United
States Securities and Exchange Commission
 Washington,
D.C. 20549
 
 Form 10-Q
 
 [X] Quarterly
Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of
1934
 For the
quarterly period ended September 30, 2009
 
 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 43,651,106 shares of
common stock, $0.001 par value, outstanding on November 13,
2009.
  
  
 
 KL
Energy Corporation
 Form
10-Q
 For
the Period Ended September 30, 2009
   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
              26Part
      II - Other InformationItem
      1. Legal Proceedings
              27Item
      1A.  Risk Factors
              28Item
      2.  Unregistered Sales of Equity Securities
              29Item
      5. Other Information
              29Item 6. Exhibits
              29
  
 
 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 CorporationConsolidated
      Balance SheetsSeptember
      30,
              
              
              December
      31,2009
              
              
              2008(unaudited)
              
              
              (audited)ASSETSCurrent
      AssetsCash
      and cash equivalents
              
              $
              219,649
              
              
              $
              698,101Trade
      receivables, net of allowance for doubtful accounts
                of $819,512 and $381,681, respectively
              
              
              3,120
              
              
              
              470,322Accounts
      receivable - related parties
              
              
              1,034
              
              
              
              -Inventories
              
              
              42,744
              
              
              
              88,255Prepaid
      expenses and other assets
              
              
              136,111
              
              
              
              101,180Deferred
      issuance costs
              
              
              195,000
              
              
              
              320,000Current
      assets of discontinued operations
              
              
              -
              
              
              
              427Total
      Current Assets
              
              
              597,658
              
              
              
              1,678,285Non-Current
      AssetsProperty,
      Plant and Equipment, Net
              
              
              3,930,941
              
              
              
              5,253,916Total
      Assets
              
              $
              4,528,599
              
              
              $
              6,932,201LIABILITIES AND STOCKHOLDERS'
      DEFICITCurrent
      LiabilitiesLines
      of credit & short-term borrowings
              
              $
              -
              
              
              $
              250,000Current
      maturities of long-term debt
              
              
              1,904,500
              
              
              
              1,015,482Current
      maturities of subordinated debt-related party
              
              
              130,000
              
              
              
              40,000Accounts
      payable
              
              
              1,692,044
              
              
              
              2,256,893Accounts
      payable-related parties
              
              
              28,733
              
              
              
              27,312Billings
      in excess of costs and estimated earnings
              
              
              
              
              
              
              -on
      uncompleted contracts
              
              
              2,039,496
              
              
              
              2,039,496Accrued
      payroll
              
              
              320,767
              
              
              
              222,361Other
      liabilities
              
              
              614,796
              
              
              
              307,314Accrued
      issuance costs
              
              
              -
              
              
              
              320,000Current
      liabilities of discontinued operations
              
              
              367,777
              
              
              
              528,770Total
      Current Liabilities
              
              
              7,098,113
              
              
              
              7,007,628Long-term
      debt, less current maturities
              
              
              55,000
              
              
              
              1,401,283Long-term
      debt-subordinated-related party
              
              
              470,000
              
              
              
              560,000Total
      Long-Term Debt
              
              
              525,000
              
              
              
              1,961,283Stockholders'
      DeficitCommon
      stock, $0.001  par value; 150,000,000 shares authorized;
                43,651,106 and 15,622,953 shares issued and outstanding as of
                September 30, 2009 and December 31, 2008, respectively
              
              
              43,651
              
              
              
              15,623Additional
      paid-in capital
              
              
              5,456,539
              
              
              
              26,842Accumulated
      deficit
              
              
              (7,907,392
              )
              
              
              (2,272,574
              )Noncontrolling
      interests
              
              
              (687,312
              )
              
              
              193,399Total
      Stockholders' Deficit
              
              
              (3,094,514
              )
              
              
              (2,036,710
              )Total
      Liabilities and Stockholders' Deficit
              
              $
              4,528,599
              
              
              $
              6,932,201
 
 See
accompanying notes to consolidated financial statements.
 
  -
3 -
  
 
 KL
      Energy CorporationConsolidated
      Statements of OperationsThree
      Months Ended
              
              
              Nine
      Months EndedSeptember
      30,
              
              
              September
      30,2009
              
              
              
              2008
              
              
              2009
              
              
              
              2008(unaudited)
              
              
              
              (unaudited)
              
              
              (unaudited)
              
              
              
              (unaudited)RevenueEngineering
      and management contracts
              
              $
              -
              
              
              
              $
              452,568
              
              
              $
              -
              
              
              
              $
              3,456,360Total
      Revenue
              
              
              -
              
              
              
              
              452,568
              
              
              
              -
              
              
              
              
              3,456,360Operating
      ExpensesCost
      of engineering and management contracts
              
              
              -
              
              
              
              
              263,578
              
              
              
              -
              
              
              
              
              2,071,467General
      and administrative
              
              
              993,427
              
              
              
              
              995,509
              
              
              
              3,953,983
              
              
              
              
              2,936,970Research
      and development
              
              
              895,137
              
              
              
              
              585,047
              
              
              
              2,465,413
              
              
              
              
              2,009,681Total
      Operating Expenses
              
              
              1,888,565
              
              
              
              
              1,844,135
              
              
              
              6,419,396
              
              
              
              
              7,018,119Loss
      from Operations
              
              
              (1,888,565
              )
              
              
              
              (1,391,567
              )
              
              
              (6,419,396
              )
              
              
              
              (3,561,759
              )Other
      Income (Expense):Other
      income (expense)
              
              
              25,182
              
              
              
              
              37,608
              
              
              
              36,591
              
              
              
              
              47,529Interest
      income
              
              
              497
              
              
              
              
              25,731
              
              
              
              44,827
              
              
              
              
              25,740Interest
      expense
              
              
              (63,808
              )
              
              
              
              (1,638,092
              )
              
              
              (165,550
              )
              
              
              
              (1,836,269
              )Total
      Other Expense, Net
              
              
              (38,129
              )
              
              
              
              (1,574,753
              )
              
              
              (84,132
              )
              
              
              
              (1,763,000
              )Loss
      From Continuing Operations and BeforeNet
      Loss Attributable to Noncontrolling Interest
              
              
              (1,926,694
              )
              
              
              
              (2,966,320
              )
              
              
              (6,503,529
              )
              
              
              
              (5,324,759
              )Net
      loss (income) attributable to noncontrolling interests
              
              
              210,414
              
              
              
              
              (3,543
              )
              
              
              880,711
              
              
              
              
              101,519Loss
      From Continuing Operations
              
              
              (1,716,280
              )
              
              
              
              (2,969,863
              )
              
              
              (5,622,818
              )
              
              
              
              (5,223,240
              )Income
      (loss) from discontinued operations
              
              
              -
              
              
              
              
              4,323
              
              
              
              (12,000
              )
              
              
              
              157,986Net
      Loss
              
              $
              (1,716,280
              )
              
              
              $
              (2,965,540
              )
              
              $
              (5,634,818
              )
              
              
              $
              (5,065,254
              )Net
      (Loss) Income Per Share, basic and diluted:Continuing
      operations
              
              $
              (0.04
              )
              
              
              $
              (0.30
              )
              
              $
              (0.16
              )
              
              
              $
              (0.53
              )Discontinued
      operations
              
              
              -
              
              
              
              
              -
              
              
              
              -
              
              
              
              
              0.02Total
              
              $
              (0.04
              )
              
              
              $
              (0.30
              )
              
              $
              (0.16
              )
              
              
              $
              (0.51
              )Weighted
      Average Common Shares Outstanding-Proforma
              
              
              41,319,327
              
              
              
              
              9,900,266
              
              
              
              34,192,821
              
              
              
              
              9,900,266
 
  See
accompanying notes to consolidated financial statements.
 
 
  -
4 -
  KL Energy CorporationConsolidated
      Statement of Stockholders' DeficitAdditional
                
                
                
                
                
                
                
                
                TotalCommon
      Stock
                
                
                Stockholders'
                
                
                Paid-In
                
                
                Accumulated
                
                
                Noncontrolling
                
                
                Stockholders'Shares
                
                
                Amount
                
                
                Contributions
                
                
                Capital
                
                
                Deficit
                
                
                Interest
                
                
                DeficitBalance
      - December 31, 2007
                
                
                -
                
                
                $
                -
                
                
                $
                9,000
                
                
                $
                -
                
                
                $
                (1,916,219
                )
                
                $
                292,990
                
                
                $
                (1,614,229
                )KL
      Process Design Group - post merger net loss - September 30,
      2008
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                (5,120,258
                )
                
                
                
                
                
                
                (5,120,258
                )Consideration
      for pre-Merger shareholders
                
                
                3,390,000
                
                
                
                3,390
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                3,390Conversion
      of equity in reverse merger acquisition
                
                
                9,900,266
                
                
                
                9,901
                
                
                
                (9,000
                )
                
                
                (7,040,768
                )
                
                
                7,036,477
                
                
                
                
                
                
                
                (3,390
                )Conversion
      of debt to equity, net of unamortized debt discount
                
                
                2,288,000
                
                
                
                2,288
                
                
                
                -
                
                
                
                4,197,712
                
                
                
                -
                
                
                
                
                
                
                
                4,200,000Equity
      payment to placement agent upon conversion of debt to
      equity
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                (305,000
                )
                
                
                -
                
                
                
                
                
                
                
                (305,000
                )Conversion
      of derivative liability to equity
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                3,050,000
                
                
                
                -
                
                
                
                
                
                
                
                3,050,000Shares
      issued for accrued interest on convertible debt
                
                
                38,437
                
                
                
                38
                
                
                
                -
                
                
                
                102,462
                
                
                
                -
                
                
                
                
                
                
                
                102,500Issuance
      of shares in private placement (net of issuance costs of
      $2,557)
                
                
                6,250
                
                
                
                6
                
                
                
                -
                
                
                
                22,436
                
                
                
                -
                
                
                
                
                
                
                
                22,442Net
      loss attributed to noncontrolling interests
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                (99,591
                )
                
                
                (99,591
                )KL
      Energy Corporation - net loss - 4th quarter 2008
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                (2,272,574
                )
                
                
                
                
                
                
                (2,272,574
                )Balance
      - December 31, 2008
                
                
                15,622,953
                
                
                $
                15,623
                
                
                $
                -
                
                
                $
                26,842
                
                
                $
                (2,272,574
                )
                
                $
                193,399
                
                
                $
                (2,036,710
                )Issuance
      of shares in private placement (February 2009)
                
                
                18,181,818
                
                
                
                18,182
                
                
                
                -
                
                
                
                3,981,818
                
                
                
                -
                
                
                
                -
                
                
                
                4,000,000Issuance
      of shares in private placement (August 2009)
                
                
                4,545,454
                
                
                
                4,545
                
                
                
                -
                
                
                
                995,455
                
                
                
                
                
                
                
                
                
                
                
                1,000,000Issuance
      of shares in settlement of payables
                
                
                5,205,569
                
                
                
                5,206
                
                
                
                -
                
                
                
                1,140,019
                
                
                
                -
                
                
                
                -
                
                
                
                1,145,225Issuance
      of shares in settlement of accrued liabilities
                
                
                95,312
                
                
                
                95
                
                
                
                
                
                
                
                152,405
                
                
                
                
                
                
                
                
                
                
                
                152,500Legal,
      professional and placement fees
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                (840,000
                )
                
                
                
                
                
                
                
                
                
                
                (840,000
                )Net
      loss attributed to noncontrolling interests
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                
                
                
                
                (880,711
                )
                
                
                (880,711
                )Net
      loss
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                (5,634,818
                )
                
                
                -
                
                
                
                (5,634,818
                )Balance
      - September 30, 2009
                
                
                43,651,106
                
                
                $
                43,651
                
                
                $
                -
                
                
                $
                5,456,539
                
                
                $
                (7,907,392
                )
                
                $
                (687,312
                )
                
                $
                (3,094,514
                )
 
 See
accompanying notes to consolidated financial statements.
 
 
  -
5 -
  KL
      Energy CorporationConsolidated
      Statements of Cash FlowsNine
      Months EndedSeptember
      30,2009
                
                
                2008(unaudited)
                
                
                (unaudited)Cash
      Flows From Operating ActivitiesNet
      loss from continuing operations
                
                $
                (5,622,818
                )
                
                $
                (5,223,240
                )Net
      (loss) income from discontinued operations
                
                
                (12,000
                )
                
                
                157,986Adjustments
      to reconcile net loss by cash used in operating
activities:Depreciation
                
                
                1,425,717
                
                
                
                1,334,969Allowance
      for doubtful accounts
                
                
                437,831
                
                
                
                110,536Noncontrolling
      interest in net loss of subsidiaries
                
                
                (880,711
                )
                
                
                (101,519
                )Loss
      (gain) on sale of assets
                
                
                9,018
                
                
                
                (3,399
                )Amortization
      of debt issuance cost
                
                
                -
                
                
                
                305,000Amortization
      of debt discount
                
                
                -
                
                
                
                1,150,000Changes
      in current assets and liabilities:(Increase)
      decrease in:Trade
      receivables
                
                
                28,337
                
                
                
                909,924Costs
      and estimated earnings in excess of billings on uncompleted
      contracts
                
                
                -
                
                
                
                168,890Inventories
                
                
                45,511
                
                
                
                124,689Prepaid
      expenses and other assets
                
                
                422,222
                
                
                
                179,257Current
      assets of discontinued operations
                
                
                427
                
                
                
                41,774Increase
      (decrease) in:Accounts
      payable
                
                
                (228,429
                )
                
                
                (507,995
                )Billings
      in excess of costs and estimated earnings on uncompleted
      contracts
                
                
                -
                
                
                
                (807,224
                )Accrued
      payroll and other liabilities
                
                
                1,098,613
                
                
                
                197,939Current
      liabilities of discontinued operations
                
                
                (160,993
                )
                
                
                (596,303
                )Net
      Cash Provided by (Used In) Operating Activities
                
                
                (3,437,275
                )
                
                
                (2,558,716
                )Cash
      Flows From Investing ActivitiesPurchases
      of property, plant and equipment
                
                
                (143,050
                )
                
                
                (520,571
                )Proceeds
      from the sale of fixed assets
                
                
                31,291
                
                
                
                48,905Net
      Cash Provided by (Used in) Investing Activities
                
                
                (111,759
                )
                
                
                (471,666
                )Cash
      Flows From Financing ActivitiesProceeds
      (payments) from lines of credit and short-term borrowings
                
                
                (250,000
                )
                
                
                120,000Proceeds
      from subordinated debt – related parties, net
                
                
                -
                
                
                
                148,148Payments
      on subordinated debt - related parties, net
                
                
                -
                
                
                
                (148,148
                )Payments
      on long-term debt principal
                
                
                (839,418
                )
                
                
                (192,086
                )Proceeds
      from convertible debt
                
                
                -
                
                
                
                3,100,000Legal,
      professional and placement fees
                
                
                (840,000
                )
                
                
                (155,000
                )Proceeds
      from issuance of common stock
                
                
                5,000,000
                
                
                
                22,443Net
      Cash Provided by (Used in)  Financing Activities
                
                
                3,070,582
                
                
                
                2,895,357Net
      Increase (Decrease) in Cash and Cash Equivalents
                
                
                (478,452
                )
                
                
                (135,025
                )Cash
      and cash equivalents at beginning of period
                
                
                698,101
                
                
                
                190,852Cash
      and cash equivalents at end of period
                
                $
                219,649
                
                
                $
                55,827Supplemental
      Disclosures of Cash Flow InformationInterest
      paid
                
                $
                80,469
                
                
                $
                356,056Conversion
      of accounts payable and accrued liabilities to common
stock
                
                
                1,012,725
                
                
                
                -Conversion
      of deferred issuance costs payable to common stock
                
                
                285,000
                
                
                
                -Settlement
      of accounts payable with debt
                
                
                335,000
                
                
                
                -Insurance
      premium finance with debt
                
                
                47,153
                
                
                
                48,807Sale
      of assets for a note receivable
                
                
                -
                
                
                
                326,000Retun
      of asset for reduction in accounts payable
                
                
                -
                
                
                
                104,689Debt
      converted to equity
                
                
                -
                
                
                
                6,100,000Debt
      proceeds in escrow net of debt issuance costs
                
                
                -
                
                
                
                2,567,443Accrued
      interest converted to equity
                
                
                -
                
                
                
                102,500Reclassification
      of derivative liability to stockholders' equity
                
                
                -
                
                
                
                3,050,000Unamortized
      debt discount to stockholders' equity
                
                
                -
                
                
                
                1,900,000Debt
      issuance costs for convertible debt
                
                
                -
                
                
                
                305,000
 
 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
 
 The
Company is a biofuels technology development, licensing, and engineering firm
with experience rooted in grain-based and cellulose-based ethanol process
design, expansion, operations and profit optimization.  In addition,
the Company, through its majority-owned Western Biomass Energy, LLC (“WBE”), has
designed, built, and operates a cellulose-based ethanol (“CBE”)
plant.    The plant is located in Upton, Wyoming and is
designed to convert wood products and wood waste products into
ethanol.  The WBE plant was built to serve as a demonstration facility
and to operate commercially with a capacity of approximately 1.5 million gallons
of CBE per year.  During 2008, a commercially viable grade of ethanol
was developed; the product has been quality tested but has not yet been marketed
to the public.
 
 The
Company also distributed ethanol blended fuel, through its majority-owned
Patriot Motor Fuels, LLC (Patriot) to two service stations located in South
Dakota and Nebraska.  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 ethanol industry but
especially due to the Company’s re-focus on cellulosic ethanol commercialization
efforts.
 
 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, 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, 2008. 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
June 2009, the Financial Accounting Standards Board (“FASB”) FASB issued
“FASB Accounting Standards CodificationTM
(“Codification”), as the single source of authoritative generally accepted
accounting principles in the United States (“US GAAP”) for all non-governmental
entities, with the exception of the SEC and its staff. The Codification, which
launched July 1, 2009, changes the referencing and organization of
accounting guidance and is effective for interim and annual periods ending after
September 15, 2009. The Company adopted the Codification on July 1, 2009
which provided for changes in references to technical accounting literature ( if
used)  in this Quarterly Report on Form 10-Q for the period ended
September 30, 2009 but no impact to its financial position, results of
operations or cash flows.
  In
September 2006, the FASB issued new accounting guidance related to fair value
measurements and related disclosures. This new guidance defines fair value,
establishes a framework for measuring fair value, and expands disclosures about
fair value measurements. The Company adopted this new guidance on January 1,
2008, as required for its financial assets and financial liabilities. However,
the FASB deferred the effective date of this new guidance for one year as it
relates to fair value measurement requirements for nonfinancial assets and
nonfinancial liabilities that are not recognized or disclosed at fair value on a
recurring basis, which include, among others, those nonfinancial long-lived
assets measured at fair value for impairment assessment. The adoption of this
accounting guidance related to these items did not have a material impact on the
Company’s financial position or results of operations.
 
 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.
 
  -
8 -
  
 KL
Energy Corporation
 Notes
to Consolidated Financial Statements
 (unaudited)
 
 Note 1 – Nature of Business and Significant
Accounting Policies (continued)
 
 Significant Accounting
Policies (continued)
 
 In
December 2007, the FASB issued new accounting guidance related to the accounting
for noncontrolling interests in consolidated financial statements. This guidance
establishes accounting and reporting standards for the noncontrolling interest
in a subsidiary and for the deconsolidation of a subsidiary. This guidance
requires that noncontrolling interests in subsidiaries be reported in the equity
section of the controlling company’s balance sheet. It also changes the manner
in which the net income of the subsidiary is reported and disclosed in the
controlling company’s income statement. This guidance is effective for fiscal
years beginning after December 15, 2008. We adopted this guidance on January 1,
2009, and have reflected the required disclosures herein.
 
 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
June 2009, the FASB issued new accounting guidance related to the accounting and
disclosures of subsequent events. This guidance incorporates the subsequent
events guidance contained in the auditing standards literature into
authoritative accounting literature. It also requires entities to disclose the
date through which they have evaluated subsequent events and whether the date
corresponds with the release of their financial statements. This guidance is
effective for all interim and annual periods ending after June 15, 2009. The
Company adopted this guidance upon its issuance and it had no material impact on
its consolidated financial statements.
 
 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.
 
 Deferred
Issuance Costs
  Deferred
issuance costs represent the fair value of the Company’s common stock issued in
full payment of financial advisor fees which are netted against the financing
proceeds in equity
  
 
  -
9 -
  
 KL
Energy Corporation
 Notes
to Consolidated Financial Statements
 (unaudited)
 
 Note 1 – Nature of Business and Significant
Accounting Policies (continued)
 
 Significant Accounting
Policies (continued)
 
 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 WBE’s research and development 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
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, 2008, we evaluated our long-lived assets for potential
impairment.  Based on our evaluation, no impairment charge was
recognized.
   Note
2 - Financing
 On
February 24, 2009, the Company consummated a Securities Purchase Agreement with
certain Investors listed on the signature pages of such Purchase
Agreement.  Pursuant to the terms of the Purchase Agreement, the
Company issued to the Investors 18,181,818 shares of the Company’s common
stock, at $.22 per share, for proceeds to the Company of
$3,600,000.
 On
August 11, 2009, the Company consummated a Securities Purchase Agreement with
certain Investors listed on the signature pages of such Purchase
Agreement.   Pursuant to the terms of the Purchase Agreement, the
Company will issue to the Investors 4,545,454 shares for a gross purchase price
of $1,000,000.  The shares were issued in October 2009 in reliance on
the exemption provided by Regulation S of the Securities Act of 1933, as
amended.
 Note
3 – Net Loss Per Common Share
 
 The FASB
Codification Section 260 provides for the calculation of “Basic” and “Diluted”
earnings per share (“EPS”). 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 and nine months ended September 30, 2009, stock warrants for 3,125 shares
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 for the three and nine months ended September 30,
2008
 
 Revision
of Earnings Per Share
  Upon
review of our earnings per share calculations for previously reported periods,
we concluded that several calculations were incorrect.   Shares
outstanding of the accounting acquirer in connection with the reverse merger on
September 30, 2008 were not reflected as if outstanding for the entire reporting
period.  These corrections have no effect on previously reported net
losses or cash flows.
  
  -
10 -
  
 
 KL
Energy Corporation
 Notes
to Consolidated Financial Statements
 (unaudited)
 
 Note
3 – Net Loss Per Common Share (continued)
 
 Effects
of Revisions
  The
following table sets forth the previously reported earnings per share and
corrected earnings per share for previously filed financial
statements:
 Year
      Ended
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  Year
      EndedDecember
      31,
                  
                  
                  March
      31, 2008
                  
                  
                  June
      30, 2008
                  
                  
                  September
      30, 2008
                  
                  
                  December
      31,2007
                  
                  
                  3
      Months
                  
                  
                  3
      Months
                  
                  
                  6
      Months
                  
                  
                  3
      Months
                  
                  
                  9
      Months
                  
                  
                  2008NET
      LOSS
                  
                  $
                  (1,391,828
                  )
                  
                  $
                  (1,361,374
                  )
                  
                  $
                  (738,340
                  )
                  
                  $
                  (2,099,714
                  )
                  
                  $
                  (2,965,450
                  )
                  
                  $
                  (5,065,254
                  )
                  
                  $
                  (7,392,832
                  )EPS AS REPORTED:Weighted
      Avg Shares
                    Outstanding
                  
                  
                  15,623,452
                  
                  
                  
                  24,107,801
                  
                  
                  
                  36,436,158
                  
                  
                  
                  30,306,036
                  
                  
                  
                  15,612,348
                  
                  
                  
                  15,612,348
                  
                  
                  
                  15,623,452Earnings
      per share
                    reported *
                  
                  $
                  (0.09
                  )
                  
                  $
                  (0.06
                  )
                  
                  $
                  (0.02
                  )
                  
                  $
                  (0.07
                  )
                  
                  $
                  (0.19
                  )
                  
                  $
                  (0.32
                  )
                  
                  $
                  (0.47
                  )EPS AS CORRECTED:Weighted
      Avg Shares
                    Outstanding
                  
                  
                  9,900,266
                  
                  
                  
                  9,900,266
                  
                  
                  
                  9,900,266
                  
                  
                  
                  9,900,266
                  
                  
                  
                  9,900,266
                  
                  
                  
                  9,900,266
                  
                  
                  
                  11,342,697Earnings
      per share
                    corrected *
                  
                  $
                  (0.14
                  )
                  
                  $
                  (0.14
                  )
                  
                  $
                  (0.07
                  )
                  
                  $
                  (0.21
                  )
                  
                  $
                  (0.30
                  )
                  
                  $
                  (0.51
                  )
                  
                  $
                  (0.65
                  )*
      Basic and diluted
 
  Note 4 - Operations
 
 Continuing
Operations
 
 During the period from its inception to
September 30, 2009, the Company has incurred significant annual net losses and
at September 30, 2009 and December 31, 2008, the Company has negative working
capital (i.e. current assets less current liabilities) of approximately $6.5
million (unaudited) and $5.3 million, respectively.  At September 30, 2009,
total liabilities exceeded total assets by approximately $3.0
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 (“PMF”), should be discontinued as a result of pricing and other
competitive factors.  PMF distributed ethanol blended fuel to two
service stations located in South Dakota and Nebraska.  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 ethanol
industry as well as the Company’s re-focus on cellulosic ethanol
efforts.
  -
11 -
  
 
 KL
Energy Corporation
 Notes
to Consolidated Financial Statements
 (unaudited)
 
 Note 4 – Operations
(continued)
 
 Discontinued
Operations (continued)
 
 Operating
results from discontinued operations were a loss of $12,000 and income of
$157,986 during the nine months ended September 30, 2009 and 2008,
respectively.   The assets and liabilities associated with these
discontinued businesses are as follows:
 
 September
      30,
              
              December
      31,2009
              
              2008Current AssetsCash
              
              $
              -
              
              
              $
              427Total
              
              $
              -
              
              
              $
              427Current LiabilitiesAccounts
      payable
              
              $
              367,777
              
              
              $
              528,770Total
              
              $
              367,777
              
              
              $
              528,770
 
 Note
5 –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). The outstanding
borrowings under this agreement were $250,000 at December 31,
2008.  This line of credit matured and was paid off in June
2009.
 In
addition, the Company had approximately $42,000 and $95,000 in credit card
liability at September 30, 2009 and December 31, 2008, 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 $600,000 at September 30, 2009 and December 31, 2008.  This
note includes interest at a variable rate, which was 5.0% at September 30, 2009
and December 31, 2008, 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 $40,000 in 2009, $120,000 in 2010, 2011,
2012, 2013, respectively, and $80,000 in 2014.  Payments of $130,000
are due on this note in the next twelve months and therefore have been
classified as current at September 30, 2009.  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.
   -
12 -
 
 KL
Energy Corporation
 Notes
to Consolidated Financial Statements
 (unaudited)
  Long-Term
Debt





Long-term debt consists of the following
as of:


September
      30,
              
              
              December
      31,2009
              
              
              2008(unaudited)Note
      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
      2009 with any remaining unpaid principal and interest due March 2010, with
      annual maturity extensions available, secured by substantially all assets
      of WBE and guaranteed by the Company and certain WBE
      members.
              
              $
              1,423,006
              
              
              $
              1,984,949Payable
      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
              
              
              205,000
              
              
              
              -Note
      payable to Lansing Securities Corp., interest at 10%.  The
      maturity date has passed and has been temporarily waived by the note
      holder until further notice.
              
              
              250,000
              
              
              
              250,000-Note
      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.
              
              
              45,388
              
              
              
              33,816Note
      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%.
              
              
              -
              
              
              
              32,000Note
      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.
              
              
              36,106
              
              
              
              116,000Subtotal
              
              $
              1,959,500
              
              
              $
              2,416,765Less
      current maturities of long-term debt
              
              
              (1,904,500
              )
              
              
              (1,015,482
              )Net
      Long-Term Debt
              
              $
              55,000
              
              
              $
              1,401,283
   Note
6 – Common Stock Activity
 
 Effective
August 14, 2009, the Company approved the issuance of 48,437 and 46,875 shares
of its common stock to Niton Capital and Green Fund, respectively,
in settlement of an aggregate of $77,500 and $75,000, respectively, in
interest penalties incurred by the Company for not filing a timely registration
statement within sixty days after the Merger.  In light of
the Company’s cash flow demands, all parties agreed that common shares
would be issued to settle these obligations.  The shares were issued
in reliance on the exemption provided by Regulation S of the Securities Act of
1933, as amended.
 On May
13, 2009, the Company approved the issuance of 2,886,364 shares of its common
stock to Pelly Management (“PM”)  in consideration of an aggregate of
$635,000 in fees incurred by the Company for certain financial advisory services
provided by PM since October 2008. Pursuant to the arrangement between the
Company and PM, the Company was obligated to pay cash for the
fees.  However, in light of the Company’s cash flow demands, the
Company and PM agreed that the common shares would be issued in lieu of cash.
The shares were issued in reliance on the exemption provided by Regulation S of
the Securities Act of 1933, as amended.







-
13 -








KL
Energy Corporation


Notes
to Consolidated Financial Statements


(unaudited)


Note 6 – Common Stock Activity
(continued)
 
 On May 13, 2009, the Company approved
the issuance of 2,319,205 shares of its common stock to Niton Capital (“NC”) in
consideration of an aggregate of $510,225 in fees incurred by the Company for
certain consulting and engineering services provided by NC from July 2008 to
March 2009.  Pursuant to the arrangement between the Company and NC,
the Company was obligated to pay cash for the fees.  However, in light
of the Company’s cash flow demands, the Company and NC agreed that the
common shares would be issued in lieu of cash. The shares were issued in
reliance on the exemption provided by Regulation S of the Securities Act of
1933, as amended.


Note 7 -Segment
Information





As of
December 31, 2008 the Company consisted of three segments, as defined by the
Codification, identified as engineering and management contracts, fuel, and
biofuel.  The fuel segment, which
provided ethanol fuel blends to retail users, was discontinued in January 2009
as a result of competition and pricing factors.  As of September 30,
2009, the Company manages its business and aggregates its operational and
financial information in accordance with two reportable segments. Its engineering and management
contract segment provides contracted engineering and project development
to third party customers.  Despite the lack of activity in this
segment during the first nine months of 2009, 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):





For
      the Three Months Ended
            
            
            For
      the Nine Months EndedEnded
      September 30,
            
            
            Ended
      September 30,2009
            
            
            2008
            
            
            2009
            
            
            2008(unaudited)
            
            
            (unaudited)
            
            
            (unaudited)
            
            
            (unaudited)RevenueEngineering
      and Management Contract
            
            $
            -
            
            
            $
            453
            
            
            $
            -
            
            
            $
            3,456Total
      Revenue
            
            
            -
            
            
            
            453
            
            
            
            -
            
            
            
            3,456Operating
      ExpensesCost
      of Engineering and Management Contract
            
            
            -
            
            
            
            264
            
            
            
            -
            
            
            
            2,071General
      and Administrative
            
            
            993
            
            
            
            996
            
            
            
            3,954
            
            
            
            2,937Research
      and Development
            
            
            895
            
            
            
            585
            
            
            
            2,465
            
            
            
            2,010Total
      Operating Expenses
            
            
            1,889
            
            
            
            1,845
            
            
            
            6,419
            
            
            
            7,018Loss
      from Operations
            
            $
            (1,889
            )
            
            $
            (1,392
            )
            
            $
            (6,419
            )
            
            $
            (3,562
            )Identifiable
      Fixed Assets:
            
            
            
            
            
            
            
            
            
            As
      of
              September
      30,
      2009
            
            
            As
      of
              December
      31, 2008(unaudited)
            
            
            (unaudited)Engineering
      and management contract
            
            
            
            
            
            
            
            
            
            $
            275
            
            
            $
            240Biofuel
      research and development
            
            
            
            
            
            
            
            
            
            
            7,408
            
            
            
            7,348Total
            
            
            
            
            
            
            
            
            
            
            7,683
            
            
            
            7,588Accumulated
      Depreciation
            
            
            
            
            
            
            
            
            
            
            (3,752
            )
            
            
            (2,334
            )Total
      Identifiable Fixed Assets
            
            
            
            
            
            
            
            
            
            $
            3,931
            
            
            $
            5,254














-
14 -





KL
Energy Corporation


Notes
to Consolidated Financial Statements


(unaudited)





Note
8 – 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 as of September 30, 2009 (unaudited) and December 31,
2008 (audited) are as follows:


September
      30,
              
              
              December
      31,2009
              
              
              2008(unaudited)
              
              
              (audited)Beginning
      of year
              
              $
              193,399
              
              
              $
              292,990Losses
      attributable to noncontrolling interests
              
              
              (880,711
              )
              
              
              (99,591
              )End
      of period
              
              $
              (687,312
              )
              
              $
              193,399


Note
9 - 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





Information
regarding litigation may be found in Part II – Item 1 of this
report.








-
15 -








KL
Energy Corporation


Notes
to Consolidated Financial Statements


(unaudited)





Note
10 – Subsequent Events





The
Company recognizes in the financial statements the effects of all subsequent
events that provide additional evidence about conditions that existed at the
date of the consolidated balance sheets, including the estimates inherent in the
process of preparing financial statements. Subsequent events are subcategorized
into two types:  recognized and nonrecognized. For the period ended
September 30, 2009, subsequent events have been evaluated through November 15,
2009, the date the financial statements were issued or were available to be
issued.





On
October 2, 2009, the Company entered into a Securities Purchase Agreement
with a certain Investor.  Pursuant to the terms of the Purchase
Agreement, the Investor paid $600,000 on that date, representing 50% of the
Investor’s commitment to purchase 800,000 shares of the Company’s common stock,
and will pay the remaining $600,000 within 14 days of receiving a written demand
from the Company.  The pricing of these shares may be reduced based on
certain subsequent events.  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 11
– Related Party Transactions
  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 and nine months ended September 30,
2009, fees paid to Messrs. Schueller, Bolan and Rae were $36,306 and $92,782,
$37,913 and $75,488, and $10,500 and $10,500, respectively.





-
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, our current focus is on owning and operating cellulose based
ethanol ("CBE") facilities that utilize our technology, and designing CBE
facilities for, and licensing our proprietary CBE technology to, third-party
participants in the CBE industry.





Initially,
KLPDG created expansion programs for grain-based ethanol (“GBE”)
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 CBE facilities. While we will continue to offer design and
engineering services to optimize existing GBE facilities, our emphasis in the
future will be on CBE facilities.





While the
majority of ethanol is produced from grain-based feedstock, predominantly corn
in the United States, it can also be produced from cellulose. Cellulose is the
primary component of plant cell walls and is one of the most abundant organic
compounds available. Renewable fuel produced from cellulosic materials draws on
non-food related feedstock sources and has been proven to reduce carbon dioxide
emissions and improve automotive motor efficiency.





Our
engineers continue to optimize our technology in cooperation with the South
Dakota School of Mines and Technology, in Rapid City, South Dakota. Based on
modeling from laboratory data, we believe our process is ultimately capable of
producing 90 gallons/dry ton.  We currently are capable of producing
65 gallons/dry ton in a laboratory setting and have consistently produced 45
gallons per dry ton at our pilot facility.





Through
Western Biomass Energy, LLC (“WBE” or “CBE 1”), a majority-owned affiliate, we
have designed, constructed and currently operate what we believe to be the first
commercial scale, second generation CBE plant in the United
States.  This plant was designed to both facilitate research and
operate commercially. This flexible design concept allows us to continue to
research and refine our cellulose conversion technology while also demonstrating
the commercial potential for this type of facility. A key part of our business
model is the design of scalable, custom-designed CBE plants based on the
economics of the project, including the geographic area and
feedstock.


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-locatingCBE
facilities with wood pellet production plants or biomass utilities.








-
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 lignin co-product chemistry is
unaltered. This results in a clean-burning, high-energy premium lignin wood
pellet product.





We have
identified several potential projects and locations for plants using our
technology and they are currently being evaluated with feasibility
studies.





Production
Processes





Several
technologies are used to convert cellulose to ethanol.  Generally
speaking, these efforts follow one of three 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;•
            thermochemical
      conversion of biomass into syngas, followed by biological conversion of
      the syngas into ethanol; or





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





We have
selected enzymatic breakdown of biomass for producing ethanol from cellulose
because we believe it has distinct advantages over the thermochemical and
gasification methods. Unlike other cellulosic ethanol technology, we use
insignificant amounts of acid (less than 0.1 %) in our process, eliminating the
environmental hazards that result with acid, and producing valuable by-products
from the resulting lignin. In addition, our process has minimal process water
discharge. Other technologies discharge waste water back into local streams or
municipal waste water systems.  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.





Our
planned process for producing cellulosic ethanol contains the following steps.
(While several steps are generic to other forms of ethanol production, there are
other important steps that we believe are unique to us and are proprietary.) The
principal steps are as follows:





1.
            Biomass
      is prepared for processing based on its specific physical and chemical
      characteristics;2.
            Biomass
      undergoes enzymatic hydrolysis and steam explosion to break down plant
      matter;3.
            Hemicellulose,
      in the form of syrup containing xylose and other C5 sugars, is drawn off
      for processing;4.
            Residue,
      in the form of a semi-solid mixture of cellulose and lignin, is sent for
      further processing;5.
            Cellulose
      is hydrolyzed into C6 sugars using enzyme cocktails.The C6
      fermentation process also yields ethanol referred to as “ethanol
      beer”;6.
            Ethanol
      beer from steps (4) and (5) is collected prior to
      distillation;7.
            Ethanol
      beer is distilled into high-grade ethanol through the removal of water and
      residues;8.
            Lignin-rich
      co-product is pelletized;9.
            High-grade
      ethanol, and high-energy lignin pellets, are ready for shipment to
      market.








-
18 -








Business
Strategies





For the
coming year, we plan to continue to optimize our technology and to design
additional CBE facilities.  Key elements of our business strategy
are:





·
            Developing
      and supplying the technologies for commercial application to produce
      cellulosic ethanol from wood waste or other
      feedstocks.  The design and production strategy involves
      developing scalable facilities based on available feedstock supplies
      providing a commercially viable alternative to solving local communities’
      energy and economic needs.





·
            Owning and
      operating our own CBE facilities.  We intend to own and
      operate CBE facilities that utilize our proprietary
      technology.  When feasible, we intend to locate plants near
      other biomass facilities that provide synergistic benefits such as the
      benefits resulting from co-locating with wood pellet
    plants.





·
            Developing
      national and international strategic partnerships and strategic
      alliances.We intend to develop cellulosic ethanol
      projects together with partnersthat
      accelerate the commercialization of our cellulosic technology, and expand
      our global market presence, while gaining a competitive
      advantage.  These strategic partners and alliances are critical
      to our success in commercializing our cellulosic ethanol technology. We
      intend to develop cellulosic ethanol projects in conjunction with partners
      who will enhance our competitiveness and ability to finance our projects.
      Our strategy includes technology licenses and other relationships with
      partners who bring key services and capabilities to project development
      such as engineering, construction, as well as feedstock supplies and
      ethanol off-take agreements.





·
            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.





Challenges





KL
Energy’s success depends on the ability to enter into and work on simultaneous
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 scale-up and demonstration
      phase, 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 that are also in the research and development phase and
      represent a significant and volatile expense in the CBE production
      process;●
            Our
      industry is rapidly developing with many existing and emerging competitors
      and competitive technologies.








-
19 -








Significant
Developments





Recent
Financing





Our
recent financings are described in Note 2 and Note 10 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 10 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.





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 research and development 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
alternative 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 alternative use is expected to generate positive cash flow
in future years.





As of
December 31, 2008, we evaluated our long-lived assets for potential
impairment.  Based on our evaluation, no impairment charge was
recognized.




-
20 -


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 September 30, 2009 and December 31, 2008 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.




Liquidity
and Capital Resources





At
September 30, 2009, the Company had approximately $598,000 of total current
assets which primarily consisted of $220,000 in cash and cash equivalents,
approximately $136,000 of prepaid insurance and legal expenses and $195,000 of
deferred issuance costs.  In addition, we had approximately $3.9
million of net property, plant and equipment.  Our total assets as of
September 30, 2009 were approximately $4.5 million.   With $7.1
million of total current liabilities, the Company had negative working capital
of approximately $6.5 million at September 30, 2009.










-
21 -








We
received additional capital of approximately $4.0 million and $1.0 million in
gross proceeds in February 2009 and August 2009, respectively, to fund operating
activities and allow long-term borrowing commitments to remain current. We
expect to rely on funds raised from this recent private placement, 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 27, 2009, 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 $1,423,006 at September 30, 2009.  A principal payment of
$500,000 was made in February 2009.  Pursuant to an amendment executed
during the first quarter of 2009, principal and interest payments of $17,560 are
due to be made from March 2009 until the maturity date of March
2010.  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 has
a variable interest rate, which was 5.0% at September 30, 2009 and December 31,
2008, 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 $40,000 in 2009,
$120,000 in each of 2010, 2011, 2012, 2013, and $80,000 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 had 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.








-
22 -





Additional
current liabilities include approximately $87,000 in current maturities of debt,
billings in excess of costs and estimated earnings on uncompleted contracts of
approximately $2.0 million, accounts payable of approximately $1.7 million (of
which approximately $29,000 was to related parties), and accrued liabilities of
$936,000 (of which approximately $321,000 was payroll related, approximately
$270,000 is for consulting and engineering services provided by Niton Capital,
approximately $137,000 for accrued legal and audit fees and approximately
$368,000 represented liabilities of discontinued operations of KLM, KLEN and
Patriot.





Long-term
liabilities of approximately $525,000 at September 30, 2009 represent long-term
subordinated indebtedness to a related party ($470,000) and the non-current
portion of the note payable to Hermanson Egge ($55,000).  Our total
liabilities were approximately $7.6 million as of September 30,
2009.





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 September 30,
2009 and December 31, 2008, WBE owed us approximately $6.8 million and $4.3
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 2009.
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 2009) 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 our technology achieves the CBE yields
that allow us to produce ethanol at a cost that can compete with other
alternative fuels.





-
23 -





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 nine months ended September 30, 2009, our operating activities used a net of
approximately $3.4 million of cash. This reflected a loss of approximately $5.6
million from continuing and discontinued operations and decreases in
noncontrolling interests ($881,000), accounts payable ($228,000) and current
liabilities of discontinued operations ($161,000) which were largely offset by
depreciation of approximately $1.4 million, allowances for doubtful accounts of
approximately $438,000, a decrease of approximately $375,000 in prepaid expenses
and other current assets (primarily deferred issuance costs of $320,000) and an
increase of approximately $1.1 million in accrued payroll and other liabilities
(of which approximately $270,000 was attributable to Niton Capital consulting
fees).
 
 During
the nine months ended September 30, 2008, our operating activities used a net of
approximately $2.6 million of cash. This primarily reflected a net loss of
approximately $5.1 million from continuing and discontinued operations and
decreases in accounts payable ($508,000), billings in excess of costs and
estimated earnings on uncompleted contracts ($807,000) and current liabilities
of discontinues operations ($596,000) which were largely offset by depreciation
($1,3 million), amortization of debt issuance and discount costs ($1.5 million)
and increases in trade receivables ($910,000), costs and estimated earnings in
excess of billings on uncompleted contracts ($169,000), inventories ($125,000),
prepaid expenses and other current assets ($130,000) and an increase of
approximately $198,000 in accrued payroll and other liabilities.
 
 Net
Cash Flow - Investing Activities
 
 Net cash
used in investing activities during the nine months ended September 30, 2009 of
approximately $112,000 decreased by approximately $360,000 over investing
activities in the nine months ended September 30, 2008.  This decrease
was the result of approximately $378,000 lower purchases of property, plant, and
equipment, primarily related to the WBE plant, as well as approximately $18,000
of lower proceeds from the sale of assets during the nine months ended September
30, 2009.
 
 Net
Cash Flow – Financing Activities


Net cash
provided by our financing activities was approximately $3.1 million for the nine
months ended September 30, 2009. During this period, we received approximately
$5.0 million in gross proceeds from the private placement of common stock offset
by approximately $840,000 in legal, professional and placement fees and
approximately $1.0 million of reductions in short-term borrowings and long-term
debt.  Net cash provided by our financing activities for the nine
months ended September 30, 2008 was approximately $2.9 million primarily due to
the restructuring of bank loans.




Results
of Operations for the Three Months Ended September 30, 2009 and
2008





Revenue





The
Company did not record any revenue for the three months ended September 30, 2009
which was approximately $453,000 lower than the corresponding period in
2008.  This decrease was due to a slowdown and/or work stoppage on
existing contracts in the grain based ethanol business in the latter half of
2008.  This decrease in revenue also reflects our focus on research
and the enhancement of our CBE technology.








-
24 -





Operating
Expenses





Operating
expenses of approximately $1.8 million, in the three months ended September 30,
2009, were approximately $5,000 lower than the comparable period in the prior
year.  The primary reason for this decrease was the absence of
engineering and management contract costs in the third quarter of 2009 (compared
to approximately $264,000 of such costs in the third quarter of 2008), due to a
slowdown and/or work stoppage on existing contracts in the grain based ethanol
business in the latter half of 2008, and a $2,000 decrease in general and
administrative expenses.  This decrease was substantially offset by a
$310,000 (or 53%) increase in research and development expenses.





General and Administrative
expense of $993,000 decreased approximately $2,000 in the three
months ended September 30, 2009 compared to the $995,000 in the three months
ended September 30, 2008.  This decrease was primarily attributable to
the $63,000 decrease in aircraft operating costs offset by $11,000 increase in
contract professional costs.




Research and Development
expense of $895,000 increased approximately $310,000 (or 53%) in the
three months ended September 30, 2009 compared to the $585,000 in the three
months ended September 30, 2008.  The increase is primarily related
to an increase in equipment repairs ($45,000), utilities ($25,000), enzymes
and chemicals ($41,000), depreciation ($62,000), rental equipment ($56,000) and
payroll taxes ($32,000).





Other
Income (Expense)





Other income of
approximately $25,000 for the three months ended September 30, 2009, primarily
consisting of approximately $30,000 in research grants received offset by a loss
on the sale of assets of approximately $6,000, was approximately $12,000
unfavorable to the $38,000 of other income for the three months ended September
30, 2008





Interest income of
approximately $497 for the three months ended September 30, 2009 was
approximately $25,000 lower than the comparable period in 2008 primarily as a
result of reduced interest earned on overdue customer balances and a lower level
of investable cash.





Interest expense of
$64,000 decreased approximately $1.6 million in the three months ended September
30, 2009 compared to approximately $1.6 million in the three months ended
September 30, 2008. This decrease was primarily due to the absence of $1.5
million in debt issuance and debt discount cost amortization.





Results
of Operations for the Nine Months Ended September 30, 2009 and 2008





Revenue





The
Company did not record any revenue for the nine months ended September 30, 2009
which was approximately $3.5 million lower than the corresponding period in
2008.  This decrease was due to a slowdown and/or work stoppage on
existing contracts in the grain based ethanol business in the latter half of
2008.  This decrease in revenue also reflects our focus on research
and the enhancement of our CBE technology.




General and Administrative
expense of $4.0 million increased approximately $1.0 million (or
35%) in the nine months ended September 30, 2009 compared to the $2.9 million in
the nine months ended September 30, 2008.  This increase was primarily
attributable to approximately $1.6 million increase in professional, consulting,
accounting, and legal fees (of which approximately $780,000 was attributable to
Niton Capital), $205,000 in travel and fund raising costs compared to nominal
expenses in 2008, a $50,000 increase in bad debts reserve, a $42,000 increase in
laboratory research costs, and a $15,000 increase in advertising and promotion
costs, offset by a decrease of $882,000 in wages and salaries, and an absence of
aircraft and its operating costs amounting to approximately
$63,000.


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Research and Development
expense of $2.5 million increased approximately $456,000 (or 23%) in the
nine months ended September 30, 2009 compared to the $2.0 million in the nine
months ended September 30, 2008.  The increase is primarily related
to an increase in equipment repairs ($88,000), utilities ($81,000), enzymes
and other feedstocks ($102,000), depreciation ($62,000), rental equipment
($56,000) and payroll taxes ($49,000).
  Other Income
(Expense)





Other income of
approximately $37,000 for the nine months ended September 30, 2009 was
approximately $11,000 unfavorable compared to the same period in
2008.  This was primarily attributable to higher losses on the sale of
assets and aircraft sales and property taxes offset by higher research grant
income and proceeds from the sale of Renewable Fuel Standard’s (RFS) renewable
identification numbers (RINS).





Interest income of
approximately $45,000 for the nine months ended September 30, 2009, compared to
approximately $26,000 of interest income during the same period in 2008, as
increased interest from higher levels of invested cash was offset by lower
interest earned on overdue customer balances. .





Interest expense of
$166,000 decreased approximately $1.7 million in the nine months ended September
30, 2009 compared to the $1.8 million in the nine months ended September 30,
2008. This decrease was primarily due to the absence of $1.5 million in debt
issuance and debt discount cost amortization.








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.





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 September 30, 2009, our disclosure controls and procedures were 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 2008 Annual Report on Form 10-K.





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 Quarterly Report on
Form 10-Q for the period ended June 30, 2009, we took 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








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·
            created 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





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 third quarter of 2009 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 claim relating to an employee of a
subcontractor of a grain based ethanol plant for which the Company was
performing services.  The plaintiff claims that an employee of the
Company gave him direction to open the boiler when it was not yet cooled and, as
a result, he suffered second and third degree burns. The employer of this
plaintiff is seeking to subrogate its workers compensation claim. The Company
strongly disagrees with these claims. 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
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.  Initial discovery in the case is
underway. 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 for Willmark Energy, Inc.
(“Willmark”). The Company believes that it provided services of approximately
$800,000 for which it was not paid and filed a lien on 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 is seeking approximately $1.5 million in damages and
the release of liens the Company has placed on Willmark assets. The Company
believes that the Willmark claims are without merit and will aggressively pursue
the amounts it believes are owed to it.





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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.  The Company intends to vigorously defend itself as well as to
pursue claims it believes it has against MRE relating to the same underlying
matters.
 
 The
Company has filed a motion to compel MRE to arbitrate its claims. The Company
has also separately filed three arbitration demands relating to the three
agreements between the Company and MRE that are at issue in
the lawsuit.  Those arbitrations are stayed pending the decision
of the Court on the motion to compel arbitration.
  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 30,
2009.  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 2, Note 6 and
Note 10 in the Notes to Consolidated Financial Statements, which are
incorporated herein by reference.








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Item 5. Other
Information


In 2009,
the Company entered into consulting contracts for the positions of Executive
Chairman of the Board with Thomas Schueller and Acting Chief Financial Officer
with Thomas Bolan.  In addition, the Company entered into a consulting
contract with Alan Rae, a Director.  Mr. Schueller’s contract calls for an
unspecified term and monthly payments of $12,102 plus travel costs and a $25 per
diem expense reimbursement.  This contract may be terminated at any
time by the Board or upon 10 days notice by Mr. Schueller.  Mr.
Bolan’s contract calls for a minimum term of three months, beginning April 2,
2009 and renewable on a month-to-month basis for an unspecified period, at a
rate of $75 per hour.  This contract may be terminated at any time
upon 30 days notice by the Board or Mr. Bolan.  Mr. Rae’s contract calls
for an unspecified term and monthly payments of $7,000 and a $25 per diem
expense reimbursement. This contract may be terminated at any time by the Board
or upon 10 days notice by Mr. Rae.







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 registration statement on Form SB-2
      (333-145183), filed on August 7, 200710.7*
            Consulting
      agreement between the registrant and Thomas Schueller10.8*
            Consulting
      agreement between the registrant and Thomas Bolan10.9*
            Consulting
      agreement between the registrant and Alan Rae31.1*
            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.





November
      16, 2009
            By:
            /s/ THOMAS
      J. BOLANThomas
      J. Bolan
              Acting
      Chief Financial Officer




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