $36,495,391, which
was included in the purchase price of ECI (Note 4). As of January 3, 2009 and
December 29, 2007, the warrant holders have not exercised any of these
warrants.





47
 Index





In June
2006, in connection with a common stock private placement, we issued 5,625,000
warrants to purchase common stock (See Note 8).  Each warrant is
exercisable into one share of common stock at $3.00 per share and will expire in
2011.  As of January 3, 2009 and December 29, 2007, the warrant
holders have not exercised any of these warrants.




During
the twelve months ended January 3, 2009 warrant holders exercised 34,467
warrants in exchange for 34,467 shares of the Company’s common stock. All of
these warrants were exercised in exchange for cash of $14,476.  A
total of 125,534 warrants were forfeited during 2008. On May 7, 2008, the
Company entered into a private placement under which it issued 9,051,310 shares
of its common stock in exchange for cash. In conjunction with this private
placement, the Company issued 4,525,655 five year warrants exercisable at $0.60
per share to investors. The Company also issued an aggregate of 140,219 5 year
warrants to consultants during the year ended January 3, 2009 with exercise
prices ranging from $.40 to $.60 per share.




During
the twelve months ended December 29, 2007 no warrants were granted, exercised or
forfeited.








10.   Debt





Operating
Line of Credit





The
Company has a loan facility which is an unsecured $120,000 line of credit at
prime plus 3 3⁄4%, due on demand with interest payable monthly.  As of
January 3, 2009 and December 29, 2007, there was $117,257 and $118,456
outstanding, respectively, under this line.  The Company was in
compliance with the terms of this line of credit at January 3,
2009.  The Company had no other term debt or loans outstanding at
January 3, 2009.








11.  Segment
Information





The
continuing operations of this business are comprised of one line of business in
the energy and demand response industry.  Therefore, no segment
information disclosures are provided.








12.  Income
Taxes





The
provision for income taxes for the years ended January 3, 2009, and December 29,
2007 differs from the amount which would be expected as a result of applying the
statutory tax rates to the losses before income taxes due primarily to changes
in the valuation allowance to fully reserve net deferred tax
assets.





As of
January 3, 2009, and December 29, 2007, EnergyConnect had deferred tax assets
primarily consisting of its net operating loss
carryforwards.  However, because of cumulative losses in several
consecutive years, the Company has recorded a full valuation allowance such that
its net deferred tax asset is zero.  The tax benefit recorded at the
statutory rate in EnergyConnect’s pre-tax loss in fiscal years 2008 and 2007
would have been approximately $4,283,213 and $4,363,892,
respectively.  However, because of recognition of a full valuation
allowance the effective tax rate for the Company was zero in 2008 and
2007.





Deferred
tax assets are comprised of the following components:





January
      3, 2009
                    
                    
                    December
      29, 2007Current:Allowance
      for doubtful accounts
                    
                    $
                    -
                    
                    
                    $
                    74,552Inventory
      allowance
                    
                    
                    -
                    
                    
                    
                    23,100Audit
      and other related costs
                    
                    
                    53,448
                    
                    
                    
                    48,125Other
      allowances
                    
                    
                    -
                    
                    
                    
                    13,47553,448
                    
                    
                    
                    159,252Non-current:Net
      operating loss carry forwards
                    
                    
                    21,213,009
                    
                    
                    
                    18,982,051Research
      and development credits
                    
                    
                    101,445
                    
                    
                    
                    101,44521,314,454
                    
                    
                    
                    19,083,496Total
      deferred tax asset
                    
                    
                    21,367,902
                    
                    
                    
                    19,242,748Deferred
      tax asset valuation allowance
                    
                    
                    (21,367,902
                    )
                    
                    
                    (19,242,748
                    )Net
      deferred tax assets
                    
                    $
                    -
                    
                    
                    $
                    -





48
 Index





At
January 3, 2009, the Company had available net operating loss carryforwards of
approximately $55,099,000 for federal income tax purposes. Such carryforwards
may be used to reduce consolidated taxable income, if any, in future years
through their expiration in 2008 to 2027 subject to limitations of Section 382
of the Internal Revenue Code, as amended.  Utilization of net
operating loss carryforwards may be limited due to the ownership changes
resulting from the Company’s initial public offering in 1995 and the Company’s
acquisitions since then.  In addition, the Company has research and
development credits aggregating $101,445 for income tax purposes at January 3,
2009.  Such credits may be used to reduce taxes payable, if any, in
future years through their expiration in 2008 to 2013.








13.   Net
Income (Loss) Per Share





Net
income per share is computed based on the weighted average number of shares of
common stock and potentially dilutive securities assumed to be outstanding
during the period using the treasury stock method. Potentially dilutive
securities consist of stock options, convertible preferred stock and warrants to
purchase common stock.





The most
significant difference between basic and diluted net income per share is that
basic net income per share does not treat potentially dilutive securities such
as preferred stock, stock options and warrants as outstanding.  For
the years ended January 3, 2009 and December 29, 2007, the computation of net
loss per share excludes the effect of stock options and warrants as they were
antidilutive.  There were 6,078,870 options and 33,055,055 warrants
outstanding at January 3, 2009, and 9,723,750 options and 28,549,182 warrants
outstanding at December 29, 2007.





The
following table presents the computation of basic and diluted losses per
share:





Year
      ended
                                    
                                    
                                    Year
      endedJanuary
      3, 2009
                                    
                                    
                                    December
      29, 2007Net
      loss
                                    
                                    $
                                    34,077,051
                                    
                                    
                                    $
                                    (14,035,506
                                    )Basic
      and diluted loss per shareContinuing
      operations
                                    
                                    $
                                    (0.37
                                    )
                                    
                                    $
                                    (0.17
                                    )Discontinued
      operations
                                    
                                    $
                                    (0.00
                                    )
                                    
                                    $
                                    (0.05
                                    )$
                                    (0.37
                                    )
                                    
                                    $
                                    (0.12
                                    )Basic
      weighted average common shares outstanding
                                    
                                    
                                    91,245,072
                                    
                                    
                                    
                                    82,536,027Diluted
      weighted average common shares outstanding
                                    
                                    
                                    91,245,072
                                    
                                    
                                    
                                    82,536,027





49
 Index


14.   Commitments and
Contingencies


Operating
lease commitments





The
Company is party to three facility lease agreements and one equipment lease
agreement. Following is a schedule of the Company’s annual operating lease
commitments as of January 3, 2009 for the coming five years.





Year
                  
                  Amount2009
                  
                  $
                  306,4922010
                  
                  
                  255,3872011
                  
                  
                  148,4212012
                  
                  
                  -2013
      and beyond
                  
                  
                  -Total
                  
                  $
                  710,300





Rental
expenses charged to operations for the year ended January 3, 2009 and December
29, 2007 were $313,686 and $135,571, respectively.








15.   Legal
Proceedings





During
2008, we were contacted by FERC and asked to provide information to them as part
of a non-public inquiry on the demand response markets, and our activity in our
markets under the FERC tariffs.  Over a period of 8 months we provided
them with the requested documentation both in paper and electronic form, and
voluntarily provided them with access to certain of our employees in an effort
to answer all questions put forth to us.  Our responses under the
inquiry were completed on December 31, 2008, and we are currently waiting for
word from FERC as to whether the inquiry is closed, or if they require further
information and assistance from us.  We believe that we have complied
with applicable law, although we cannot provide any assurance
that FERC will not bring formal proceedings against the
Company.





From time
to time, we may become involved in various lawsuits and legal proceedings which
arise in the ordinary course of business. However, litigation is subject to
inherent uncertainties, and an adverse result in these or other matters may
arise from time to time that may harm our business. We are currently not aware
of any such legal proceedings or claims other than those mentioned in this Item
that we believe will have, individually or in the aggregate, a material adverse
affect on our business, financial condition or operating results.








16. 
Going Concern Matters





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.  As shown in the
consolidated financial statements during the year ended January 3, 2009, the
Company incurred net losses of $34,077,050 and generated negative cash flow from
operations in the amount of $4,100,473.  The Company’s current
liabilities exceeded its current assets by $7,506 as of January 3,
2009.  These factors among others may indicate that the Company may be
unable to continue as a going concern for a reasonable period of
time.





The
Company's existence is dependent upon management's ability to develop profitable
operations and resolve its liquidity problems.  Management anticipates
the Company will attain profitable status and improve its liquidity through
continued growth, distribution and sale of its products and services, and
additional equity investment in the Company.  The accompanying
consolidated financial statements do not include any adjustments that might
result should the Company be unable to continue as a going concern.





At
January 3, 2009, the Company did not have any available credit, bank financing
or other external sources of liquidity. Due to our brief history and historical
operating losses, our operations have not been a source of liquidity. In
February 2009, the Company secured additional financing that will supplement the
Company’s cash needs for 2009.  While we believe this debt facility
along with cash generated by operations will be adequate for the next twelve
months, we may need to obtain additional capital in order to expand operations
and become profitable. In order to obtain capital, we may need to sell
additional shares of our common stock or borrow funds from private lenders.
There can be no assurance that we will be successful in obtaining additional
funding.





We may
still need additional investments in order to continue operations to cash flow
break even. Additional investments may being sought, but we cannot guarantee
that we will be able to obtain such investments. Financing transactions may
include the issuance of equity or debt securities, obtaining credit facilities,
or other financing mechanisms. However, the trading price of our common stock
and the downturn in the U.S. stock and debt markets could make it more difficult
to obtain financing through the issuance of equity or debt securities. Even if
we are able to raise the funds required, it is possible that we could incur
unexpected costs and expenses, fail to collect significant amounts owed to us,
or experience unexpected cash requirements that would force us to seek
alternative financing. Further, if we issue additional equity or debt
securities, stockholders may experience additional dilution or the new equity
securities may have rights, preferences or privileges senior to those of
existing holders of our common stock. If additional financing is not available
or is not available on acceptable terms, we may have to curtail our
operations.





50
 Index





By
adjusting the Company’s operations and development to the level of
capitalization, management believes it has sufficient capital resources to meet
projected cash flow deficits. However, if during that period or thereafter, the
Company is not successful in generating sufficient liquidity from operations or
in raising sufficient capital resources, on terms acceptable to them, this could
have a material adverse effect on the Company’s business, results of operations
liquidity and financial condition. If operations and cash flows continue to
improve through these efforts, management believes that the Company can continue
to operate.  However, no assurance can be given that management’s
actions will result in profitable operations or the resolution of its liquidity
problems.








17.  Subsequent
Events





New CEO





The
Company appointed Kevin R. Evans President and Chief Executive effective January
5, 2009.  Mr. Evans will also serve as a director on the Company’s
Board of Directors.  It has not yet been determined whether Mr. Evans
will serve on any board committees in his capacity as
director.  During the past five years Mr. Evans has been Senior Vice
President, Chief Business Officer, and Chief Financial Officer of the Electric
Power Research Institute (“EPRI”), a world renowned leader in research and
development in the electricity industry.  While at EPRI, Mr. Evans was
instrumental in building its sales, marketing, planning and regulatory
programs.  Prior to joining EPRI, Mr. Evans was the Chief Financial
Officer of PlaceWare, a leading designer and producer of collaboration and
meeting software.  He helped develop the company through its startup
phase, raised several rounds of capital, and ultimately sold it to
Microsoft.  Prior to PlaceWare, he had substantial banking and
international business experience.  Mr. Evans holds an MBA in finance
from San Diego State University and a dual baccalaureate in Economics and
Management from Sonoma State University.





Pursuant
to an employment agreement, the Company has agreed to pay Mr. Evans an annual
base salary of $300,000.  Mr. Evans also received a grant of four
million stock options, consistent with the Company’s approved stock option plan,
with an exercise price equal to $0.12, the closing price of the Company’s stock
on January 5, 2009.  In addition, and pursuant to a change of control
agreement, the Company has agreed to pay Mr. Evans twelve months of severance
pay upon a change of control of the Company or upon Mr. Evan’s termination
without cause or his resignation for good reason.





Debt
Facility





On
February 26, 2009 we entered into a Business Loan Agreement, a Convertible
Secured Promissory Note and Commercial Security Agreement (collectively the
“Loan Agreements”) with Aequitas Commercial Finance, LLC
(“Aequitas”).  Aequitas is a commercial finance company that provides
loan and lease financing to companies. Aequitas is managed by Aequitas Capital
Management, Inc. (“Aequitas Capital”). Aequitas Capital and its affiliates have
previously provided the Companies with debt and equity
financing.  William C. McCormick, the Chairman of the Board of
Directors of EnergyConnect Group, Inc., is a member of the Advisory Board
of Aequitas Capital.





Pursuant
to the terms and conditions of the Loan Agreements, Aequitas will provide the
Companies with a revolving credit facility enabling the Companies to borrow
money in a maximum principal amount not to exceed $5,000,000.  The
current interest rate for funds borrowed by the Companies in the first twelve
(12) month term is twenty-three percent (23%) with an additional seven percent
(7%) deferred interest per annum.  The accrued deferred interest shall
be added to the then current principal balance of the loan at the end of the
first twelve (12) month term.  The interest rate for funds borrowed in
the second twelve (12) month term is thirty percent (30%).  The loan
matures on January 1, 2011.  As security for this loan, the Companies
granted Aequitas a first priority security interest in the assets of the
Companies.  The Loan Agreements grant Aequitas the right to convert up
to two-thirds (2/3rds) of unpaid principal and interest into shares of ECNG’s
common stock at an exercise price of $0.09.





51
 Index




18.  Selected
Quarterly Data (UNAUDITED)




The
following table sets forth selected unaudited quarterly information for the
Company’s year-ended January 3, 2009 and December 29, 2007.





Quarters
      ended in 2008
                  
                  March
      29
                  
                  
                  June
      28
                  
                  
                  September
      27
                  
                  
                  January
      3, 2009Revenue
                  
                  $
                  7,379,000
                  
                  
                  $
                  5,063,000
                  
                  
                  $
                  11,641,000
                  
                  
                  $
                  1,776,000Gross
      Profit
                  
                  
                  1,192,000
                  
                  
                  
                  763,000
                  
                  
                  
                  5,183,000
                  
                  
                  
                  301,000Provision
      for income taxes
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -Basic
      and diluted loss per share
                  
                  
                  (0.03
                  )
                  
                  
                  (0.02
                  )
                  
                  
                  0.02
                  
                  
                  
                  (0.33
                  )Quarters
      ended in 2007
                  
                  March
      31
                  
                  
                  June
      30
                  
                  
                  September
      29
                  
                  
                  December
      29Revenue
                  
                  $
                  2,600,000
                  
                  
                  $
                  3,117,000
                  
                  
                  $
                  4,690,000
                  
                  
                  $
                  2,218,000Gross
      Profit
                  
                  
                  432,000
                  
                  
                  
                  616,000
                  
                  
                  
                  2,446,000
                  
                  
                  
                  343,000Provision
      for income taxes
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -Basic
      and diluted loss per share
                  
                  
                  (0.02
                  )
                  
                  
                  (0.01
                  )
                  
                  
                  0.01
                  
                  
                  
                  (0.14
                  )





There was
no allowance for doubtful accounts or any bad debt expense in the continuing
operations for any of the years presented.





52
 Index





ITEM9.  CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
ACCOUNTING AND FINANCIAL DISCLOSURE




None.







ITEM9A.  CONTROLS AND PROCEDURES





Disclosure
controls and procedures are controls and other procedures that are designed to
ensure that information required to be disclosed by us in the reports that we
file or submit under the Exchange Act is recorded, processed, summarized and
reported, within the time periods specified in the Securities and Exchange
Commission’s rules and forms. Disclosure controls and procedures include,
without limitation, controls and procedures designed to ensure that information
required to be disclosed by us in the reports that we file under the Exchange
Act is accumulated and communicated to our management, including our principal
executive and financial officers, as appropriate to allow timely decisions
regarding required disclosure.








Evaluation of Disclosure Controls and
Procedures





As of the
end of the period covered by this Annual Report, we carried out an evaluation,
under the supervision and with the participation of our Chief Executive Officer
(CEO) and Chief Financial Officer (CFO), of our disclosure controls and
procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the
Securities Exchange Act of 1934, as amended (the “Exchange
Act”)).  Based on that  evaluation our CEO and CFO
concluded, as of the end of such period,  our disclosure controls and
procedures were effective in ensuring that the information required to be filed
or submitted under the Exchange Act is recorded, processed, summarized and
reported as specified in the Securities and Exchange Commission's rules and
forms, and accumulated and communicated to our management, including our CEO and
CFO, as appropriate to allow timely decisions regarding required
disclosure.  Our management has undergone an intensive testing process
with respect to our disclosure controls and procedures measures, which includes
the establishment of new internal policies related to financial
reporting.










Management’s
Annual Report on Internal Control over Financial Reporting







Our
management is responsible for establishing and maintaining adequate internal
control over financial reporting, as such term is defined in Exchange Act
Rules 13a-15(f) and 15d-15(f).  Those rules define internal
control over financial reporting as a process designed to provide reasonable
assurance regarding the reliability of financial reporting and the preparation
of financial statements for external purposes in accordance with generally
accepted accounting principles. Our internal control over financial reporting
includes those policies and procedures that:





·
            pertain
      to the maintenance of records that, in reasonable detail, accurately and
      fairly reflect the transactions and dispositions of our
      assets;








·
            provide
      reasonable assurance that transactions are recorded as necessary to permit
      preparation of financial statements in accordance with generally accepted
      accounting principles, and that receipts and expenditures are being made
      only in accordance with authorizations of our management and directors;
      and








·
            provide
      reasonable assurance regarding prevention or timely detection of
      unauthorized acquisition, use or disposition of our assets that could have
      a material effect on the financial
statements.





Because
of its inherent limitations, internal control over financial reporting may not
prevent or detect misstatements. Also, projection of any evaluation of
effectiveness to future periods is subject to the risk that controls may become
inadequate because of changes in conditions, or that the degree of compliance
with the policies or procedures may deteriorate.





53
 Index





A
material weakness is a control deficiency (as defined in PCAOB Auditing Standard
No. 2 and as amended by PCOAB Auditing Standard No. 5), or combination of
control deficiencies, that results in there being more than a remote likelihood
that a material misstatement of the annual or interim financial statements will
not be prevented or detected.





Management’s
assessment of the effectiveness of our internal control over financial reporting
has not identified any material weaknesses as of January 3, 2009.  In
making this assessment, management used the criteria set forth by the Committee
of Sponsoring Organizations of the Treadway Commission (COSO) in Internal
Control-Integrated Framework.


This
annual report does not include an attestation report of the Company's
independent registered public accounting firm regarding internal control over
financial reporting. Management's report was not subject to attestation by the
Company's independent registered public accounting firm pursuant to rules of the
SEC that permit the Company to provide only management's report in this annual
report.


Changes
in Internal Control over Financial Reporting





There
were no changes in internal controls over financial reporting that occurred
during the period covered by this report that have materially affected, or are
reasonably likely to materially effect, our internal control over financial
reporting.








ITEM9B.  OTHER INFORMATION





None





54
 Index





PART
III





ITEM10.  DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND
CONTROL PERSONS;





The following table sets forth
information regarding our directors and executive officers as of January 3,
2009:





Name
                              
                              Age
                              
                              PositionsRodney
      M. Boucher
                              
                              65
                              
                              Chief
      Executive Officer and DirectorRandall
      R. Reed
                              
                              52
                              
                              Chief
      Financial OfficerGene
      Ameduri
                              
                              60
                              
                              President
      of ECI and DirectorWilliam
      C. McCormick
                              
                              75
                              
                              Chairman
      of the Board of DirectorsGary
      D. Conley
                              
                              48
                              
                              DirectorJohn
      Metcalf
                              
                              58
                              
                              DirectorKurt
      E. Yeager
                              
                              69
                              
                              Director





Directors
are elected to serve until the next annual meeting of stockholders and until
their successors are elected and qualified. Currently there are six directors on
our board of directors.  Those directors considered as outside
directors, were compensated $500 for each board meeting held at the Company’s
headquarters or other location where the director is required to
travel.  Starting with the fourth quarter of 2008, outside directors
were compensated for their position as directors and for their chairmanship and
participation on the board committees.  Each year at the discretion of
the board, directors are awarded a certain number of non-qualified stock
options.  During 2008 no options were granted to board
members.  Officers are elected by the Board of Directors and serve
until their successors are appointed by the Board of Directors. Biographical
resumes of each officer and director are set forth below.





Rodney M. Boucher joined us
through the acquisition of EnergyConnect in October 2005.  He was
appointed Chief Executive Officer on that date.  Prior to that date
Mr. Boucher was the founder, President and CEO of EnergyConnect, Inc. from its
inception in 1998 until its acquisition by us in October 2005.  Before
forming EnergyConnect Mr. Boucher was Chief Executive Officer of Calpine Power
Services and Senior Vice President of Calpine Corporation from 1995 to
1998.  Prior to that Mr. Boucher served as Chief Operating Officer of
Citizens Power and Light and held a number of senior management positions with
PacifiCorp and United Illuminating Company including Chief Information Officer,
Vice President of Operations, Vice President of Power Resources, and Director of
Engineering.  Mr. Boucher holds an AMP certificate from Harvard
Business School, a MS in electrical engineering from Rensselaer Polytechnic
University and a Bachelor of Science from Oregon State
University.  Mr. Boucher is a member of several non-profit boards and
a senior fellow of the American Leadership Forum.  Mr. Boucher
resigned his position effective January 3, 2009.





Randall R. Reed joined us in
September 2005 when he was appointed Chief Financial Officer.  Mr.
Reed provided financial, accounting and SEC consulting for us from September
2002 through September 2005 through his consulting firm Reed Financial Services,
which he operated from January 2001 through September 2005.  From July
1999 to January 2001, Mr. Reed was Chief Financial Officer for Dry, Inc. a
consumer products company.  Mr. Reed was Chief Financial Officer and
Controller of EnergyConnect Graphics, Inc., a publicly traded manufacturer of
technology products from August 1985 to July 1999.  Prior to his
position there he was with Coopers & Lybrand, an international public
accounting firm, from 1981 to 1985. Mr. Reed is presently serving on the Board
of Directors for Bio-Reaction Industries LLC.  Mr. Reed is a
CPA.  Mr. Reed holds a BS in Business Administration from Southern
Oregon University.





Gene Ameduri joined us in
October 2005 through our acquisition of EnergyConnect, Inc.  On that
date he was named President of EnergyConnect.  He joined EnergyConnect
in 2003 as Senior Vice President.  Prior to that, Mr. Ameduri was with
Roth Brothers, Inc., a mechanical contractor.  Roth Brothers is a
subsidiary of First Energy. He was there from 1981 to 2003, and held the office
of Vice President of the Facilities Automation Division among other management
positions.  Mr. Ameduri holds a BS in Engineering from Case Western
Reserve University and an MS in Mechanical Engineering from Youngstown State
University.  Mr. Ameduri is a Registered Professional Engineer in
Ohio, Pennsylvania and Florida.





55
 Index





William C. McCormick joined us
in January 2004 as Interim Chief Executive Officer and resigned that post
in November 2004.  Prior to coming to us, Mr. McCormick was
Chief Executive Officer of Precision Castparts, Corp., a publicly traded
aerospace company, from August 1994 to August 2002. He also served as the
Chairman of the board of directors there from October 1994 to
August 2003. Mr. McCormick joined Precision Castparts in
April 1985. Prior to Precision Castparts, Mr. McCormick spent
32 years at General Electric in various businesses, including GE Aircraft
Engines, Carboloy Systems, Distribution Equipment, and Industrial Electronics.
Mr. McCormick serves on the board of directors of Merix Corporation, a
publicly traded manufacturer of high performance interconnect products. He
serves on the boards of several other “for profit” and non profit companies.
McCormick holds a BS in Mathematics from the University of
Cincinnati.  Mr. McCormick is currently employed by the
Company.





Gary D. Conley was elected as
a director on December 13, 2005.  Mr. Conley is currently the CEO of
SolFocus, a concentrator of solar technology founded to commercialize advanced
concentrator solar technology.  Mr. Conley was CEO of GuideTech, a
manufacturer of semiconductor test equipment from July 2003 to February
2005.  Prior to that, Mr. Conley was Senior Vice President in charge
of the Memory Test Division at Credence Corporation, a manufacturer of
semiconductor test equipment, from May 1993 to November 1996.  Mr.
Conley was President of EPRO, a manufacturer of semiconductor test equipment
from January 1990 to May 1993, at which time the business was sold to
Credence.  Mr. Conley has been an active investor in early stage,
advanced technology companies.  He sits on the boards of several
companies.  Mr. Conley holds a BS degree in Physics from the
University of South Florida.





John P. Metcalf was elected as
a director on June 29, 2007.  Since November 2002, Mr. Metcalf has
been a CFO Partner with Tatum LLC, the largest executive services and consulting
firm in the United States. Mr. Metcalf has 18 years experience as a CFO, most
recently at ESI, a provider of high-technology manufacturing equipment to the
global electronics market. Prior to ESI, Mr. Metcalf served as CFO for
Siltronic, WaferTech, Siltec Corporation, and OKI Semiconductor. Mr. Metcalf
began his career at AMD, where he worked for eleven years in a number of finance
managerial positions including Director and Controller of North American
Operations. Mr. Metcalf also currently serves on the Board of Directors and is
Chairman of the Audit Committee for ParkerVision (NASDAQ:PRKR).





Kurt E. Yeager was elected as
a director on May 10, 2007.  Mr. Yeager has more than 30 years of
experience in the energy industry and energy research and was the past President
and Chief Executive Officer of the Electric Power Research Institute (“EPRI”),
the national collaborative research and development organization for electric
power.  Under Mr. Yeager's leadership, EPRI evolved from a non-profit
electric power research institute into a family of companies encompassing
collaborative and proprietary R&D as well as technical solution applications
for the electricity enterprise in the U.S. and over 40 other
countries.  As CEO, Mr. Yeager also led the electricity
enterprise-wide collaborative development of the landmark Electricity Technology
Roadmap, and the Electricity Sector Framework for the
Future.   Mr. Yeager also served as the director of Energy
R&D Planning for the EPA Office of Research.  Prior to that, he
was with the MITRE Corporation as associate head of the Environmental Systems
Department.





Compliance
with Section 16(a) of the Exchange Act





Section 16(a) of
the Securities Exchange Act of 1934 requires our officers and directors, and
persons who own more than ten percent of a registered class of our equity
securities, to file reports of ownership and changes in ownership with the
Securities and Exchange Commission.  Officers, directors and greater than
ten percent stockholders are required by SEC regulation to furnish us with
copies of all Section 16(a) forms they file.




Based on
a review of the copies of such forms received, we believe that during 2008, all
filing requirements applicable to our officers, directors and greater than ten
percent beneficial owners were complied with.





Audit
Committee





The Audit
Committee consists of Mr. Metcalf, Mr. Yeager and Mr.
McCormick.  The Board of Directors has determined that Mr. Metcalf is
an “audit committee financial expert” as defined in SEC rules. The audit
committee held several meetings during fiscal year 2008 coincident with the
filing of SEC quarterly Forms 10-QSB and other press releases involving
financial matters.  On November 29, 2007, the board approved a revised
Audit Committee charter.  On August 21, 2007, Mr. Metcalf was
appointed Chairman of the audit committee.  Mr. Yeager was also
appointed to the audit committee on that date.  Mr. McCormick was
appointed to the audit committee on October 1, 2008.





56
 Index





The Audit
Committee oversees the accounting, financial reporting and audit processes;
makes recommendations to the board of directors regarding the selection of
independent auditors; reviews the results and scope of audit and other services
provided by the independent auditors; reviews the accounting principles and
auditing practices and procedures to be used in preparing the Company’s
financial statements; and reviews the Company’s internal controls.





Governance
Committee





On August
21, 2007, the board of directors appointed Mr. Yeager as chairman of the
Governance committee, joining  Mr. Conley, Mr. Metcalf and Mr.
McCormick as members of that committee. Mr. Conley left the committee as of
October 1, 2008.  The current policy requires that the governance
committee consist of at least two Board Members. The governance committee had
several meetings and discussions throughout 2008.  A copy of our Code of
Ethics is available from us by contacting Mr. Bill Munger, c/o EnergyConnect
Group, Inc., 5335 SW Meadows., Suite 325, Lake Oswego, Oregon
97035.





Compensation
Committee





Our
compensation committee consisted on Mr. Conley, as Chairman, Mr. Yeager and Mr.
Metcalf as committee members.  All three members were appointed to
their positions on November 29, 2007. The compensation committee had several
meetings during the year and numerous informal meetings and discussions
throughout 2008. The committee determines the compensation level, option grants
and other compensation for our executive officers.




Compensation
Committee Interlocks and Insider Participation




During
our 2008 fiscal year, no member of our compensation committee had a position as
an officer of our company.  None of the members of our compensation
committee had any other relationship with us.




During
the fiscal year ended January 3, 2009, one of our executive officers, Rod
Boucher served as a director on the board of Solfocus, Inc. whose Chief
Executive Officer, Gary Conley sat on the compensation committee of our
company.  At the November 29, 2007 board of directors meeting, Mr.
Conley resigned from the Compensation Committee and rejoined as chairman of that
committee in October 1, 2008.







ITEM11.  EXECUTIVE COMPENSATION





The
following table provides certain summary information concerning compensation
awarded to, earned by or paid to our Chief Executive Officer, Chief Financial
Officer and our two other executive officers  whose total annual salary and
bonus exceeded $100,000 (collectively, the “named officers”) for fiscal years
2008, 2007 and 2006.





SUMMARY
COMPENSATION TABLE





AllOtherOption
                                        
                                        
                                        CompensationName & Principal Position
                                        
                                        Year
                                        
                                        Salary ($)
                                        
                                        
                                        Awards ($) *
                                        
                                        
                                        ($) (7)
                                        
                                        
                                        Total ($)Rodney
      M. Boucher (1)
                                        
                                        2008
                                        
                                        
                                        300,000
                                        
                                        
                                        
                                        61,334
                                        
                                        
                                        
                                        13,974
                                        
                                        
                                        
                                        375,308Chief
      Executive Officer and Director
                                        
                                        2007
                                        
                                        
                                        300,000
                                        
                                        
                                        
                                        41,430
                                        
                                        
                                        
                                        12,415
                                        
                                        
                                        
                                        353,8452006
                                        
                                        
                                        300,000
                                        
                                        
                                        
                                        2,771
                                        
                                        
                                        
                                        12,415
                                        
                                        
                                        
                                        315,186Randall
      R. Reed (2)
                                        
                                        2008
                                        
                                        
                                        208,000
                                        
                                        
                                        
                                        61,334
                                        
                                        
                                        
                                        1,469
                                        
                                        
                                        
                                        270,803Chief
      Financial Officer
                                        
                                        2007
                                        
                                        
                                        208,000
                                        
                                        
                                        
                                        34,349
                                        
                                        
                                        
                                        -
                                        
                                        
                                        
                                        242,3492006
                                        
                                        
                                        208,000
                                        
                                        
                                        
                                        19,250
                                        
                                        
                                        
                                        -
                                        
                                        
                                        
                                        227,250Gene
      Ameduri (3)
                                        
                                        2008
                                        
                                        
                                        200,000
                                        
                                        
                                        
                                        43,234
                                        
                                        
                                        
                                        6,666
                                        
                                        
                                        
                                        249,900President
      of ECI and Director
                                        
                                        2007
                                        
                                        
                                        200,000
                                        
                                        
                                        
                                        16,249
                                        
                                        
                                        
                                        5,736
                                        
                                        
                                        
                                        221,9852006
                                        
                                        
                                        200,000
                                        
                                        
                                        
                                        1,150
                                        
                                        
                                        
                                        5,736
                                        
                                        
                                        
                                        206,886John
      Stremel (4)
                                        
                                        2008
                                        
                                        
                                        180,000
                                        
                                        
                                        
                                        25,639
                                        
                                        
                                        
                                        224,429
                                        (5)
                                        
                                        
                                        430,068Senior
      Vice President
                                        
                                        2007
                                        
                                        
                                        180,000
                                        
                                        
                                        
                                        7,649
                                        
                                        
                                        
                                        99,746
                                        (5)
                                        
                                        
                                        287,3952006
                                        
                                        
                                        180,000
                                        
                                        
                                        
                                        501
                                        
                                        
                                        
                                        501
                                        
                                        
                                        
                                        180,501




57
 Index





*
            Amounts
      represented stock-based compensation expense for fiscal year 2008 under
      SFAS 123R as discussed in Note 2, “Stock-Based Compensation” of
      the Notes to Consolidated Financial Statements included elsewhere in this
      annual report.





(1)
            Mr.
      Boucher was appointed our Chief Executive Officer on October 13, 2005 and
      President of EnergyConnect Group, Inc. on February 27,
      2008.  Mr. Boucher resigned as CEO of the Company
      effective  January 3, 2009, and is now a consultant to the
      Company.  Mr. Boucher remained on the Board of
      Directors.




(2)
            Mr.
      Reed was appointed our Chief Financial Officer on September 19,
      2005.




(3)
            Mr.
      Ameduri was appointed President of ECI on October 13, 2005.  Mr.
      Ameduri resigned from the Company effective March 6, 2009, and he remained
      on the Board of Directors.





(4)
            Mr.
      Stremel was appointed Senior Vice President on October 13,
      2005.





(5)
            This
      income is the result of gains upon the exercise of non-statutory stock
      options received by Mr. Stremel at the acquisition date of
      EnergyConnect.  Mr. Stremel exercised 575,460 options in 2008
      and 383,640 options in the 2007.











Employment
Agreements With Named Executive Officers




As of
January 3, 2009, we had not entered into employment agreements with any of our
executive officers.  On January 5, 2009 the Company appointed Kevin R.
Evans President and Chief Executive Officer, and a director.  Pursuant
to an employment agreement we have agreed to pay Mr. Evans an annual base salary
of $300,000.  Mr. Evans also received a grant of four million stock
options exercisable at $0.12 per share.  Pursuant to a change in
control agreement, the Company has agreed to pay Mr. Evans twelve months of
severance pay upon a change in control or upon Mr. Evans termination without
cause, or his resignation for good reason.





Outstanding
equity awards at fiscal year-end





The
following table sets forth information with respect to grants of options to
purchase our common stock under our Stock Incentive Plan to the named officers
as of January 3, 2009.





Name
                                  
                                  Number
                                    of
                                    Securities
                                    Underlying
                                    Unexercised
                                    Options
                                    (#)
                                    Exercisable
                                  
                                  
                                  Number
                                    of
                                    Securities
                                    Underlying
                                    Unexercised
                                    Options
                                    (#)
                                    Unexercisable
                                  
                                  
                                  Option
                                    Exercise
                                    Price
                                    ($)
                                  
                                  Option
                                    Expiration
                                    DateRodney
      M. Boucher
                                  
                                  
                                  135,417
                                  
                                  
                                  
                                  364,583
                                  
                                  
                                  $
                                  0.94
                                  
                                  11/29/12122,396
                                  
                                  
                                  
                                  112,604
                                  
                                  
                                  $
                                  0.65
                                  
                                  11/21/11Randall
      R. Reed
                                  
                                  
                                  40,625
                                  
                                  
                                  
                                  109,375
                                  
                                  
                                  $
                                  0.94
                                  
                                  11/29/1250,781
                                  
                                  
                                  
                                  46,719
                                  
                                  
                                  $
                                  0.65
                                  
                                  11/21/1116,667
                                  
                                  
                                  
                                  83,333
                                  
                                  
                                  $
                                  0.84
                                  
                                  8/23/10Gene
      Ameduri
                                  
                                  
                                  40,625
                                  
                                  
                                  
                                  109,375
                                  
                                  
                                  $
                                  0.94
                                  
                                  11/29/1250,781
                                  
                                  
                                  
                                  46,719
                                  
                                  
                                  $
                                  0.65
                                  
                                  11/21/11John
      Stremel
                                  
                                  
                                  27,083
                                  
                                  
                                  
                                  72,917
                                  
                                  
                                  $
                                  0.94
                                  
                                  11/29/1222,135
                                  
                                  
                                  
                                  20,365
                                  
                                  
                                  $
                                  0.65
                                  
                                  11/21/11








58
 Index





Director
Compensation




During
the year ended January 3, 2009, the Board of Directors voted to increase the
compensation paid to independent directors.  Previous to this change,
independent directors were paid $500 per formal, in-person
meeting.  Meetings attended by telephone were not
compensated.  Starting with the third quarter of 2008, the independent
directors are to be paid quarterly, one fourth of an annual
retainer.  These annual retainers were set at $40,000 for the Chairman
and $20,000 for independent directors.  Each independent director is
also to be compensated for his or her participation on board committees and for
duties as a committee chair.  These annual retainers range from $2,000
to $3,000 for committee participation, and from $6,000 to $9,000 for
chairmanship of a board committee.





The
following table sets forth summary information concerning the total compensation
paid to our independent directors in 2008 for services to our
company.  No stock option awards were granted to directors during
2008.





Name
                  
                  Fees Earned
                    or Paid in
                    Cash
                    ($)
                  
                  
                  Option
                    Awards
                    ($)
                  
                  
                  Total
                    ($)William
      C. McCormick
                  
                  $
                  11,750
                  
                  
                  $
                  -
                  
                  
                  $
                  11,750Gary
      D. Conley
                  
                  $
                  7,875
                  
                  
                  $
                  -
                  
                  
                  $
                  7,875Kurt
      E. Yeager
                  
                  $
                  8,875
                  
                  
                  $
                  -
                  
                  
                  $
                  8,875John
      P. Metcalf
                  
                  $
                  9,375
                  
                  
                  $
                  -
                  
                  
                  $
                  9,375Phillip
      G. Harris (1)
                  
                  $
                  1,000
                  
                  
                  $
                  -
                  
                  
                  $
                  1,000





(1)
 Mr. Harris resigned from the board of directors on September 1,
2008.





59
 Index





ITEM12.  SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
MANAGEMENT AND RELATED STOCKHOLDER MATTERS




The
following table sets forth certain information regarding the beneficial
ownership of our Common Stock as of December 29, 2009 as to (i) each person who
is known by us to own beneficially more than 5% of the outstanding shares of any
class of our common or preferred stock, (ii) each of our directors, (iii) each
of the executive officers named in the Summary Compensation Table below and (iv)
all directors and executive officers as a group. Except as otherwise noted, we
believe the persons listed below have sole investment and voting power with
respect to the
 common Stock owned by
them.










Common Stock and
                                              Common Stock EquivalentsFive
      Percent Shareholders, Directors, Director
                                              Nominees
      and Certain Executive Officers
                                            
                                            Equivalent
                                              Common
                                              Shares
                                              Beneficially
                                              Owned (1)
                                            
                                            
                                            Approximate
                                              Voting
                                              Percentage
                                              (2)(3)
                                            Brecken
      Capital LLC
                                              346
      Hartshorn Dr.
                                              Short
      Hills, NJ 07078
                                            
                                            
                                            7,284,579
                                            
                                            
                                            
                                            7.7
                                            %(4)
                                            CCM
      Master Qualified Fund, Ltd.One
      North Wacker Drive, Suite 4350
                                              Chicago,
      IL 60606
                                            
                                            
                                            5,682,755
                                            
                                            
                                            
                                            6.0
                                            %(5)
                                            Robert
      J. Jesenik
                                              5300
      Meadows Rd., Suite 400
                                              Lake
      Oswego, OR 97035
                                            
                                            
                                            7,570,230
                                            
                                            
                                            
                                            7.9
                                            %(6)
                                            Rodney
      M. Boucher
                                              5335
      Meadows Rd., Suite 325
                                              Lake
      Oswego, OR 97035
                                            
                                            
                                            15,359,588
                                            
                                            
                                            
                                            15.1
                                            %(7)
                                            Randall
      R. Reed
                                              5335
      Meadows Rd., Suite 325
                                              Lake
      Oswego, OR 97035
                                            
                                            
                                            244,948
                                            
                                            
                                            
                                            *(8)
                                            Gene
      Ameduri
                                              5335
      Meadows Rd., Suite 325
                                              Lake
      Oswego, OR 97035
                                            
                                            
                                            9,649,040
                                            
                                            
                                            
                                            9.7
                                            %(9)
                                            John
      Stremel
                                              5335
      Meadows Rd., Suite 325
                                              Lake
      Oswego, OR 97035
                                            
                                            
                                            1,057,694
                                            
                                            
                                            
                                            1.1
                                            %(10)
                                            William
      C. McCormick
                                              5335
      Meadows Rd., Suite 325
                                              Lake
      Oswego, OR 97035
                                            
                                            
                                            2,959,792
                                            
                                            
                                            
                                            3.0
                                            %(11)
                                            Gary
      D. Conley
                                              5335
      Meadows Rd., Suite 325
                                              Lake
      Oswego, OR 97035
                                            
                                            
                                            140,625
                                            
                                            
                                            
                                            *(12)
                                            John
      P. Metcalf
                                              5335
      Meadows Rd., Suite 325
                                              Lake
      Oswego, OR 97035
                                            
                                            
                                            177,396
                                            
                                            
                                            
                                            *(13)
                                            Kurt
      E. Yeager
                                              5335
      Meadows Rd., Suite 325
                                              Lake
      Oswego, OR 97035
                                            
                                            
                                            80,104
                                            
                                            
                                            
                                            *(14)
                                            All
      directors and executive officers as a group (8 persons)
                                            
                                            
                                            29,669,187
                                            
                                            
                                            
                                            27.4
                                            %







*
            Less
      than 1%




(1)
            Shares
      to which the person or group has the right to acquire within 60 days after
      March 1, 2009 are deemed to be outstanding in calculating the percentage
      ownership of the person or group but are not deemed to be outstanding as
      to any other person or group.




(2)
            Percentage
      is based on 95,179,961 shares of common stock outstanding as of March 1,
      2009.




(3)
            Includes  625,000
      warrants convertible into common stock within 60 days after March 1,
      2009.





60
 Index





(4)
            Includes
      1,250,000 warrants convertible into common stock within 60 days after
      March 1, 2009.




(5)
            Includes
      955,654 warrants convertible into common stock within 60 days after March
      1, 2009.




(6)
            Includes
      319,063 options and 6,128,871 warrants convertible into common stock
      within 60 days after March 1, 2009.




(7)
            Includes
      203,698 options and 13,750 warrants convertible into common stock within
      60 days after March 1, 2009.




(8)
            Includes
      112,031 options and 3,870,138 warrants convertible into common stock
      within 60 days after March 1, 2009.




(9)
            Includes
      61,094 options and 12,500 warrants convertible into common stock within 60
      days after March 1, 2009.




(10)
            Includes
      1,953,091options and 12,500 warrants convertible into common stock within
      60 days after March 1, 2009.




(11)
            Includes
      121,875 options and 6,250 warrants convertible into common stock within 60
      days after March 1, 2009.




(12)
            Includes
      83,646 options and 31,250 warrants convertible into common stock within 60
      days after March 1, 2009.




(13)
            Includes
      80,104 options convertible into common stock within 60 days after March 1,
      2009.




(14)
            Includes
      13,009,860 options and warrants convertible into common stock within 60
      days after March 1, 2009.







ITEM13.  CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR
INDEPENDENCE





Our board
of directors has determined that Messrs. Metcalf and Yeager are “independent” as
that term is defined in Rule 4200(a) of the Nasdaq listing
standards.







ITEM14.  PRINCIPAL ACCOUNTANT FEES AND SERVICES





The
following is a summary of the fees billed to EnergyConnect Group, Inc. by RBSM
LLP for professional services rendered in connection with the fiscal years
ended, January 3, 2009 and December 29, 2007, respectively.





January
      3, 2009
                      
                      
                      December
      29, 2007Fee TypeAudit
      fees
                      
                      $
                      162,133
                      
                      
                      $
                      162,387Audit
      related fees
                      
                      
                      49,280
                      
                      
                      
                      61,260Tax
      fees
                      
                      
                      30,251
                      
                      
                      
                      17,150All
      other fees
                      
                      
                      85,900
                      
                      
                      
                      92,243Total
      fees
                      
                      $
                      327,564
                      
                      
                      $
                      333,040





Audit
fees consist of billings for professional services rendered for the audit of our
consolidated financial statements and review of the interim consolidated
financial statements included in quarterly reports that are normally provided by
independent accounting firms in connection with regulatory filings, including
audit services performed related to mergers and acquisitions.





61
 Index





Audit-related
fees consists of fees billed for assurance and related services that are
reasonably related to the performance of the audit or review of our consolidated
financial statements, which are not reported under "Audit Fees."





Tax fees
consist of billings for professional services for tax compliance and tax
planning regarding federal and state tax filings.





Prior to
engagement of our independent auditor, such engagement is approved by our audit
committee. The services provided under this engagement may include audit
services, audit-related services, tax services and other services. Pre-approval
is generally provided for up to one year and any pre-approval is detailed as to
the particular service or category of services and is generally subject to a
specific budget. Pursuant to our Audit Committee Charter, the independent
auditors and management are required to report to our audit committee at least
quarterly regarding the extent of services provided by the independent auditors
in accordance with this pre-approval, and the fees for the services performed to
date. The audit committee may also pre-approve particular services on a
case-by-case basis. All audit-related fees, tax fees and other fees incurred by
us for the year ended January 3, 2009, were approved by our audit
committee.






ITEM15.  EXHIBITS AND FINANCIAL STATEMENT
SCHEDULES





(a)           Exhibits
included herein:




EXHIBIT
INDEX
 
 Exhibit
      No.
                    
                    Description2.1
                    
                    Acquisition
      Agreement by and between Registrant and CEI Acquisition, LLC dated as of
      November 27, 2007 (Incorporated by reference to Exhibit 2.1 to
      Registrant’s Current Report on Form 8-K filed December 3,
      2007).2.2
                    
                    First
      Amendment to Acquisition Agreement by and between CEI Acquisition, LLC and
      Registrant dated January 30, 2008 (Incorporated by reference to Exhibit
      2.1 to Registrant’s Current Report on Form 8-K filed February 5,
      2008).3.2
                    
                    Eighth
      Restated Articles of Incorporation (Incorporated by reference to Exhibit
      3(i) to Registrant’s Current Report on Form 8-K filed March 21,
      2005).3.3
                    
                    Bylaws,
      as amended (Incorporated by reference to Exhibit 3.2 to Registrant’s
      Registration Statement on Form SB-2 (File No.
  33-918900).4.1
                    
                    Form
      of Warrant to purchase shares of common stock (Incorporated by reference
      to Exhibit 4.1 to Registrant’s Current Report on Form 8-K filed May 13,
      2008).10.1
                    
                    Microfield
      Group, Inc. 2004 Stock Incentive Plan (Incorporated by reference to
      Exhibit 10.22 to the Registrant’s Annual Report on Form 10-KSB filed May
      20, 2005).10.2
                    
                    Form of
      Securities Purchase Agreement dated May 7, 2008 by and among
      Microfield Group, Inc. and the purchasers set forth on the signature
      page thereto (Incorporated by reference to Exhibit 10.1 to
      Registrant’s Current Report on Form 8-K filed May 13,
    2008).10.3
                    
                    Form of
      Registration Rights Agreement dated May 7, 2008 by and among
      Microfield Group, Inc. and the purchasers signatory thereto
      (Incorporated by reference to Exhibit 10.1 to Registrant’s Current Report
      on Form 8-K filed May 13, 2008).10.4
                    
                    Revolving
      Credit Agreement dated February 26, 2009.14
                    
                    Code
      of Business Conduct and Ethics (Incorporated by reference to Exhibit 14 to
      Amendment No. 1 to Form S-1 filed on May 2, 2006).21.1
                    
                    Subsidiaries
      of the Registrant.23.1
                    
                    Consent
      of RBSM LLP, Registered Independent Accountants31.1
                    
                    Certification
      of Chief Executive Officer pursuant to Section 302, of the
      Sarbanes-Oxley Act of 2002.31.2
                    
                    Certification
      of Chief Financial Officer pursuant to Section 302, of the
      Sarbanes-Oxley Act of 2002.32.1
                    
                    Certification
      of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as
      adopted pursuant to Section 906 of the Sarbanes-Oxley Act of
      2002.32.2
                    
                    Certification
      of Chief Financial  Officer pursuant to 18 U.S.C.
      Section 1350, as adopted pursuant to Section 906 of the
      Sarbanes-Oxley Act of
2002




62
 Index




SIGNATURES





In
accordance with Section 13 or 15(d) of the Exchange Act, the registrant caused
this report to be signed on its behalf by the undersigned, thereunto duly
authorized.





Dated:   March
25, 2009





ENERGYCONNECT
      GROUP, INC.By:Kevin
      R. EvansChief
      Executive
Officer





Pursuant
to the requirements of the Securities Exchange Act of 1934, this report has been
signed below by the following persons on behalf of the Registrant and in the
capacities and on the dates indicated:





Signature
                                
                                TitleChief
      Executive Officer and DirectorKevin
      R. Evans
                                
                                Date:Chief
      Financial Officer and SecretaryRandall
      R. Reed
                                
                                Date:Chairman
      of the Board and DirectorWilliam
      C. McCormick
                                
                                Date:DirectorGene
      Ameduri
                                
                                Date:DirectorRodney
      M. Boucher
                                
                                Date:DirectorGary
      D. Conley
                                
                                Date:DirectorJohn
      P. Metcalf
                                
                                Date:DirectorKurt
      E. Yeager
                                
                                Date:





63
 Index





SIGNATURES





In
accordance with Section 13 or 15(d) of the Exchange Act, the registrant caused
this report to be signed on its behalf by the undersigned, thereunto duly
authorized.





Dated:   March
25, 2009





ENERGYCONNECT
      GROUP, INC.By:
                /s/Kevin R. EvansKevin
      R. EvansChief
      Executive Officer








Pursuant
to the requirements of the Securities Exchange Act of 1934, this report has been
signed below by the following persons on behalf of the Registrant and in the
capacities and on the dates indicated:





Signature
                
                Title/s/Kevin R. Evans
                
                Chief
      Executive Officer and DirectorKevin
      R. Evans
                
                Date:/s/Randall R. Reed
                
                Chief
      Financial Officer and SecretaryRandall
      R. Reed
                
                Date:/s/William C. McCormick
                
                Chairman
      of the Board and DirectorWilliam
      C. McCormick
                
                Date:/s/ Gene Ameduri
                
                DirectorGene
      Ameduri
                
                Date:/s/Rodney M. Boucher
                
                DirectorRodney
      M. Boucher
                
                Date:/s/Gary D. Conley
                
                DirectorGary
      D. Conley
                
                Date:/s/ John P. Metcalf
                
                DirectorJohn
      P. Metcalf
                
                Date:/s/ Kurt E. Yeager
                
                DirectorKurt
      E. Yeager
                
                Date:
   64