United
States Securities and Exchange Commission


Washington,
D.C. 20549




Form 10-Q/A


(Amendment
No. 1)




x  Quarterly Report
Pursuant to Section 13 or 15(d) of the Securities Exchange Act of
1934


For the
quarterly period ended March 31, 2010




or




 ̈  Transition Report
Pursuant to Section 13 or 15(d) of the Securities Exchange Act


For the
transition period from ______ to _______




Commission
file number 333-145183




KL ENERGY
CORPORATION


(Name of
registrant as specified in its charter )




Nevada
                
                39-2052941(State
      or other jurisdiction of incorporation or organization)
                
                (IRS
      Employer Identification
No.)





306
East Saint Joseph Street, Suite 200


Rapid City, South Dakota
57701


(Address
of principal executive offices)





(605)
718-0372


(Registrant’s
telephone number)





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.


x Yes   
 ̈ No





Indicate
by check mark whether the registrant has submitted electronically and posted on
its corporate website, if any, every Interactive Data File required to be
submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this
chapter) during the preceding 12 months (or for such shorter period that the
registrant was required to submit and post such
files).  Yes    ̈
     No  ̈





Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer, or a smaller reporting
company.




Large
      accelerated filer  ̈
                Accelerated
      filer  ̈Non-accelerated
      filer  ̈ (Do
      not check if a smaller reporting
                  company)
                Smaller
      reporting company x





Indicate
by check mark whether the registrant is a shell company  ̈
Yes      x No





Indicate
the number of shares outstanding of each of the issuer’s classes of common
stock, as of the latest practicable date: We had 47,696,560 shares of common
stock, $0.001 par value, outstanding on May 7, 2010.







KL
Energy Corporation


Form
10-Q


For
the Period Ended March 31, 2010




Table
of Contents





PagePart
      I - Financial InformationItem
      1. Financial Statements
                    
                    3-
      Notes to Consolidated Financial Statements
                    
                    7Item
      2. Management's Discussion and Analysis of Financial Condition and Results
      of Operations
                    
                    17Item
      4T. Controls and Procedures
                    
                    24Part
      II - Other InformationItem
      1. Legal Proceedings
                    
                    25Item
      1A.  Risk Factors
                    
                    26Item
      2.  Unregistered Sales of Equity Securities
                    
                    26Item
      5. Other Information
                    
                    26Item 6. Exhibits
                    
                    27




EXPLANATORY
NOTE




This
Amendment No. 1 on Form 10-Q/A (“Form 10-Q/A”) amends our Quarterly Report on
Form 10-Q for the quarter ended March 31, 2010, as initially filed with the
Securities and Exchange Commission on May 14, 2010 (“Original Filing”), to
correct what the Company believes are immaterial errors in the document
previously filed.  These corrections are for clarification purposes
only and had no impact on the consolidated statements of operations,
stockholders’ deficit, and cash flows for the periods presented.




Except
for the aforementioned clerical corrections, this Form 10Q/A continues to
describe conditions as presented in the original report on Form 10-Q filed on
May 14, 2010. This Amendment does not reflect events occurring after the date of
the Original Filing or modify or update any disclosures that may have been
affected by subsequent events. The Company believes there have been no events
since the Original Filing that would represent a fundamental change in the
information presented in the Original Filing.  Except as described
above, all other information included in the Original Filing remains
unchanged.





CAUTIONARY
STATEMENT REGARDING FORWARD-LOOKING INFORMATION





The
report includes certain forward-looking statements.  Forward-looking
statements are statements that estimate the happening of future events and are
not based on historical fact.  Forward-looking statements may be
identified by the use of forward-looking terminology such as, “may,” “shall,”
“could,” “expect,” “estimate,” “anticipate,” “predict,” “probable,” “possible,”
“should,” “continue,” or similar terms, variations of those terms or the
negative of those terms.  The forward-looking statements specified in
the following information have been compiled by us and are considered by us to
be reasonable.  Our future operating results, however, are impossible
to predict; the reader should infer no representation, guaranty or warranty from
those forward-looking statements.





The
assumptions we used for purposes of the forward-looking statements specified in
the following information represent estimates of future events and are subject
to uncertainty as to possible changes in economic, legislative, industry and
other circumstances.  As a result, our identification and
interpretation of data and other information and their use in developing and
selecting assumptions from and among reasonable alternatives require us to
exercise judgment.  To the extent that the assumed events do not
occur, the outcome may vary substantially from anticipated or projected
results.  We cannot assure that any of the assumptions relating to the
forward-looking statements specified in the following information are accurate,
and we assume no obligation to update any such forward-looking
statements.  You should read the following discussion and analysis in
conjunction with our financial statements and the related notes included
elsewhere in this report.  The following discussion and analysis is
qualified in its entirety by reference to such financial statements and related
notes.





When used
in this report, the terms the "Company," "KL Energy", "we," "us," "ours," and
similar terms refer to KL Energy Corporation, a Nevada corporation, and its
subsidiaries.


-
2 -





PART
1:  FINANCIAL INFORMATION





Item 1. Financial
Statements




KL
Energy Corporation


Consolidated
Balance Sheets


(unaudited)





March
      31,
                                              
                                              
                                              December
      31,2010
                                              
                                              
                                              2009ASSETSCurrent
      AssetsCash
      and cash equivalents
                                              
                                              $
                                              370,785
                                              
                                              
                                              $
                                              65,049Trade
      receivables, net of allowance for doubtful accounts of $393,840 and
      $393,840, respectively
                                              
                                              
                                              -
                                              
                                              
                                              
                                              35,000Accounts
      receivable - related parties
                                              
                                              
                                              61,034
                                              
                                              
                                              
                                              1,034Inventories
                                              
                                              
                                              14,975
                                              
                                              
                                              
                                              14,975Prepaid
      expenses and other assets
                                              
                                              
                                              250,769
                                              
                                              
                                              
                                              138,765Deferred
      issuance costs
                                              
                                              
                                              90,000
                                              
                                              
                                              
                                              135,000Total
      Current Assets
                                              
                                              
                                              787,563
                                              
                                              
                                              
                                              389,823Non-Current
      AssetsProperty,
      Plant and Equipment, Net
                                              
                                              
                                              3,083,117
                                              
                                              
                                              
                                              3,501,197Total
      Assets
                                              
                                              $
                                              3,870,680
                                              
                                              
                                              $
                                              3,891,020LIABILITIES AND STOCKHOLDERS'
      DEFICITCurrent
      LiabilitiesCurrent
      maturities of long-term debt
                                              
                                              $
                                              1,812,635
                                              
                                              
                                              $
                                              1,851,389Current
      maturities of subordinated debt-related party
                                              
                                              
                                              368,961
                                              
                                              
                                              
                                              262,500Accounts
      payable
                                              
                                              
                                              1,674,264
                                              
                                              
                                              
                                              1,672,156Accounts
      payable-related parties
                                              
                                              
                                              40,753
                                              
                                              
                                              
                                              48,234Billings
      in excess of costs and estimated earnings on uncompleted
      contracts
                                              
                                              
                                              1,640,588
                                              
                                              
                                              
                                              1,640,588Accrued
      payroll
                                              
                                              
                                              148,593
                                              
                                              
                                              
                                              203,161Other
      liabilities
                                              
                                              
                                              831,573
                                              
                                              
                                              
                                              770,052Current
      liabilities of discontinued operations
                                              
                                              
                                              331,138
                                              
                                              
                                              
                                              356,970Total
      Current Liabilities
                                              
                                              
                                              6,848,505
                                              
                                              
                                              
                                              6,805,050Long-term
      debt, less current maturities
                                              
                                              
                                              4,505
                                              
                                              
                                              
                                              9,121Subordinated
      debt-related party
                                              
                                              
                                              167,500
                                              
                                              
                                              
                                              297,500Total
      Long-Term Debt
                                              
                                              
                                              172,005
                                              
                                              
                                              
                                              306,621Stockholders'
      DeficitCommon
      stock, $0.001  par value; 150,000,000 shares authorized;
      46,787,469 and 45,029,894 shares issued and outstanding as of March 31,
      2010 and December 31, 2009, respectively
                                              
                                              
                                              46,788
                                              
                                              
                                              
                                              45,029Additional
      paid-in capital
                                              
                                              
                                              8,900,902
                                              
                                              
                                              
                                              7,060,161Accumulated
      deficit
                                              
                                              
                                              (10,744,915
                                              )
                                              
                                              
                                              (9,267,385
                                              )Noncontrolling
      interest
                                              
                                              
                                              (1,352,
      605
                                              )
                                              
                                              
                                              (1,058,456
                                              )Total
      Stockholders' Deficit
                                              
                                              
                                              (3,149,830
                                              )
                                              
                                              
                                              (3,220,651
                                              )Total
      Liabilities and Stockholders' Deficit
                                              
                                              $
                                              3,870,680
                                              
                                              
                                              $
                                              3,891,020





See
accompanying notes to consolidated financial statements.


-
3 -




KL
Energy Corporation


Consolidated
Statements of Operations





Three
      Months EndedMarch
      31,2010
                                        
                                        
                                        2009(Restated)RevenueBiofuel
      income
                                        
                                        $
                                        120,000
                                        
                                        
                                        $
                                        -Total
      Revenue
                                        
                                        
                                        120,000
                                        
                                        
                                        
                                        -Operating
      ExpensesBiofuel
      costs
                                        
                                        
                                        60,000
                                        
                                        
                                        
                                        -General
      and administrative
                                        
                                        
                                        914,836
                                        
                                        
                                        
                                        2,074,766Research
      and development
                                        
                                        
                                        881,096
                                        
                                        
                                        
                                        901,266Total
      Operating Expenses
                                        
                                        
                                        1,855,932
                                        
                                        
                                        
                                        2,976,032Loss
      from Operations
                                        
                                        
                                        (1,735,932
                                        )
                                        
                                        
                                        (2,976,032
                                        )Other
      Income (Expense):Other
      expense
                                        
                                        
                                        (21,984
                                        )
                                        
                                        
                                        (17,522
                                        )Interest
      income
                                        
                                        
                                        718
                                        
                                        
                                        
                                        42,587Interest
      expense
                                        
                                        
                                        (40,313
                                        )
                                        
                                        
                                        (74,930
                                        )Total
      Other Expense, Net
                                        
                                        
                                        (61,579
                                        )
                                        
                                        
                                        (49,865
                                        )Loss
      From Continuing Operations and Before  Net Loss Attributable to
      Noncontrolling Interest
                                        
                                        
                                        (1,797,511
                                        )
                                        
                                        
                                        (3,025,897
                                        )Net
      loss attributable to noncontrolling interests
                                        
                                        
                                        294,149
                                        
                                        
                                        
                                        290,502Loss
      From Continuing Operations
                                        
                                        
                                        (1,503,362
                                        )
                                        
                                        
                                        (
      2,735,395
                                        )Income
      (loss) from discontinued operations
                                        
                                        
                                        25,832
                                        
                                        
                                        
                                        (11,980
                                        )Net
      Loss
                                        
                                        $
                                        (1,477,530
                                        )
                                        
                                        $
                                        (
      2,747,375
                                        )Net
      (Loss) Income Per Share, basic and diluted:Continuing
      operations
                                        
                                        $
                                        (0.03
                                        )
                                        
                                        $
                                        (0.11
                                        )Discontinued
      operations
                                        
                                        
                                        0.00
                                        
                                        
                                        
                                        0.00Total
                                        
                                        $
                                        (0.03
                                        )
                                        
                                        $
                                        (0.11
                                        )Weighted
      Average Common Shares Outstanding
                                        
                                        
                                        46,073,328
                                        
                                        
                                        
                                        24,107,801




See
accompanying notes to consolidated financial statements.


-
4 -




KL Energy Corporation


Consolidated Statement of Stockholders' Deficit





Additional
                        
                        
                        
                        
                        
                        
                        
                        
                        TotalCommon Stock
                        
                        
                        Paid-In
                        
                        
                        Accumulated
                        
                        
                        Noncontrolling
                        
                        
                        Stockholders'Shares
                        
                        
                        Amount
                        
                        
                        Capital
                        
                        
                        Deficit
                        
                        
                        Interest
                        
                        
                        DeficitBalance
      - December 31, 2009
                        
                        
                        45,029,894
                        
                        
                        $
                        45,029
                        
                        
                        $
                        7,060,161
                        
                        
                        $
                        (9,267,385
                        )
                        
                        $
                        (1,058,456
                        )
                        
                        $
                        (3,220,651
                        )Issuance
      of shares in private placement - Jan. 2010
                        
                        
                        1,000,000
                        
                        
                        
                        1,000
                        
                        
                        
                        1,499,000
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        1,500,000Legal,
      professional and placement fees
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        (165,000
                        )
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        (165,000
                        )Additional
      shares issued at $1.10 per share
                        
                        
                        303,030
                        
                        
                        
                        303
                        
                        
                        
                        (303
                        )
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        -Issuance
      of shares in private placement at $1.10 per share
                        
                        
                        454,545
                        
                        
                        
                        456
                        
                        
                        
                        499,544
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        500,000Legal,
      professional and placement fees
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        (80,000
                        )
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        (80,000
                        )Stock
      based compensation
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        87,500
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        87,500Net
      loss attributed to noncontrolling interests
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        (294,149
                        )
                        
                        
                        (294,149
                        )Net
      loss
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        (1,477,530
                        )
                        
                        
                        
                        
                        
                        
                        (1,477,530
                        )Balance
      - March 31, 2010
                        
                        
                        46,787,469
                        
                        
                        $
                        46,788
                        
                        
                        $
                        8,900,902
                        
                        
                        $
                        (10,744,915
                        )
                        
                        $
                        (1,352,605
                        )
                        
                        $
                        (3,149,830
                        )




See
accompanying notes to consolidated financial statements.


-
5 -




KL
Energy Corporation


Consolidated
Statements of Cash Flows





Three
      Months EndedMarch
      31,2010
                                  
                                  
                                  2009(Restated)Cash
      Flows From Operating ActivitiesNet
      loss from continuing operations
                                  
                                  $
                                  (1,503,362
                                  )
                                  
                                  $
                                  (
      2,735,395
                                  )Net
      (loss) income from discontinued operations
                                  
                                  
                                  25,832
                                  
                                  
                                  
                                  (11,980
                                  )Adjustments
      to reconcile net loss by cash used in operating
activities:Depreciation
                                  
                                  
                                  483,289
                                  
                                  
                                  
                                  485,757Allowance
      for doubtful accounts
                                  
                                  
                                  -
                                  
                                  
                                  
                                  453,463Net loss attributable to noncontrolling interests
                                  
                                  
                                  (294,149
                                  )
                                  
                                  
                                  (290,502
                                  )Gain
      on sale of property, plant and equipment
                                  
                                  
                                  (533
                                  )
                                  
                                  
                                  -Stock based
      compensation expense
                                  
                                  
                                  87,500
                                  
                                  
                                  
                                  -Amortization
      of deferred issuance cost
                                  
                                  
                                  45,000
                                  
                                  
                                  
                                  -Changes
      in current assets and liabilities:(Increase)
      decrease in:Trade
      receivables
                                  
                                  
                                  (25,000
                                  )
                                  
                                  
                                  (18,928
                                  )Inventories
                                  
                                  
                                  -
                                  
                                  
                                  
                                  36,978Prepaid
      expenses and other assets
                                  
                                  
                                  (32,004
                                  )
                                  
                                  
                                  349,937Current
      assets of discontinued operations
                                  
                                  
                                  -
                                  
                                  
                                  
                                  15Increase
      (decrease) in:Accounts
      payable
                                  
                                  
                                  (5,373
                                  )
                                  
                                  
                                  (130,047
                                  )Accrued
      payroll and other current liabilities
                                  
                                  
                                  6,953
                                  
                                  
                                  
                                  886,060Current
      liabilities of discontinued operations
                                  
                                  
                                  (25,832
                                  )
                                  
                                  
                                  11,966Net
      Cash Used In Operating Activities
                                  
                                  
                                  (1,237,679
                                  )
                                  
                                  
                                  (962,676
                                  )Cash
      Flows From Investing ActivitiesPurchases
      of property, plant and equipment
                                  
                                  
                                  (64,976
                                  )
                                  
                                  
                                  (120,776
                                  )Proceeds
      from the sale of property, plant and equipment
                                  
                                  
                                  300
                                  
                                  
                                  
                                  -Net
      Cash Used in Investing Activities
                                  
                                  
                                  (64,676
                                  )
                                  
                                  
                                  (120,776
                                  )Cash
      Flows From Financing ActivitiesPayments
      from lines of credit and short-term borrowings
                                  
                                  
                                  -
                                  
                                  
                                  
                                  (250,000
                                  )Proceeds
      from subordinated debt – related parties, net
                                  
                                  
                                  -
                                  
                                  
                                  
                                  75,000Payments
      on subordinated debt - related parties, net
                                  
                                  
                                  (23,539
                                  )
                                  
                                  
                                  -Payments
      on long-term debt principal
                                  
                                  
                                  (123,370
                                  )
                                  
                                  
                                  (540,869
                                  )Issuance
      costs
                                  
                                  
                                  (245,000
                                  )
                                  
                                  
                                  (750,000
                                  )Proceeds
      from issuance of common stock
                                  
                                  
                                  2,000,000
                                  
                                  
                                  
                                  4,000,000Net
      Cash Provided by Financing Activities
                                  
                                  
                                  1,608,091
                                  
                                  
                                  
                                  2,534,131Net
      Increase in Cash and Cash Equivalents
                                  
                                  
                                  305,736
                                  
                                  
                                  
                                  1,450,679Cash
      and cash equivalents at beginning of period
                                  
                                  
                                  65,049
                                  
                                  
                                  
                                  698,148Cash
      and cash equivalents at end of period
                                  
                                  $
                                  370,785
                                  
                                  
                                  $
                                  2,148,827Supplemental
      Disclosures of Cash Flow InformationInterest
      paid
                                  
                                  $
                                  38,743
                                  
                                  
                                  $
                                  75,237Deferred
      issuance costs netted in equity
                                  
                                  
                                  245,000
                                  
                                  
                                  
                                  750,000Insurance
      premium financed with debt
                                  
                                  
                                  80,000
                                  
                                  
                                  
                                  -




See
accompanying notes to consolidated financial statements.


-
6 -




KL
Energy Corporation


Notes
to Consolidated Financial Statements


(unaudited)




Note 1 – Nature of Business and Significant
Accounting Policies




Nature of
Business




KL Energy
Corporation (“KL”, formerly known as Revive-it Corp.) was incorporated on
February 26, 2007, in the State of Nevada, to engage in the development of skin
care and cosmetic products. On September 30, 2008, we entered into an Agreement
and Plan of Merger with KL Process Design Group, Inc. (“KLPDG”), which provided
for the merger of KLPDG with and into our Company (the “Merger”).  As
a result of the Merger, our Company acquired all of the assets and liabilities
of KLPDG.





For
accounting purposes, the Merger was treated as a reverse acquisition with KLPDG
as the acquirer and the Company as the acquired party. As a result, the business
and financial information included in this report is the business and financial
information of KLPDG. KLPDG was a South Dakota corporation that was organized in
April 2003, and commenced business operations in January 2006.





While we
have historically provided engineering, construction, operating and ethanol
marketing services, our focus is now on owning and operating cellulose based
ethanol ("CBE") facilities that utilize our proprietary technology, and
designing CBE facilities for, and licensing our proprietary CBE technology to
third-party participants in the CBE industry.  The Company, through
its majority-owned Western Biomass Energy, LLC (“WBE”), has designed, built, and
operates a cellulose-based ethanol (“CBE”) plant based on KL’s proprietary
technology.    The plant is located in Upton, Wyoming and is
designed to convert biomass into ethanol.  The WBE plant serves as a
demonstration and research and development facility and could operate as a
commercial plant pending added investment.





The
Company also distributed ethanol blended fuel, through its majority-owned
Patriot Motor Fuels, LLC.  As a result of pricing and competitive
factors, the Patriot business was discontinued in January 2009.  In
June 2009, the Company also discontinued two additional businesses in which it
held a majority interest:  KL Management LLC, which managed ethanol
facilities for third parties, and KLHC LLC (formerly known as KL Energy LLC)
which sold wholesale ethanol.  Both businesses were discontinued as a
result of the severe change in the economics of the first generation ethanol
industry but especially due to the Company’s re-focus on cellulosic second
generation ethanol commercialization.




The
amounts reported in this Form 10-Q related to the quarter ended March 31, 2009
have been restated to correct a previous error and to be consistent with the
Company’s presentation in its Annual Report on Form 10-K for the year ended
December 31, 2009, by recording the net loss attributable to noncontrolling
interests.  The effect of this error did not have an effect on any balance
sheet period presented in this Form 10-Q.  The following table presents the
effects of correctly recording the net loss attributable to noncontrolling
interests for the quarter ended March 31, 2009:




As
      PreviouslyReported
                  
                  
                  Adjustment
                  
                  
                  As
      RestatedNet
      loss attributable to noncontrolling interests
                  
                  $
                  -
                  
                  
                  $
                  290,502
                  
                  
                  $
                  290,502Loss
      from continuing operations
                  
                  $
                  (3,025,897
                  )
                  
                  $
                  290,502
                  
                  
                  $
                  (2,735,395
                  )Net
      loss
                  
                  $
                  (3,037,877
                  )
                  
                  $
                  290,502
                  
                  
                  $
                  (2,747,375
                  )Net
      loss per share, basic and diluted
                  
                  $
                  (0.13
                  )
                  
                  $
                  0.01
                  
                  
                  $
                  (0.11
                  )




Significant Accounting
Policies





Use
of Estimates




The
preparation of financial statements requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period.  Actual results could differ from those
estimates.  The following estimates are significant to the Company’s
consolidated financial statements: costs to complete long-term contracts, useful
lives of property, plant and equipment, impairment of long-lived
assets, valuation of share based compensation, going concern analysis,
valuation allowance on deferred tax assets and the allowance for doubtful
accounts.




Principles
of Consolidation




The
accompanying consolidated financial statements include the results of operations
and financial position of the Company, KL Energy Services LLC (“KLES”, a
wholly-owned subsidiary, as well as its wholly-owned KLHC LLC (formerly known as
KL Energy LLC, “KLHC”) and majority-owned KL Management, LLC (“KLM”), Patriot
Motor Fuels LLC (“Patriot”) and Western Biomass Energy LLC
(“WBE”).  Until September 30, 2008, KLHC and KLM were 53% owned by
KLPDG and the remaining 47% was owned by three other individuals; Patriot was
50% owned by KLPDG and two other owners held the remaining 50% interest .   At September 30,
2008, the Company ownership interest increased to 75% for KLHC, KLM and Patriot.
WBE is 64% owned by the Company and 36% owned by various unrelated
investors.  All significant intercompany accounts and transactions
have been eliminated in consolidation.


-
7 -




KL
Energy Corporation


Notes
to Consolidated Financial Statements


(unaudited)




Note 1 – Nature of Business and Significant
Accounting Policies (continued)




Significant Accounting
Policies (continued)





Basis
of Presentation




The
accompanying unaudited consolidated financial statements and related notes have
been prepared in accordance with accounting principles generally accepted in the
United States of America for interim financial information and the instructions
to Form 10-Q and Rule 10-01 of Regulation S-X. Results for interim
periods should not be considered indicative of results for a full year. These
interim consolidated financial statements should be read in conjunction with the
consolidated financial statements and related notes contained in the Company’s
Annual Report on Form 10-K for the year ended December 31, 2009. In the
opinion of management, all adjustments (consisting of normal recurring
adjustments) considered necessary for a fair statement of the results for
interim periods have been included.




We have
reclassified certain data in the financial statements of the prior period to
conform to the current period presentation.





Recently
Issued Accounting Pronouncements




In
January 2010, the Financial Accounting Standards Board, or FASB, issued guidance
requiring additional fair value disclosures for significant transfers between
levels of the fair value hierarchy and gross presentation of items within the
Level 3 reconciliation. This guidance also clarifies that entities need to
disclose fair value information for each class of asset and liability measured
at fair value and that valuation techniques need to be provided for all
non-market observable measurements. Our adoption of this guidance on
January 1, 2010, did not impact our consolidated financial statements as we
have no items classified as Level 3.




In August
2009, the FASB issued new accounting guidance to provide clarification on
measuring liabilities at fair value when a quoted price in an active market is
not available. This guidance became effective for us on October 1, 2009. The
Company adopted this guidance on October 1, 2009, and it had no material impact
on our consolidated financial statements.


-
8 -




KL
Energy Corporation


Notes
to Consolidated Financial Statements


(unaudited)




Note 1 – Nature of Business and Significant
Accounting Policies (continued)




Significant Accounting
Policies (continued)





Recently
Issued Accounting Pronouncements (continued)





In April
2009, the FASB issued additional guidance regarding fair value measurements and
impairments of securities which makes fair value measurements more consistent
with fair value principles, enhances consistency in financial reporting by
increasing the frequency of fair value disclosures, and provides greater clarity
and consistency in accounting for and presenting impairment losses on
securities.  The additional guidance is effective for interim and
annual periods ending after June 15, 2009, with early adoption permitted for
periods ending after March 15, 2009.  The Company adopted the
provisions for the period ending March 31, 2009.  The adoption did not
have a material impact on our financial position or results of
operations.




In April
2009, the FASB issued new accounting guidance related to interim disclosures
about the fair values of financial instruments. This guidance requires
disclosures about the fair value of financial instruments whenever a public
company issues financial information for interim reporting periods. This
guidance is effective for interim reporting periods ending after June 15, 2009.
The Company adopted this guidance upon its issuance, and it had no material
impact on our consolidated financial statements.




In March
2008, the FASB issued guidance requiring enhanced disclosures about our
derivative and hedging activities that is effective for financial statements
issued for fiscal years and interim periods beginning after November 15,
2008.  We adopted the disclosure requirements beginning January 1,
2009.  The adoption did not have an impact on our financial position
or results of operations.




Long-Lived
Assets




The
Company assesses the realizable value of long-lived assets for potential
impairment at least annually or when events and circumstances warrant such a
review.  The net carrying value of a long-lived asset is considered
impaired when the anticipated fair value is less than its carrying value. 
Approximately 96% of the Company’s property, plant and equipment is attributable
to the WBE facility in Upton, WY.





In
assessing the recoverability of our long-lived assets, we must make assumptions
regarding estimated future cash flows, useful lives and other factors to
determine the fair value of the respective assets.  Since the
construction and equipment costs paid to complete this facility were incurred
approximately two years ago, the Company believes that the net carrying value of
this facility and equipment approximates its fair value.  This
facility is currently used for developing new, or refining old, cellulosic
ethanol technology.  It is the Company’s intent that this facility’s
alternative future use will involve the production and sale of small but
commercial quality volumes of ethanol and lignin and currently there are no
indications that the Company will be unable to execute its business
plan.  This alternative use is expected to generate positive cash flow
in future years.





As of
December 31, 2009, we evaluated our long-lived assets for potential
impairment.  Based on our evaluation, no impairment charge was
recognized.


-
9 -




KL
Energy Corporation


Notes
to Consolidated Financial Statements


(unaudited)




Note
2 - Property, Plant, and Equipment





Property,
plant, and equipment consist of the following as of:





March 31,
                        
                        
                        December 31,2010
                        
                        
                        2009Plant
      and Plant Equipment
                        
                        $
                        7,402,634
                        
                        
                        $
                        7,402,413Office
      Furnishings and Equipment
                        
                        
                        333,454
                        
                        
                        
                        274,103Vehicles
                        
                        
                        51,698
                        
                        
                        
                        51,6987,787,786
                        
                        
                        
                        7,728,214Less
      Accumulated Depreciation
                        
                        
                        (4,704,669
                        )
                        
                        
                        (4,227,017
                        )Total
      Property, Plant, and Equipment, Net
                        
                        $
                        3,083,117
                        
                        
                        $
                        3,501,197





Construction
costs associated with the WBE demonstration plant are stated at cost (including
direct construction costs, and capitalized interest).  The Company has
also capitalized approximately $471,000 of professional engineering and
construction services provided by the Company through March 31,
2010.




Note
3 - Financing





On March
30, 2010, the Company received the final installment of the December 2009
Securities Purchase Agreement with a certain Investor listed on the signature
page of such Purchase Agreement.  Pursuant to the terms of the
Purchase Agreement, the Company will issue to the Investor 454,545 shares of the
Company’s common stock, at $1.10 per share, for net proceeds to the
Company of $450,000.  The shares will be issued in reliance on the
exemption provided by Regulation S of the Securities Act of 1933, as
amended.




On
January 6, 2010, the Company entered into a Securities Purchase Agreement
with a certain Investor.  Pursuant to the terms of the Purchase
Agreement, the Company received $1.5 million before expenses on that date,
representing 50% of the Investor’s commitment to purchase 2,000,000 shares of
the Company’s common stock, and will pay the remaining $1.5 million within 14
days of receiving a written demand from the Company.  The pricing of
these shares may be reduced based on certain subsequent events.  (See
Note 15 for additional details.)  This Purchase Agreement provides
for: (i) piggyback registration rights allowing the Investor to participate in
registration statements filed by the Company and (ii) participation rights
allowing the Investor to purchase its pro rata share of equity securities issued
by the Company for cash, with certain exceptions including, without limitation,
issuances relating to compensation, commercial credit arrangements, and
strategic transactions involving ongoing business relationships. The shares will
be issued in reliance on the exemption provided by Regulation S of the
Securities Act of 1933, as amended.




Note
4 – Net Loss Per Common Share




Basic EPS
includes no dilution and is computed by dividing income or
(loss) applicable to common stock by the weighted average number of common
shares outstanding for the period. Diluted EPS reflects the potential dilution
of securities that could share in the earnings of an entity, similar to fully
diluted EPS.   For the three months ended March 31, 2010 and 2009,
stock warrants for 3,125 shares were not included in the computation of diluted
loss per share because their effect was anti-dilutive.  For the three
months ended March 31, 2010, stock options for 83,333 shares of common stock
were not included in the computation of diluted loss per share because their
effect was anti-dilutive.  There were no other stock warrants issued
or outstanding, or stock options granted, for the three months ended March 31,
2010.


-
10 -




KL
Energy Corporation


Notes
to Consolidated Financial Statements


(unaudited)




Note 5 - Operations




Continuing
Operations




During
the period from its inception to March 31, 2010, the Company has incurred
significant annual net losses and at March 31, 2010 and December 31, 2009, the
Company had negative working capital (i.e. current assets less current
liabilities) of approximately $6.1 million and $6.4 million,
respectively.  At March 31, 2010, total liabilities exceeded total
assets by approximately $3.1 million.  The corn ethanol industry, in
which the Company has historically operated, continues to face new challenges
including the rising cost of raw materials, increased construction costs, and a
reduction in public and governmental support.




These
factors, among others, indicate the Company may be unable to meet its current
obligations and may be unable to continue as a going concern unless it raises
additional capital.  Management is continuing its efforts to raise
additional capital through various methods and is refocusing its business to
cellulosic ethanol.





Discontinued
Operations





In
January 2009, the Company determined that its majority-owned subsidiary, Patriot
Motor Fuels LLC (“Patriot”), should be discontinued as a result of pricing and
other competitive factors.  Patriot distributed ethanol blended
fuel.  In June 2009, the Company also discontinued two additional
businesses in which it held a majority interest:  KL Management LLC
(“KLM”), which managed ethanol facilities for third parties, and KLHC LLC
(formerly known as KL Energy LLC, “KLHC”), which sold wholesale
ethanol. Both businesses were discontinued as a result of the severe change
in the economics of the first generation ethanol industry but especially due to
the Company’s re-focus on cellulosic second generation ethanol
commercialization.





Operating
results from discontinued operations were income of approximately $26,000
and a loss of approximately $12,000 during the three months ended March 31, 2010
and 2009, respectively.   The assets and liabilities associated
with these discontinued businesses were as follows:





March
      31,
                                
                                December
      31,2010
                                
                                
                                
                                2009Current AssetsCash
                                
                                $
                                -
                                
                                
                                $
                                -Total
                                
                                $
                                -
                                
                                
                                $
                                -Current LiabilitiesAccounts
      payable
                                
                                $
                                331,138
                                
                                
                                $
                                356,970Total
                                
                                $
                                331,138
                                
                                
                                $
                                356,970


-
11 -




KL
Energy Corporation


Notes
to Consolidated Financial Statements


(unaudited)




Note
6 –Debt





Short-Term
Borrowing Arrangements





The
Company had available a $250,000 revolving line of credit with Wells Fargo Bank,
N.A. that was personally guaranteed by certain Company shareholders, and
collateralized by their personal property, with accrued interest payable monthly
at the prime rate plus 0.5% (3.75% at December 31, 2008). This line of credit
matured and was paid off in June 2009.





In
addition, the Company had approximately $41,000 and $44,000 in credit card
liability at March 31, 2010 and December 31, 2009, respectively, which are also
guaranteed by certain shareholders. These credit card liability balances are
included in accounts payable in the accompanying consolidated balance
sheets.





Subordinated
Debt – Related Parties





The
Company has a subordinated unsecured note payable to a Company shareholder
totaling $536,461and $560,000 at March 31, 2010 and December 31, 2009,
respectively.  This note includes interest at a variable rate, which
was 5.0% at March 31, 2010 and December 31, 2009, respectively, with interest
paid quarterly.  This note was unsecured and did not have a specified
due date. In February 2009, the note was modified to include principal payments
of $10,000 per month, beginning in September 2009, over a 60 month term. The
principal payments are scheduled to be $120,000 in 2010, 2011, 2012, 2013,
respectively, and $56,461 in 2014.  Payments of $120,000 are due on
this note in the next twelve months and therefore have been classified as
current at March 31, 2010.  As security for our obligations under this
note, we granted to the lender a security interest in our current and future
accounts receivable.  In addition, if the Company receives additional
equity financing, the Company is obligated to pay 5% of the proceeds towards
principal payments on this note.  Based on equity financing since
February 2009, an additional $242,500 has been classified as currently payable.
Total current maturities on this note as of March 31, 2010 were
$368,961.


-
12 -




KL
Energy Corporation


Notes
to Consolidated Financial Statements


(unaudited)




Note
6 –Debt (continued)





Long-Term
Debt




Long-term
debt consists of the following as of:




March
      31,
                    
                    December
      31,2010
                    
                    2009Note
      payable to bank with interest at 6.5%. The note is payable in twelve
      monthly installments of $17,560 of principal and interest beginning March
      2010 with any remaining unpaid principal and interest due March 2011, with
      additional maturity extensions available. This note is secured by
      substantially all assets of WBE and guaranteed by the Company and certain
      WBE members.
                    
                    $
                    1,362,704
                    
                    
                    $
                    1,394,043Payable
      to Hermanson Egge to replace overdue payables for construction services
      with unsecured agreement, interest at 0% with payments of $70,000 in July
      2009, $15,000 monthly from July 2009 to April 2010, $10,000 monthly from
      May 2010 to August 2010, $20,000 monthly for September 2010 to November
      2010 and $15,000 in December 2010.
                    
                    
                    115,000
                    
                    
                    
                    160,000Note
      payable to Lansing Securities Corp., interest at 10% and the maturity date
      has passed and has been temporarily waived by the note holder until
      further notice.
                    
                    
                    250,000
                    
                    
                    
                    250,000Note
      payable to Universal Premium Acceptance Corp. for payment of insurance
      premiums, interest at 9.24%, payable in monthly principal and interest
      installments of $5,239.
                    
                    
                    15,479
                    
                    
                    
                    30,605Note
      payable to Avid Solutions for centrifuge equipment of $195,000, payable in
      monthly principal and interest installments of $10,000, including interest
      at 10% secured by equipment.
                    
                    
                    -
                    
                    
                    
                    6,767Note
      payable to Shimadzu for lab equipment of $32,114, payable in monthly
      principal and interest installments of $1,072, including interest at 13.6%
      secured by equipment.
                    
                    
                    17,372
                    
                    
                    
                    19,095Note
      payable to First Insurance Funding Corporation for payment of director and
      officer insurance premiums, payable in monthly installments of $3,692,
      including interest at 9.1%.
                    
                    
                    56,585
                    
                    
                    
                    -Subordinated
      note payable to Randy Kramer and assigned to First National Bank,
      interest at 5.0%, secured by accounts receivable of the Company, payable
      in monthly installments of $10,000 per month plus interest beginning
      September 2009 and 5% of equity financings after February
      2009.
                    
                    
                    536,461
                    
                    
                    
                    560,000Subtotal
                    
                    $
                    2,353,601
                    
                    
                    $
                    2,420,510Less
      current maturities of long-term debt
                    
                    
                    (2,181,596
                    )
                    
                    
                    (2,113,889
                    )Total
      Long-Term Debt
                    
                    $
                    172,005
                    
                    
                    $
                    306,621


-
13 -




KL
Energy Corporation


Notes
to Consolidated Financial Statements


(unaudited)




Note
7 – Common Stock Activity





Pursuant
to the terms of two Securities Purchase Agreements consummated in November and
December 2009, which Agreements required pricing of these shares to be reduced
to $1.10 per share based on the absence of an investment by an additional
institutional investor within 90 days after the date of the agreement, the
Company issued to these Investors 303,030 shares of the Company’s common stock
at $1.10 per share. The shares will be issued in reliance on the exemption
provided by Regulation S of the Securities Act of 1933, as amended.





Note 8 - Segment
Information




As of
March 31, 2010, the Company manages its business and aggregates its operational
and financial information in accordance with two reportable segments. Its engineering and management
contracts segment provides contracted engineering and project development
to third party customers. Despite the lack of activity in this segment during
the first three months of 2010, during which time the Company focused its
resources on biofuel research and development, management believes this will be
a viable business segment in the near future. The biofuel segment is
focused on developing unique technical and operational capabilities designed to
enable the production and commercialization of biofuel, in particular ethanol
from cellulosic biomass, and is expected to begin operations starting in 2010.




Management
assesses performance and allocates resources based on specific financial
information for the business segments. For the biofuel segment, performance is
assessed based on total operating expenses and capital expenditures. Operating
expenses for each segment include direct costs of that segment. Expenses and
assets shared by the segments require the use of judgments and estimates in
determining the allocation of expenses to the segments. Different assumptions or
allocation methods could result in materially different results by
segment.




Financial
information for the Company’s business segments was as follows (in
thousands):





As of
                          March 31, 2010
                        
                        
                        As of
                          December
                          31, 2009Identifiable
      Fixed Assets:Engineering
      and management contracts
                        
                        $
                        332
                        
                        
                        $
                        326Biofuel
      research and development
                        
                        
                        7,456
                        
                        
                        
                        7,402Total
                        
                        
                        7,788
                        
                        
                        
                        7,728Accumulated
      depreciation
                        
                        
                        (
      4,705
                        )
                        
                        
                        (
      4,227
                        )Total
      Identifiable Fixed Assets
                        
                        $
                        3,083
                        
                        
                        $
                        3,501





For the Three Months Ended
                            March
                            31,2010
                          
                          
                          2009Revenues:Engineering
      and management contracts
                          
                          $
                          -
                          
                          
                          $
                          -Biofuel
      research and development
                          
                          
                          120
                          
                          
                          
                          -Total
      Revenues
                          
                          $
                          120
                          
                          
                          $
                          -Depreciation:Engineering
      and management contracts
                          
                          $
                          15
                          
                          
                          $
                          16Biofuel
      research and development
                          
                          
                          468
                          
                          
                          
                          470Total
      Depreciation
                          
                          $
                          483
                          
                          
                          $
                          486Interest
      Expense:Engineering
      and management contracts
                          
                          $
                          18
                          
                          
                          $
                          41Biofuel
      research and development
                          
                          
                          22
                          
                          
                          
                          34Total
      Interest Expense
                          
                          $
                          40
                          
                          
                          $
                          75




-
14 -




KL
Energy Corporation


Notes
to Consolidated Financial Statements


(unaudited)




Note 9
– Noncontrolling Interests





On
January 1, 2009, the Company adopted changes issued by the FASB to
consolidation accounting and reporting. These changes establish accounting and
reporting for the noncontrolling interest in a subsidiary and for the
deconsolidation of a subsidiary. This guidance defines a noncontrolling
interest, previously called a minority interest, as the portion of equity in a
subsidiary not attributable, directly or indirectly, to a parent. These changes
require, among other items, that (a) noncontrolling interests to be included in
the consolidated statement of financial position within equity separate from the
parent’s equity, (b) consolidated net income to be reported at amounts inclusive
of both the parent’s and noncontrolling interest’s shares and, separately, the
amounts of consolidated net income attributable to the parent and noncontrolling
interest all on the consolidated statement of operations, and (c) if a
subsidiary is deconsolidated, any retained noncontrolling equity investment in
the former subsidiary should be measured at fair value and a gain or loss be
recognized in net income based on such fair value. Other than the change in
presentation of noncontrolling interests, the adoption of these changes had no
impact on the consolidated financial statements. The presentation and disclosure
requirements of these changes were applied
retrospectively.




Components
of noncontrolling interests are as follows:




March 31,
                        
                        
                        December
      31,2010
                        
                        
                        2009(unaudited)Beginning
      of period
                        
                        $
                        (1,058,456
                        )
                        
                        $
                        193,399Net
      loss attributable to noncontrolling interests
                        
                        
                        (294,149
                        )
                        
                        
                        (1,251,855
                        )End
      of period
                        
                        $
                        (1,352,605
                        )
                        
                        $
                        (1,058,456
                        )




Note
10 - Commitments and Contingencies





Licensing
Agreement




The
Company had an agreement with the South Dakota School of Mines and Technology
(“SDSM&T”) whereby SDSM&T granted the Company all intellectual property
rights associated with joint discovery and development of any CBE technology in
exchange for potential royalty payments.  No licenses have been sold
to date and no amounts have been recorded in the consolidated financial
statements related to this agreement.  In September 2009, the Company
received confirmation from SDSM&T that the Company has no related current or
future financial obligations and that this agreement has been
terminated.  However, the Company and SDSM&T continue to
collaborate on various technology projects.




Litigation




The
Company is named in a personal injury lawsuit relating to an employee of a
subcontractor performing acid cleaning services of a grain based ethanol plant
boiler.  The Company was also performing services at the grain based
ethanol plant in 2006. The amount of liability, if any, is not determinable but
the Company plans to vigorously defend its position. The insurance company for
the grain based ethanol plant is defending the Company employee.  The jury
trial, originally scheduled for March 2010, is now expected to take place in the
third quarter of 2010 or later.




The
Company is named in a pending action, which is captioned Dakota Supply Group,
Inc. (“DSG”) v. KL Process Design Group, LLC (“KL”), and Midwest Renewable
Energy, LLC, (“MRE”).  The action was commenced in 2008 for the collection
of a debt of approximately $524,000 plus interest for electrical supplies and
materials furnished by DSG to MRE.  DSG alleges that KL and MRE are
responsible for the debt because KL executed the purchase order without
clarifying that the debt was the responsibility of MRE and that credit was
extended directly to KL rather than MRE.  Depositions have taken place
between all parties. At this time, the Company is unable to predict the outcome
of the case but plans to vigorously defend its position.




The
Company provided construction management and engineering services for the
construction of a new biofuels production facility in Iowa in 2007 for Willmark
Energy, Inc. (“Willmark”). The Company believes that it would have provided
services of approximately $800,000, including approximately $350,000 of services
actually performed, for which it was not paid and filed a lien on the Willmark
property.  Willmark refused to pay the Company for the unpaid services
and subsequently filed a request for arbitration, counter-claiming that the
Company failed to perform its design and project management duties under the
construction contract and was seeking approximately $1.5 million in damages and
the release of liens the Company has placed on Willmark assets.  In
February 2010, in view of legal costs and especially management time, the
Company accepted a settlement offer which required that Willmark pay $35,000 to
the Company and the Company release its lien on the Willmark
property.





On June
30, 2009, a lawsuit was brought against the Company, certain subsidiaries, and
certain current and past officers in the District Court of Lincoln County,
Nebraska.  The plaintiff is Midwest Renewable Energy, LLC, a Nebraska
limited liability company ("MRE").  MRE previously engaged the Company to
manage its existing ethanol facility, oversee its expansion construction and
market the ethanol produced at its facilities.  The plaintiff alleges,
among other things, that the named individuals and entities engaged in
breaches of fiduciary duties owed to MRE, breaches of contract, fraud,
interference with contract, conversion and negligence relating to the management
and expansion of its corn-based ethanol facilities in
Nebraska.





In August
2009, Company filed a motion to compel MRE to arbitrate its claims, and also
separately filed three arbitration demands for claims relating to the three
agreements between the Company and its affiliates and MRE that were at issue in
the lawsuit.  In November 2009, the Court ruled for the Company
and issued an order to compel arbitration. The arbitration proceedings for two
of the three arbitrations have begun and are expected to conclude in the fourth
quarter of 2010. The Company and MRE are currently waiting for the third
arbitration claim and demand to begin.




In the
normal course of business, the Company is party to litigation from time to time.
The Company maintains insurance to cover certain actions and believes resolution
of such general litigation matters will not have a material adverse effect on
the Company.




Note 11
– Related Parties




In February
2009 and April 2009, the Company entered into a consulting contract with Thomas
Schueller, for the position of Executive Chairman of the Board, and Thomas
Bolan, for the position of Chief Financial Officer,
respectively.  In July 2009, the Company also entered into
a consulting services contract with Alan Rae, a
Director.  During the three months ended March 31, 2010 and 2009, fees
paid to Messrs. Schueller, Bolan and Rae were approximately $36,000 and $20,000,
$ 38,000 and $0, and $35,000 and $0, respectively.


-
15 -




KL
Energy Corporation


Notes
to Consolidated Financial Statements


(unaudited)




Note
12 – Share Based Compensation





On March
2, 2010, the Company issued to Mr. Corcoran an option to purchase 83,333 shares
of the Company’s common stock at an exercise price of $1.10 which became fully
vested on April 2, 2010 and is exercisable for three years.  The
options were issued to Mr. Corcoran pursuant to Regulation D of the Securities
Act of 1933, as amended.  The fair value of this option, based on
volatility of 232%, and dividend and risk-free interest rates of 0% and 1.51%,
respectively, was $87,500 and this amount is included in general and
administrative expense in the consolidated statements of
operations.  This is the only option awarded since the
Merger.




The
Company adopted accounting guidance that sets accounting requirements for
share-based compensation to employees and non-employee directors and
consultants, and requires companies to recognize in the statement of operations
the grant-date fair value of stock options and other equity based compensation
expensed over the requisite service and vesting period. For the purpose of
determining the fair value of stock option awards, the Company uses the
Black-Scholes option-pricing model. The estimation of forfeitures is required
when recognizing compensation expense which is then adjusted over the requisite
service period should actual forfeitures differ from such estimates. Changes in
estimated forfeitures are recognized through a cumulative adjustment to
compensation in the period of change.   As of March 31, 2010, the
Company has not experienced any forfeitures.




The
prescribed accounting guidance also requires tax benefits relating to excess
stock-based compensation deductions to be prospectively presented in the
statement of cash flows as financing cash inflows. As of March 31, 2010, the
Company does not have any tax expense (benefits) resulting from stock-based
compensation deductions in excess of amounts reported for financial reporting
purposes.




Note
13 – Subsequent Events




Effective
April 6, 2010, pursuant to the terms of a Securities Purchase Agreement
consummated on January 6, 2010 and which Agreement required pricing of these
shares to be reduced to $1.10 per share based on the absence of an investment by
an additional institutional investor within 90 days after the date of the
agreement, the Company issued to this Investor an additional 363,636 shares of
the Company’s common stock at $1.10 per share.  The shares will
be issued in reliance on the exemption provided by Regulation S of the
Securities Act of 1933, as amended.




On May 3,
2010, the Company received the final installment of a Securities Purchase
Agreement with a certain Investor listed on the signature page of such
Purchase Agreement.  Pursuant to the terms of the Purchase Agreement,
the Company issued to the Investors 545,455 shares of the Company’s common
stock, at $1.10 per share, for net proceeds to the Company of
$540,000.  The shares will be issued in reliance on the exemption
provided by Regulation S of the Securities Act of 1933, as
amended.


-
16 -




Item
2.  Management's Discussion and Analysis of Financial Condition and
Results of Operations





Business





While we
have historically provided engineering, construction, operating and ethanol
marketing services, for first generation grain based ethanol (“1st Gen” or
“GBE”) our focus is now on owning and operating second generation cellulose
based ethanol (“2nd Gen” or "CBE") integrated facilities that utilize our
proprietary technology, and designing these facilities for, and licensing our
proprietary process technology to, third-parties seeking to participate in the
renewable energy and advanced biofuel markets.


Initially,
we created expansion and optimization programs for 1st Gen facilities. The
experience in the design and operation of these GBE’s has given our company a
significant advantage in the development and future operations of 2nd Gen
facilities. While we are able to offer design and engineering services to
optimize existing GBE facilities, our emphasis in the future will be on
integrated CBE facilities.





The
majority of first generation ethanol is currently produced from sugar cane or
grain-based feedstocks, predominantly corn in the United States, however it can
also be produced from cellulose. The growth of first generation ethanol is
limited due the widespread opposition to using land and crops that can be used
for food or feed, for the production of fuels. This is especially relevant now
that technology has provided a solution that uses widely available cellulose as
a feedstock for ethanol production.  Cellulose is the primary
component of plant cell walls and is one of the most abundant organic compounds
available. Advanced biofuels produced from cellulosic materials draws on
non-food related and waste feedstock sources and has been proven to
substantially reduce carbon dioxide emissions and improve engine
efficiency.





Our
scientists and engineers continue to optimize our technology both independently
and in cooperation with the South Dakota School of Mines and Technology in Rapid
City, South Dakota. Based on laboratory data, we have shown our process is
capable of producing up to 90 gallons of ethanol form every dry metric ton of
certain biomass feedstock. Using pretreated sugarcane bagasse and eucalyptus, we
currently are achieving up to 75 gallons per dry metric ton at our bench scale
facility.




A key
part of our business model is the design of scalable, custom-designed fully
integrated CBE plants, preferably with integrated Combined Heat and Power
(“CHP”) and Bio-Lignin production, tailored to a project’s geographic area and
locally available feedstock.  Through Western Biomass Energy, LLC
(“WBE”), a majority-owned subsidiary of ours, we have designed, constructed
and operated what we believe to be one of the first CBE demonstration
plants in the United States.  This allows us to continue to research, and
refine our cellulose conversion technology, while also demonstrating the
commercial viability for this type of technology.


Biomass,
unlike corn, includes all plants and plant-derived materials and is more evenly
distributed among regions of the world.  The quantity of biomass
available for a CBE plant can come from many different sources, including fuel
wood harvesting, wood processing residue, urban wood residue, fuel treatment
operations, municipal solid waste, crop residue, and perennial crops. The
extensive biomass distribution facilitates co-locating CBE plants closer to
plant feedstock, reducing transportation costs relating to feedstock. Locating
CBE facilities near blending facilities and retail fuel outlets will reduce
transportation costs related to the sale of ethanol. This has the potential to
create a truly local and commercially viable energy source.  We
believe that our CBE facilities provide a commercially viable alternative that
may contribute to solving local communities’ energy and economic
needs.





Future
Synergistic Projects





Our
design also offers us better access to synergistic opportunities, such as
co-locating  CBE
facilities with combined heat and power plants, pulp & paper industries and
first generation ethanol production plants.




-
17 -




As a
natural consequence of converting the fermentable portion of the biomass
feedstock to ethanol, the solid co-product left behind is rich in lignin, a high
energy solid fuel component.  Using a conventional wood pellet mill,
this co-product can be formed into pellets that are more dense and durable than
the typical wood pellet marketed today.  Our process minimizes
chemical biomass pretreatment because the bio-lignin co-product chemistry is
unaltered. This results in a clean-burning, high-energy premium bio-lignin
pellet product.





We have
identified several potential projects and locations for plants using our
technology and are currently conducting multiple  pre-feasibility
studies.




Production
Processes




Several
technologies have been developed to produce ethanol from
biomass.  Generally speaking, efforts to convert cellulose into
ethanol follow one of two main processes:





•
            Thermochemical conversion of
      biomass into synthesis gas or “syngas” (a process often referred to as
      “gasification”), followed by catalytic conversion of the syngas into mixed
      alcohols that include ethanol and/or alkaline via modified chemistry;
      or





•
            Biomechanical conversion, which
      is the enzymatic or chemical breakdown of biomass into component sugars,
      followed by biological fermentation of the sugars into
      ethanol.




We have
selected the enzymatic breakdown of biomass for producing ethanol from cellulose
alternative because we believe it has distinct advantages over the
thermochemical/gasification methods. Gasification methods present a number of
challenges, including the capital intensity of the process, selectivity of the
syngas conversion to ethanol, and alcohol tolerance of the organisms capable of
converting syngas to ethanol. Furthermore, unlike other cellulosic ethanol
technology, we use insignificant amounts of acid (up to
..3%) in our process, eliminating the environmental hazards that result
with acid, and producing valuable by-products from the resulting lignin. Our
process has significantly reduced process water discharge. Other technologies
discharge waste water back into local streams or municipal waste water
systems.





In terms
of reduction of greenhouse gases, cellulosic ethanol represents a significant
advance over grain-based ethanol.  According to a report by Argonne
National Laboratory, grain ethanol reduces greenhouse gas by 18% to 29% per
vehicle mile traveled as compared to gasoline, while cellulosic ethanol reduces
greenhouse gas emissions by approximately 85% per vehicle mile traveled. Other
advantages may include additional revenues through the sale of carbon credits,
federal and state tax incentives and other measures that result from
governmental support of cellulosic ethanol.





Business
Strategies





During
the current year, we plan to continue to optimize our technology and to design
our first commercial (and possibly second) CBE facility. In addition, we intend
to license our technology and contract our design engineering to third
parties.  We will focus on developing cellulosic ethanol projects
integrated into existing industries like CHP plants, together with partners that
will help us accelerate the commercialization of our cellulosic technology and
expand our global market presence.  These strategic partners and
alliances provide an important advantage in realizing success in commercializing
our process technologies.  Key elements of our business strategy
are:





·
Developing and supplying the
technologies for commercial production of cellulosic ethanol from certain
biomass feedstocks like sugarcane bagasse, eucalyptus and other hard woods, soft
woods and ag waste .  The design and production strategy
involves developing scalable facilities preferably with integrated Combined Heat
and Power (CHP) and Bio-Lignin production, based on available feedstock supplies
and providing a commercially viable alternative for local energy and economic
needs.





·
Owning and operating our own
CBE facilities .  We intend to (co-)own and operate fully
integrated CHP/CBE facilities that utilize our proprietary
technology.  When feasible, we intend to co-locate plants with other
industrial operations such as pulp and paper industries, first generation
ethanol and sugar plants that provide synergistic
opportunities.




-
18 -




·
Developing national and
international strategic partnerships and strategic alliances
..  We intend to develop our projects together with partners that will
help accelerate the commercialization of our cellulosic technology and expand
our global market presence.  These strategic partners and alliances
will be important in accelerating the commercialization of our process
technologies.





·
Improving existing ethanol
production through KL CapacitySM .  KL CapacitySM is a service
that provides existing grain-based ethanol plants with specialized engineering
enhancements that improve the efficiency of ethanol production and potential for
increased profitability. KL CapacitySM was developed to respond to rapidly
changing market conditions in grain-based ethanol plants in the US and
sugar-based ethanol plants in Brazil.




We
currently do not sell a material amount of ethanol and/or
bio-lignin.  Our WBE facility is currently designed to gather
data for process enhancements, provide input to the design of commercial-scale
projects and validate our technology as part of the feasibility
studies.




Challenges





KL
Energy’s success depends on the ability to develop multiple projects while also
enhancing our process technology. This strategy places increased demand on our
limited human resources and requires us to substantially expand the capabilities
of our operational staff. The ability to attract, train, manage and retain
qualified management, technical, and engineering personnel presents our greatest
challenge.  Other significant challenges are:




●
              A significant portion of our
      business is in the process of scaling-up to commercial operations, causing
      us to rely on outside sources of funding, rather than supporting ourselves
      from our own
operations.


●
              We may be unable to raise debt or
      equity funding, upon which we will be highly dependent, in the near
      term.


●
              Our poor liquidity may deter
      existing or potential vendors, suppliers or customers from engaging in
      transactions with us.


●
              We depend on enzymes, some of
      which are in the research and development phase, which currently represent
      a significant and volatile expense in the CBE production process. Recent
      developments have demonstrated that these costs should continue to drop
      rapidly over the next two
years.


●
              Our industry continues to develop
      both existing and emerging competitors and competitive
      technologies.




Significant
Developments





Recent
Financing





Our
recent financings are described in Note 3 and Note 13 of the Notes to
Consolidated Financial Statements included in this Report and incorporated by
reference herein.




Subsequent
Events





Information
regarding subsequent events may be found in Note 13 of the Notes to Consolidated
Financial Statements included in this Report and incorporated by reference
herein.




Critical
Accounting Policies and Estimates:





Trade
Receivables





Trade
receivables are carried at original invoice less an estimate made for doubtful
receivables based on a periodic review of all outstanding
amounts.  Management of the Company has established an allowance for
doubtful accounts based on their estimate of uncollectible accounts and is
established based on historical performance that is tracked by the Company on an
ongoing basis.  Trade receivables are written off when deemed
uncollectible. Recoveries of trade receivables previously written off are
recorded when received.


-
19 -
 Long-Lived
Assets





The
Company assesses the realizable value of long-lived assets for potential
impairment at least annually or when events and circumstances warrant such a
review. The net carrying value of a long-lived asset is considered impaired when
the anticipated fair value is less than its carrying value. Approximately 96% of
the Company’s property, plant and equipment is attributable to the WBE facility
in Upton, WY.





In
assessing the recoverability of our long-lived assets, we must make assumptions
regarding estimated future cash flows, useful lives and other factors to
determine the fair value of the respective assets.  Since the
construction and equipment costs paid to complete this facility were incurred
approximately two years ago, the Company believes that the net carrying value of
this facility and equipment approximates its fair value.  This
facility is used for developing new, or refining old, cellulosic ethanol
technology.  It is the Company’s intent that this facility’s future
use will involve the production and sale of small but commercial quality volumes
of ethanol and lignin and currently there are no indicators that the Company
will be unable to execute its business plan.  This future use is
expected to generate positive cash flow in subsequent years.


As of
December 31, 2009, we evaluated our long-lived assets for potential
impairment.  Based on our evaluation, no impairment charge was
recognized.




Revenue
and Cost Recognition




Revenue
from fixed price contracts is recognized on the percentage-of-completion method,
measured by the percentage of costs incurred to date to estimated total costs
for each contract. This method is used because management considers expended
costs to be the best available measure of progress on these contracts. Due to
uncertainties inherent in the estimation process, it is at least reasonably
possible that the completion costs for contracts in progress at March 31, 2010
and December 31, 2009 will be revised significantly in the near
term.




Contract
costs include all direct material, subcontract and labor costs, and those
indirect costs related to contract performance, such as labor, supply, tool, and
depreciation costs. Operating costs are charged to expense as incurred. Revenue
is reported net of sales tax collected. Provisions for estimated losses on
uncompleted contracts are made in the period in which such losses are
determined. Changes in job performance, job conditions, and estimated
profitability, including those arising from contract penalty provisions and
final contract settlements, may result in revisions to costs and income and are
recognized in the period in which the revisions are determined.





The
asset, "Costs and estimated earnings in excess of billings on uncompleted
contracts," represents revenue recognized in excess of amounts
billed.  The liability, "Billings in excess of costs and estimated
earnings on uncompleted contracts," represents billings in excess of revenue
recognized.





Patriot
provided blended fuel on consignment to service stations.  Revenue
related to the sale of blended fuel by Patriot was recorded when the ethanol was
sold by the service station to the end customer.  This operation was
discontinued in January 2009.





Income
Taxes





The
Company uses the asset and liability method to account for income
taxes.  Under the asset and liability method, deferred tax assets and
liabilities are recognized for the future tax consequences attributable to
differences between the financial statement carrying amounts of existing assets
and liabilities and their respective tax basis.  Deferred tax assets
and liabilities are measured using enacted tax rates expected to apply to
taxable income in the years in which those temporary differences are expected to
be recovered or settled.  The effect on deferred tax assets and
liabilities of a change in tax rates is recognized in income in the period that
includes the enactment date.  The measurement of deferred tax assets
is reduced, if necessary, by a valuation allowance for future tax benefits for
which realization is not considered more likely than not .




Share
Based Compensation




We follow
the guidance in FASB Topic 718 related to share-based payments to recognize all
grants of stock options in our financial statements based upon their respective
grant date fair values.  Under this standard, the fair value of each
employee stock option is estimated on the date of grant using an option pricing
model that meets certain requirements.  We currently use the Black-Scholes
option pricing model to estimate the fair value of our stock options.  The
Black-Scholes model meets the requirements of FASB Topic 718 but the fair values
generated by the model may not be indicative of the actual fair values of our
equity awards as it does not consider certain factors important to those awards
to employees, such as continued employment and periodic vesting
requirements.  The determination of the fair value of share-based payment
awards utilizing the Black-Scholes model is affected by our stock price and a
number of assumptions, including expected volatility, expected life and
risk-free interest rate.  We use a historical volatility rate on our stock
options.  The fair value of our common stock is based on recent private
placement transactions by the Company, as of the date of the grant, which have
been at $1.10 per share.  Because its stock is thinly traded, the
Company does not believe that quotations for our common stock, as reported on
the OTC Bulletin Board particularly at December 31, 2009, are indicative of the
market value of the business.  If there are any modifications or
cancellations of the underlying securities, we may be required to accelerate,
increase or cancel any remaining unearned stock-based compensation
expense.  To the extent that we grant additional equity securities to
employees, our stock-based compensation expense will be increased by the
additional unearned compensation resulting from those additional
grants.




-
20 -




Liquidity
and Capital Resources





At March
31, 2010, the Company had approximately $788,000 of total current assets which
primarily consisted of $371,000 in cash and cash equivalents, approximately
$251,000 of prepaid insurance and legal expenses and $90,000 of deferred
issuance costs.  In addition, we had approximately $3.1 million of net
property, plant and equipment.  Our total assets as of March 31, 2010
were approximately $3.9 million.   With $6.8 million of total
current liabilities, the Company had negative working capital of approximately
$6.1 million at March 31, 2010.





We
received additional capital of approximately $1.5 million and $500,000 in gross
proceeds in January 2010 and March 2010, respectively, to fund operating
activities and allow long-term borrowing commitments to remain current. These
transactions are described in Note 3 and Note 13 of the Notes to Consolidated
Financial Statements. In early May 2010, the Company received additional capital
of approximately $600,000 in gross proceeds.  We expect to rely
on funds raised from these recent private placements, as well as future equity
and debt offerings, to implement our growth plan and meet our liquidity needs
going forward. We continue to seek additional financing but are not certain
whether any such financing would be available on terms acceptable to us, if at
all.




In their
report dated March 9, 2010, the Company’s auditors indicated there was
substantial doubt about the Company’s ability to continue as a going concern.
Accordingly, unless we raise additional working capital, obtain project
financing and/or revenues grow to support our business plan, we may be unable to
remain in business.




Line
of Credit; Loans





The
Company and certain WBE members are guarantors for, and the Company is
funding payments with respect to, a note payable by WBE to Security
National Bank of $1,362,704 at March 31, 2010.  A principal payment of
$500,000 was made in February 2009.  Pursuant to amendments executed
during the first quarter of 2009 and 2010, principal and interest payments of
$17,560 were required to be made from March 2009 until the current maturity date
of March 2011.  This loan’s maturity may be extended on an annual
basis if the Company is in compliance with the note terms. As of the date of
this report, the Company is in compliance with these terms.  This note
bears interest at 6.5% and is secured by substantially all of the assets of
WBE.





We had a
line of credit with Wells Fargo for borrowings up to $250,000 and at December
31, 2008 we had borrowed the full amount available.  The interest rate
with respect to borrowed amounts was the prime rate used by Wells Fargo plus
0.5%. This line of credit was personally guaranteed by certain persons who
were officers of the Company during 2008. This line of credit has matured and
was paid off in 2009 by a Company payment of $175,000 (plus interest) and by the
proceeds from a line of credit of $75,000 extended to us by a current
shareholder and officer of the Company.  This latter amount (plus
interest) was paid off in June 2009.





We had a
subordinated unsecured note payable to a current shareholder and former officer
of the Company totaling $600,000 at December 31, 2008.  This note had
a variable interest rate, which was 5.0% at March 31, 2010 and December 31,
2009, with interest paid quarterly.  This note was unsecured and did
not have a specified due date. In February 2009, the note was modified to
require principal payments of $10,000 per month beginning September 2009 over a
60 month term. The principal payments are scheduled to be $120,000 in each of
2010, 2011, 2012, 2013, and $56,461 in 2014.  As security for our
obligations under this note, we granted to the lender a security interest in our
current and future accounts receivable. In addition, if the Company receives
additional equity financing, the Company is obligated to pay 5% of the proceeds
towards principal payments on this note.




The
Company also has a secured promissory note payable to Lansing Securities Corp.
in the amount of $250,000 at 10% interest. The maturity date of this loan has
passed and has been temporarily waived by Lansing Securities until further
notice.





In June
2009, the Company negotiated a repayment of its overdue payables to
Hermanson Egge, a vendor that supplied construction services to
WBE.   The repayment arrangement is unsecured, requires no
interest payments and includes the following schedule of payments:  $70,000
in July 2009, $15,000 monthly from July 2009 to April 2010, $10,000 monthly from
May 2010 to August 2010, $20,000 monthly for September 2010 to November 2010 and
$15,000 in December 2010.  Up to $75,000 of this payable may be
reduced in exchange for the Company engaging Hermanson Egge to provide
future engineering services with scheduled completion and payment dates not
later than December 1, 2010.




-
21 -





Additional
current liabilities include approximately $89,000 in current maturities of debt,
billings in excess of costs and estimated earnings on uncompleted contracts of
approximately $1.7 million, accounts payable of approximately $1.6 million (of
which approximately $41,000 was to related parties), and accrued liabilities of
$980,000 (of which approximately $186,000 was payroll related, an estimated
$420,000 for consulting and engineering services provided by Niton Capital, an
estimated $125,000 for accrued legal and audit fees) and approximately
$331,000 representing liabilities of discontinued operations of KLM, KLHC and
Patriot.





Long-term
liabilities of approximately $172,000 at March 31, 2010 represent long-term
subordinated indebtedness to a related party ($167,500) and the non-current
portion of the note payable to Hermanson Egge ($4,505).  Our total
liabilities were approximately $7.0 million as of March 31, 2010.




On
October 9, 2008, we entered into a term loan agreement (“O2D Loan”) with
O2Diesel Corporation (“O2D”), formerly a publically traded company, pursuant to
which we agreed to provide O2D with up to $1,000,000 for O2D’s working capital
purposes.  O2D is a commercial developer of cleaner-burning diesel
fuel alternatives, including O2DieselTM, an ethanol-diesel additive.  We
previously licensed certain technology to O2D under a Technology License
and Services Agreement, dated March 6, 2008 (the "License
Agreement"). The O2D Loan provided an initial loan of $250,000 in the form
of a secured promissory note (the “Note”) with an annual interest rate of
10%.   As of March 31, 2009, O2D defaulted on this Note and, due to
O2Diesel’s financial condition, the Company determined it would not make any
additional loans to O2D and reserved for the entire amount of
the Note.   The Company sold this Note at face value to a third
party (the "Note Purchaser") in April 2009.  Subsequently, O2D
declared bankruptcy and the Note Purchaser acquired O2D out of
bankruptcy.  The Company acquired the License Agreement from the Note
Purchaser in exchange for a payment of $150,000 in October 2009 and the
Company's agreement to negotiate a new license for limited territories with the
Note Purchaser.




We have
provided substantial funding for WBE, a 64% owned subsidiary of ours, relating
to the development of our cellulosic technology.  As of March 31, 2010
and December 31, 2009, WBE owed us approximately $8.7 million and $8.8 million,
respectively.  There is currently no specific repayment schedule for
these debts owed to the Company by WBE.




Net
Cash Flow – Operating Activities




Our cash
flow from operations has been negative since the inception of the company. We do
not anticipate that we will have a positive cash flow from operations in 2010.
Whether we have positive cash flow in 2010 depends on whether we are able to
realize engineering design and licensing revenue from new CBE projects (expected
to start as early as the last quarter of 2010) and any facility improvement
contracts for GBE plants and other operational revenue.  A significant
piece of our business is still in the research and development phase and we
expect to continue to incur losses until we are able to license our technology
for third party projects or raise financing for our own projects.




We are in
the process of implementing cost control measures that should help us reach our
technology and business goals more efficiently. We have implemented a strict
budgetary and financial control process.  We have also re-focused our
human and financial resources towards the goal of being a technology provider
and eliminated positions that are not critical to this business
mission.




During
the three months ended March 31, 2010, our operating activities used a net of
approximately $1.2 million of cash. This reflected a loss of approximately $1.5
million from continuing and discontinued operations, a net loss attributable to
noncontrolling interests ($294,000), increases in prepaid expenses and
other current assets ($32,000) and decreases in accounts payable ($5,000)
and current liabilities of discontinued operations ($26,000) which were largely
offset by approximately $619,000 in cash flows provided by depreciation
($483,000), stock compensation  ($88,000), deferred issuance cost
amortization ($45,000) and accrued payroll and other liabilities
($7,000).




-
22 -




During
the three months ended March 31, 2009, our operating activities used a net of
approximately $963,000 of cash. This primarily reflected a net loss of
approximately $2.7 million from continuing and discontinued operations, a net
loss attributable to noncontrolling interests of approximately $291,000, a
decrease in accounts payable ($130,000), and an increase in trade receivables of
$19,000, which were largely offset by $486,000 of depreciation, an increase of
$435,000 in the allowance for doubtful accounts and increases in accrued payroll
and other liabilities by $886,000, current liabilities of discontinued
operations $12,000, and decreases in prepaid expenses and other current assets
($350,000 – primarily the $185,000 reduction in deferred issuance costs) and a
decrease in inventories of approximately $37,000.





Net
Cash Flow - Investing Activities





Net cash
used in investing activities during the three months ended March 31, 2010 of
approximately $65,000 decreased by approximately $56,000 over investing
activities in the three months ended March 31, 2009.  This decrease
was the result of approximately $56,000 lower purchases of property, plant, and
equipment, primarily related to the WBE plant.





Net
Cash Flow – Financing Activities




Net cash
provided by our financing activities was approximately $1.6 million for the
three months ended March 31, 2010. During this period, we received $2.0 million
in gross proceeds from the private placement of common stock offset by $245,000
in legal, professional and placement fees and approximately $147,000 of
reductions in short-term borrowings and long-term debt.  Net cash
provided by our financing activities for the three months ended March 31, 2009
was approximately $2.5 million. During this period, we received $4.0 million in
gross proceeds from the private placement of common stock offset by $750,000 in
legal, professional and placement fees and approximately $716,000 of net
reductions in short-term borrowings and long-term debt.




Results
of Operations for the Three Months Ended March 31, 2010 and 2009




Revenue




In the
three months ended March 31, 2010, the Company recognized $120,000 in biofuel
income from several feedstock testing programs.  The Company did not
record any revenue for the three months ended March 31, 2009 which was
primarily due to the discontinuance and/or work stoppage on existing contracts
in the grain based ethanol business in the latter half of 2008 and it also
reflects our focus on research and the enhancement of our CBE
technology.




Operating
Expenses




Operating
expenses of approximately $1.8 million, in the three months ended March 31,
2010, were approximately $1.2 million lower than the comparable period in the
prior year.  The primary reason for this decrease was an approximately
$1.2 million decrease in general and administrative expenses, and $20,000
decrease in research and development costs offset by $60,000 of higher biofuel
costs.  These decreases were primarily a result of lower wages and
salaries expense due to personnel reductions in the first quarter of
2009.





Biofuel costs of
$60,000 in the three months ended March 31, 2010 compared to $0 costs in
the comparable period in the prior year.  This increase is
attributable to several feedstock testing programs.




General and Administrative
expense of approximately $915,000 decreased approximately $1.2
million (or 56%) in the three months ended March 31, 2010 compared to the
$2.1 million in the three months ended March 31, 2009.  This decrease
was primarily attributable to the approximate $375,000 decrease in wages and
salaries, and $372,000 of professional fees and expenses (mainly related to the
absence of $510,000 Niton consulting fees in the first quarter of 2010), $34,000
of O2D contract costs and $83,000 of consultant, lobbyist and other advisor
costs.




Research and Development
expense of approximately $881,000 decreased approximately $20,000 (or 2%)
in the three months ended March 31, 2010 compared to approximately $901,000 in
the three months ended March 31, 2009.  The decrease is primarily
related to a reduction in plant utilities ($35,000), inventory expenses
($10,000), land rent ($23,000) and equipment repairs and supplies ($34,000)
offset by an increase in salaries and benefits ($50,000) and lab expenses
($32,000).





Other
Income (Expense)




Other expense of
approximately $22,000 for the three months ended March 31, 2010, primarily
consisting of WBE property taxes of approximately $18,000, which was
approximately $4,000 unfavorable when compared to approximately $18,000 of other
expense for the three months ended March 31, 2009.




-
23 -




Interest income of
approximately $718 for the three months ended March 31, 2010 was approximately
$42,000 lower than the comparable period in 2009 primarily as a result of an
absence of chargeable interest earned on overdue customer balances and a lower
level of investable cash.




Interest expense of
approximately $40,000 decreased approximately $35,000 in the three months ended
March 31, 2010 compared to approximately $75,000 in the three months ended March
31, 2009. This decrease was primarily due to the absence of $40,000 in interest
fees on past due vendor balances and approximately $2,000 interest paid on the
line of credit the Company held in the first quarter of 2009, offset by interest
paid on additional notes issued to the Company in the first quarter of
2010.




Item 4T.  Controls
and Procedures





(a) Disclosure Controls and
Procedures. We maintain disclosure controls and procedures designed
to provide reasonable assurance that information required to be disclosed in our
reports under the United States Securities and Exchange Act of 1934, as amended,
is recorded, processed, summarized and reported within the time periods
specified in the SEC’s rules and forms, and that such information is accumulated
and communicated to our management, including our Chief Executive Officer and
Chief Financial Officer, to allow timely decisions regarding required
disclosure.





Because
of the inherent limitations from being a small company, internal control over
financial reporting may not prevent or detect misstatements. Therefore, even
those systems determined to be effective can provide only reasonable assurance
with respect to financial statement preparation and presentation.





Our
management, with the participation and oversight of our Chief Executive Officer
and our Chief Financial Officer, has reviewed and evaluated the design and
effectiveness of our disclosure controls and procedures as of the end of the
period covered by this quarterly report on Form 10-Q. Based on that evaluation
our Chief Executive Officer and Chief Financial Officer have concluded that as
of March 31, 2010, our disclosure controls and procedures were, because of the
inherent limitations of being a small company,  not effective, as a
result of the continued existence of material weaknesses in internal controls as
identified more fully in “Item 9A (T) Controls and Procedures” in our Annual
Report on Form 10-K for the year ended December 31, 2009.





Because
of these material weaknesses, we have added additional controls and performed
procedures and analyses designed to ensure that our unaudited consolidated
financial statements are presented fairly in all material respects in accordance
with accounting principles generally accepted in the United States. We relied on
increased monitoring and review to compensate for the material weaknesses in our
internal controls. Accordingly, management believes that the unaudited
consolidated financial statements included in this quarterly report fairly
present, in all material respects, our financial position, results of operations
and cash flows for the periods presented.





(b) Internal Controls . In order
to remediate the weaknesses in our disclosure controls and procedures and
internal control over financial reporting identified in our Annual Report on
Form 10-K for the period ended December 31, 2009 we continued to take the
following actions during the period covered by this report:




·
            mandated the segregation of
      duties regarding cash
transactions;





·
            increased the oversight and
      review functions over internally developed
      documentation





·
            maintained a Disclosure
      Committee to review material developments at the Company, as well as the
      effectiveness of the Company’s disclosure controls and
      procedures





·
            engaged a Chief Financial
      Officer and outside securities counsel, both with SEC reporting
      experience





·
            utilized, as needed, a
      third-party financial consulting firm to assist management in evaluating
      complex accounting issues and implement a system to improve control and
      review procedures over all financial statement and account
      balances




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24 -




Other
than described above there were no changes in our internal controls over
financial reporting (as defined in Rule 13a-15(f) under the Exchange Act) during
the first quarter of 2010 that materially affected, or is reasonably likely to
materially affect, our internal control over financial reporting.




Management
does not expect that our disclosure controls or our internal control over
financial reporting will prevent or detect all errors and fraud. A control
system cannot provide absolute assurance due to its inherent limitations as it
is a process that involves human diligence and is subject to lapses in judgment
and breakdowns resulting from human failures. However, these inherent
limitations are known features of the financial reporting process; therefore, it
is possible to design into the process safeguards to reduce, though not
eliminate, this risk.




PART
II – OTHER INFORMATION




Item 1.  Legal
Proceedings




The
Company is named in a personal injury lawsuit relating to an employee of a
subcontractor performing acid cleaning services of a grain based ethanol plant
boiler.  The Company was also performing services at the grain based
ethanol plant in 2006. The amount of liability, if any, is not determinable but
the Company plans to vigorously defend its position. The insurance company for
the grain based ethanol plant is defending the Company employee.  The jury
trial, originally scheduled for March 2010, is now expected to take place in the
third quarter of 2010 or later.




The
Company is named in a pending action, which is captioned Dakota Supply Group,
Inc. (“DSG”) v. KL Process Design Group, LLC (“KL”), and Midwest Renewable
Energy, LLC, (“MRE”).  The action was commenced in 2008 for the collection
of a debt of approximately $524,000 plus interest for electrical supplies and
materials furnished by DSG to MRE.  DSG alleges that KL and MRE are
responsible for the debt because KL executed the purchase order without
clarifying that the debt was the responsibility of MRE and that credit was
extended directly to KL rather than MRE.  Depositions have taken place
between all parties. At this time, the Company is unable to predict the outcome
of the case but plans to vigorously defend its position.




The
Company provided construction management and engineering services for the
construction of a new biofuels production facility in Iowa in 2007 for Willmark
Energy, Inc. (“Willmark”). The Company believes that it would have provided
services of approximately $800,000, including approximately $350,000 of services
actually performed, for which it was not paid and filed a lien on the Willmark
property.  Willmark refused to pay the Company for the unpaid services
and subsequently filed a request for arbitration, counter-claiming that the
Company failed to perform its design and project management duties under the
construction contract and was seeking approximately $1.5 million in damages and
the release of liens the Company has placed on Willmark assets.  In
February 2010, in view of legal costs and especially management time, the
Company accepted a settlement offer which required that Willmark pay $35,000 to
the Company and the Company release its lien on the Willmark
property.




On June
30, 2009, a lawsuit was brought against the Company, certain subsidiaries, and
certain current and past officers in the District Court of Lincoln County,
Nebraska.  The plaintiff is Midwest Renewable Energy, LLC, a Nebraska
limited liability company ("MRE").  MRE previously engaged the Company to
manage its existing ethanol facility, oversee its expansion construction and
market the ethanol produced at its facilities.  The plaintiff alleges,
among other things, that the named individuals and entities engaged in
breaches of fiduciary duties owed to MRE, breaches of contract, fraud,
interference with contract, conversion and negligence relating to the management
and expansion of its corn-based ethanol facilities in
Nebraska.




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In August
2009, Company filed a motion to compel MRE to arbitrate its claims, and also
separately filed three arbitration demands for claims relating to the three
agreements between the Company and its affiliates and MRE that were at issue in
the lawsuit.  In November 2009, the Court ruled for the Company
and issued an order to compel arbitration. The arbitration proceedings for two
of the three arbitrations have begun and are expected to conclude in the fourth
quarter of 2010. The Company and MRE are currently waiting for the third
arbitration claim and demand to begin.




In the
normal course of business, the Company is party to litigation from time to time.
The Company maintains insurance to cover certain actions and believes resolution
of such general litigation matters will not have a material adverse effect on
the Company.





Item 1A.  Risk
Factors





We are
affected by risks specific to us as well as factors that affect all businesses
operating in a global market.  Certain of the significant factors
known to us that could materially adversely affect our business, financial
condition or operating results are described in our Form 10-K filed with the SEC
on March 9, 2010.  You should consider such risk factors in addition
to the other information set forth below and elsewhere in this
report.  The risks described in our Form 10-K are not the only risks
facing our Company.  Additional risks and uncertainties not currently
known to us or that we currently deem to be immaterial also may materially
adversely affect our business, financial condition, and/or reporting results.





Item
2.  Unregistered Sales of Equity Securities





Descriptions
of unregistered sales of equity securities are contained in Note 3, Note 7 and
Note 13 in the Notes to Consolidated Financial Statements, which are
incorporated herein by reference.





Item 5. Other
Information





None.




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Item 6.
Exhibits





(a)
Exhibits





Exhibit
                    Number
                  
                  Description3.1
                  
                  Articles
      of Incorporation, incorporated by reference to our registration statement
      on Form SB-2 (333-145183), filed on August 7, 20073.2
                  
                  Bylaws,
      incorporated by reference to our Annual Report on Form 10-K for the year
      ended December 31, 2009, filed on March 9, 201010.1*
                  
                  Amended
      consulting agreement with add blue Consultoria Ltda.31.1*
                  
                  Certification
      of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley
      Act of 200231.2*
                  
                  Certification
      of Acting Chief Financial Officer Pursuant to Section 302 of the
      Sarbanes-Oxley Act of 200232.1*
                  
                  Certification
      of Chief Executive Officer Pursuant to Section 18 U.S.C. Section
      135032.2*
                  
                  Certification
      of Acting Chief Financial Officer Pursuant to Section 18 U.S.C. Section
      1350




*
Filed herewith.




Signature





Pursuant
to the requirements of the Securities Exchange Act of 1934, the registrant has
duly caused this report to be signed on its behalf by the undersigned thereunto
duly authorized.




May
      14, 2010
                By:
                /s/ THOMAS
      J. BOLANThomas
      J. BolanChief
      Financial Officer




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