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 March 31, 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  [ X ]     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 33,804,771 shares of
common stock, $0.001 par value, outstanding on May 13, 2009.
  
 
 
 Table
of Contents
  PagePart
      I - Financial Information
                  4Item
      1. Financial Statements
                  4Item
      2. Management's Discussion and Analysis of Financial Condition and Results
      of Operations
                  21Item
      4T. Controls and Procedures
                  29Part
      II - Other Information
                  30Item
      1. Legal Proceedings
                  30Item
      1A.  Risk Factors
                  30Item
      2.  Unregistered Sales of Equity Securities
                  30Item
      6. Exhibits
                  31


-
2 -
  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 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 annual report, the terms the "Company," "KL Energy", "we," "us," "ours,"
and similar terms refer to KL Energy Corporation, a Nevada corporation, and its
subsidiaries.
  -
3 -
  PART
1:  FINANCIAL INFORMATION
 
 Item
1. Financial
Statements
   KL
      Energy CorporationConsolidated
      Balance SheetsMarch
      31,
                                                  
                                                  
                                                  December
      31,2009
                                                  
                                                  
                                                  2008(unaudited)
                                                  
                                                  
                                                  (audited)ASSETSCurrent
      AssetsCash
      and cash equivalents
                                                  
                                                  $
                                                  2,148,827
                                                  
                                                  
                                                  $
                                                  698,148Trade
      receivables, net of allowance for doubtful accounts of $835,144 and
      $381,681, respectively
                                                  
                                                  
                                                  35,787
                                                  
                                                  
                                                  
                                                  470,322Accounts
      receivable - related parties
                                                  
                                                  
                                                  -
                                                  
                                                  
                                                  
                                                  -Inventories
                                                  
                                                  
                                                  51,277
                                                  
                                                  
                                                  
                                                  88,255Prepaid
      expenses and other assets
                                                  
                                                  
                                                  56,243
                                                  
                                                  
                                                  
                                                  101,180Deferred
      issuance costs
                                                  
                                                  
                                                  15,000
                                                  
                                                  
                                                  
                                                  320,000Current
      assets of discontinued operations
                                                  
                                                  
                                                  365
                                                  
                                                  
                                                  
                                                  380Total
      Current Assets
                                                  
                                                  
                                                  2,307,499
                                                  
                                                  
                                                  
                                                  1,678,285Non-Current
      AssetsProperty,
      Plant and Equipment, Net
                                                  
                                                  
                                                  4,888,935
                                                  
                                                  
                                                  
                                                  5,253,916Total
      Assets
                                                  
                                                  $
                                                  7,196,434
                                                  
                                                  
                                                  $
                                                  6,932,201LIABILITIES AND STOCKHOLDERS'
      DEFICITCurrent
      LiabilitesLines
      of credit & short-term borrowings
                                                  
                                                  $
                                                  -
                                                  
                                                  
                                                  $
                                                  250,000Current
      maturites of long-term debt
                                                  
                                                  
                                                  1,875,896
                                                  
                                                  
                                                  
                                                  1,015,482Current
      maturities of subordinated debt-related party
                                                  
                                                  
                                                  145,000
                                                  
                                                  
                                                  
                                                  40,000Accounts
      payable
                                                  
                                                  
                                                  2,338,576
                                                  
                                                  
                                                  
                                                  2,293,534Accounts
      payable-related parties
                                                  
                                                  
                                                  178,655
                                                  
                                                  
                                                  
                                                  353,744Billings
      in excess of costs and estimated earningson
      uncompleted contracts
                                                  
                                                  
                                                  2,039,496
                                                  
                                                  
                                                  
                                                  2,039,496Accrued
      payroll
                                                  
                                                  
                                                  383,695
                                                  
                                                  
                                                  
                                                  222,361Other
      liabilities
                                                  
                                                  
                                                  987,040
                                                  
                                                  
                                                  
                                                  307,314Accrued
      issuance costs
                                                  
                                                  
                                                  365,000
                                                  
                                                  
                                                  
                                                  320,000Current
      liabilities of discontinued operations
                                                  
                                                  
                                                  177,663
                                                  
                                                  
                                                  
                                                  165,697Total
      Current Liabilities
                                                  
                                                  
                                                  8,491,021
                                                  
                                                  
                                                  
                                                  7,007,628Long-term
      debt, less current maturities
                                                  
                                                  
                                                  -
                                                  
                                                  
                                                  
                                                  1,401,283Long-term
      debt-subordinated-related party
                                                  
                                                  
                                                  530,000
                                                  
                                                  
                                                  
                                                  560,000Total
      Long-Term Debt
                                                  
                                                  
                                                  530,000
                                                  
                                                  
                                                  
                                                  1,961,283Stockholders'
      DeficitCommon
      stock, $0.001  par value; 150,000,000 shares authorized,
      33,804,771 and 15,623,452 shares issued and outstanding as of
                                                    March
      31, 2009 and December 31, 2008, respectively
                                                  
                                                  
                                                  33,805
                                                  
                                                  
                                                  
                                                  15,623Additional
      paid-in capital
                                                  
                                                  
                                                  3,258,660
                                                  
                                                  
                                                  
                                                  26,842Accumulated
      deficit
                                                  
                                                  
                                                  (5,310,451
                                                  )
                                                  
                                                  
                                                  (2,272,574
                                                  )Noncontrolling
      interest
                                                  
                                                  
                                                  193,399
                                                  
                                                  
                                                  
                                                  193,399Total
      Stockholders' Deficit
                                                  
                                                  
                                                  (1,824,587
                                                  )
                                                  
                                                  
                                                  (2,036,710
                                                  )Total
      Liabilities and Stockholders' Deficit
                                                  
                                                  $
                                                  7,196,434
                                                  
                                                  
                                                  $
                                                  6,932,201
  See
accompanying notes to consolidated financial statements.
  -
4 -
  
 KL Energy CorporationConsolidated
      Statements of OperationsThree
      Months EndedMarch
      31,2009
                                              
                                              
                                              2008(unaudited)
                                              
                                              
                                              (unaudited)RevenueEngineering
      and Management Contract
                                              
                                              $
                                              -
                                              
                                              
                                              $
                                              1,917,781Total
      Revenue
                                              
                                              
                                              -
                                              
                                              
                                              
                                              1,917,781Operating
      ExpensesCost
      of engineering and management contract
                                              
                                              
                                              -
                                              
                                              
                                              
                                              804,683General
      and administrative
                                              
                                              
                                              2,214,738
                                              
                                              
                                              
                                              1,810,695Reseach
      and development
                                              
                                              
                                              761,294
                                              
                                              
                                              
                                              677,375Total
      Operating Expenses
                                              
                                              
                                              2,976,032
                                              
                                              
                                              
                                              3,292,753Loss
      from Operations
                                              
                                              
                                              (2,976,032
                                              )
                                              
                                              
                                              (1,374,972
                                              )Other
      Income (Expense):Other
      income (expense)
                                              
                                              
                                              (17,522
                                              )
                                              
                                              
                                              8,020Interest
      income
                                              
                                              
                                              42,587
                                              
                                              
                                              
                                              8Interest
      expense
                                              
                                              
                                              (74,930
                                              )
                                              
                                              
                                              (98,667
                                              )Total
      Other Expense, Net
                                              
                                              
                                              (49,865
                                              )
                                              
                                              
                                              (90,639
                                              )Loss
      From Continuing Operations and BeforeNet
      Loss Attributable to Noncontrolling Interest
                                              
                                              
                                              (3,025,897
                                              )
                                              
                                              
                                              (1,465,611
                                              )(Loss)
      income from discontinued operations
                                              
                                              
                                              (11,980
                                              )
                                              
                                              $
                                              33,457Net
      loss attributable to noncontrolling interest
                                              
                                              
                                              -
                                              
                                              
                                              $
                                              70,780Net
      Loss
                                              
                                              $
                                              (3,037,877
                                              )
                                              
                                              $
                                              (1,361,374
                                              )Net
      Loss Per Share, basic and diluted:Continuing
      operations
                                              
                                              $
                                              (0.13
                                              )
                                              
                                              $
                                              (0.06
                                              )Discontinued
      operations
                                              
                                              $
                                              (0.00
                                              )
                                              
                                              $
                                              0.00Total
                                              
                                              $
                                              (0.13
                                              )
                                              
                                              $
                                              (0.06
                                              )Weighted
      Average Common Shares Outstanding-Proforma
                                              
                                              
                                              24,107,801
                                              
                                              
                                              
                                              24,107,801
  See
accompanying notes to consolidated financial statements.
  -
5 -
   KL
      Energy CorporationConsolidated
      Statements of Cash FlowsThree
      Months EndedMarch
      31,2009
                                                    
                                                    
                                                    2008(unaudited)
                                                    
                                                    
                                                    (unaudited)Cash
      Flows From Operating ActivitiesNet
      loss from continuing operations
                                                    
                                                    $
                                                    (3,025,897
                                                    )
                                                    
                                                    $
                                                    (1,394,831
                                                    )Net
      (loss) income from discontinued operations
                                                    
                                                    
                                                    (11,980
                                                    )
                                                    
                                                    
                                                    33,457Adjustments
      to reconcile net loss by cash used in operating
activities:Depreciation
                                                    
                                                    
                                                    485,757
                                                    
                                                    
                                                    
                                                    459,897Allowance
      for doubtful accounts
                                                    
                                                    
                                                    453,463
                                                    
                                                    
                                                    
                                                    405,334Noncontrolling
      interest in net loss of subsidiaries
                                                    
                                                    
                                                    -
                                                    
                                                    
                                                    
                                                    (70,870
                                                    )Changes
      in current assets and liabilities:(Increase)
      decrease in:Trade
      receivables
                                                    
                                                    
                                                    (18,928
                                                    )
                                                    
                                                    
                                                    346,305Costs
      and estimated earnings in excess of billings on uncompleted
      contracts
                                                    
                                                    
                                                    -
                                                    
                                                    
                                                    
                                                    168,890Inventories
                                                    
                                                    
                                                    36,978
                                                    
                                                    
                                                    
                                                    12,081Prepaid
      expenses and other assets
                                                    
                                                    
                                                    349,937
                                                    
                                                    
                                                    
                                                    42,717Current
      assets of discontinued operations
                                                    
                                                    
                                                    15
                                                    
                                                    
                                                    
                                                    (14,866
                                                    )Increase
      (decrease) in:Accounts
      payable
                                                    
                                                    
                                                    (130,047
                                                    )
                                                    
                                                    
                                                    9,511Billings
      in excess of costs and estimated earnings on uncompleted
      contracts
                                                    
                                                    
                                                    -
                                                    
                                                    
                                                    
                                                    (266,014
                                                    )Accrued
      payroll and other liabilities
                                                    
                                                    
                                                    886,060
                                                    
                                                    
                                                    
                                                    34,964Current
      liabilities of discontinued operations
                                                    
                                                    
                                                    11,966
                                                    
                                                    
                                                    
                                                    27,582Net
      Cash Provided by (Used In) Operating Activities
                                                    
                                                    
                                                    (962,676
                                                    )
                                                    
                                                    
                                                    (205,843
                                                    )Cash
      Flows From Investing ActivitiesPurchases
      of property, plant and equipment
                                                    
                                                    
                                                    (120,776
                                                    )
                                                    
                                                    
                                                    (52,617
                                                    )Proceeds
      from the sale of fixed assets
                                                    
                                                    
                                                    -
                                                    
                                                    
                                                    
                                                    110,012Net
      Cash Provided by (Used in) Investing Activities
                                                    
                                                    
                                                    (120,776
                                                    )
                                                    
                                                    
                                                    57,395Cash
      Flows From Financing ActivitiesProceeds
      (payments) from lines of credit and short-term borrowings
                                                    
                                                    
                                                    (250,000
                                                    )
                                                    
                                                    
                                                    20,000Proceeds
      from subordinated debt – related parties, net
                                                    
                                                    
                                                    75,000
                                                    
                                                    
                                                    
                                                    -Payments
      on long-term debt principal
                                                    
                                                    
                                                    (540,869
                                                    )
                                                    
                                                    
                                                    (53,012
                                                    )Debt
      issuance costs for convertible debt
                                                    
                                                    
                                                    (750,000
                                                    )
                                                    
                                                    
                                                    -Proceeds
      from issuance of common stock
                                                    
                                                    
                                                    4,000,000
                                                    
                                                    
                                                    
                                                    -Net
      Cash Provided by (Used in)  Financing Activities
                                                    
                                                    
                                                    2,534,131
                                                    
                                                    
                                                    
                                                    (33,012
                                                    )Net
      Increase (Decrease) in Cash and Cash Equivalents
                                                    
                                                    
                                                    1,450,679
                                                    
                                                    
                                                    
                                                    (181,460
                                                    )Cash
      and cash equivalents at beginning of period
                                                    
                                                    
                                                    698,148
                                                    
                                                    
                                                    
                                                    182,026Cash
      and cash equivalents at end of period
                                                    
                                                    $
                                                    2,148,827
                                                    
                                                    
                                                    $
                                                    566Supplemental
      Disclosures of Cash Flow InformationInterest
      paid
                                                    
                                                    $
                                                    75,237
                                                    
                                                    
                                                    $
                                                    69,571
  See
accompanying notes to consolidated financial statements.
  -
6 -
  KL
Energy Corporation
 Notes
to Consolidated Financial Statements
 (unaudited)
  Note 1 – Nature of Business and Significant
Accounting Policies
  Nature of
Business
  KL Energy
Corporation (“KLE” or “Company”), a Nevada corporation, was incorporated on
February 26, 2007.  On September 30, 2008, KL Energy Corporation
entered into an Agreement and Plan of Merger (the “Merger”) with KL Process
Design Group, LLC (“KLPDG”), a South Dakota LLC, which provided for the merger
of KLPDG with and into the Company, and accordingly, the Company and KLPDG filed
the Articles of Merger with the State of Nevada effecting the
merger.  All of the outstanding membership interests of KLPDG were
converted into an aggregate of 9,900,765 newly issued shares of common stock of
the Company, which were issued to the former members of KLPDG.
  As a
result of the merger, KLPDG merged with and into the Company, with the Company
as the surviving corporation.  The Company succeeded to, acquired all
of, the assets and liabilities of KLPDG, including all of the contractual rights
and interests of KLPDG.  For accounting purposes, the merger was
treated as a reverse acquisition with KLPDG as the acquirer and the Company as
the acquired party.  As a result, the business and financial
information included in this report is the business and financial information of
KLPDG.  In accordance with Staff Accounting Bulletin 1 Topic 4,
KLPDG’s accumulated deficit as of the date of Merger was included in additional
paid in capital.
 
 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 Western Biomass Energy, LLC (“WBE”), has designed, built,
and operates a cellulose-based ethanol (“CBE”) plant.  Construction on
the plant began during the year ended December 31, 2006 and was substantially
completed in August 2007.  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; however, the product has not been quality tested and is not yet
marketed to the public.
 
 The
Company also distributed ethanol blended fuel, through 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.
  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 on long-term contracts,
useful lives of property, plant and equipment, impairment of long-lived assets,
going concern analysis, and the allowance for doubtful accounts.
  -
7 -
 
 
 KL
Energy Corporation
 Notes
to Consolidated Financial Statements
 (unaudited)
  Note 1 – Nature of Business and Significant
Accounting Policies (continued)
 
 Principles
of Consolidation
 
 The
accompanying consolidated financial statements include the results of operations
and financial position of the Company, KL Energy, LLC (KLEN), KL
Management, LLC (KLM), WBE, and Patriot.  Until September 30, 2008,
KLM and KLEN were 53% owned by KLPDG and the remaining 47% is owned by three
other individuals and 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 Patriot, KLM, and
KLEN. WBE is 61% owned by the Company and 39% owned by various unrelated
investors.  All significant intercompany accounts and transactions
have been eliminated in consolidation.
 
 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
 
 Effective
January 1, 2008 the Company adopted SFAS No. 157, “Fair Value Measurements”
(“SFAS 157”), issued by the Financial Accounting Standards Board (“FASB”), which
defines fair value, establishes guidelines for measuring fair value and expands
disclosures regarding fair value measurements.  SFAS 157 does not
require any new fair value measurements but rather eliminates inconsistencies in
guidance found in various prior accounting pronouncements.  In
February 2008, the FASB issued FASB Staff Position No. FAS 157-2,
“Effective Date of FASB
Statement No. 157 ” (“FSP 157-2”), to partially defer
SFAS 157.  FSP 157-2 defers the effective date of
SFAS 157 for non-financial assets and non-financial liabilities, except
those that are recognized or disclosed at fair value in the financial statements
on a recurring basis (at least annually), to fiscal years, and interim periods
within those fiscal years, beginning after November 15,
2008.  The adoption of SFAS 157 and FSP 157-2 has not had a
material impact on the Company’s consolidated financial statements.
 
 Effective
January 1, 2008 the Company adopted SFAS No. 159 (“SFAS 159”), “The Fair Value Option for Financial
Assets and Financial Liabilities”.  SFAS 159 establishes
presentation and disclosure requirements designed to facilitate comparisons
between companies that choose different measurement attributes for similar types
of assets and liabilities.  Previously, accounting rules required
different measurement attributes for different assets and liabilities that
created artificial volatility in earnings.  SFAS 159 helps to mitigate
this type of accounting-induced volatility by enabling companies to report
related assets and liabilities at fair value, which would likely reduce the need
for companies to comply with detailed rules for hedge
accounting.  SFAS 159 is effective as of the beginning of an entity’s
first fiscal year beginning after November 15, 2007, though early adoption is
permitted.  The adoption of SFAS 159 did not have an impact on the
Company’s consolidated financial statements.
  -
8 -
  
 KL
Energy Corporation
 Notes
to Consolidated Financial Statements
 (unaudited)
  Note 1 – Nature of Business and Significant
Accounting Policies (continued)
 
 Recently
Issued Accounting Pronouncements (continued)
 
 Effective
January 1, 2009 the Company adopted SFAS No. 161,“Disclosures About Derivative
Instruments and Hedging Activities – an amendment to FASB Statement No.
133”(“SFAS 161”).  SFAS No. 161 is intended to improve
financial standards for derivative instruments and hedging activities by
requiring enhanced disclosures to enable investors to better understand their
effects on an entity's financial position, financial performance, and cash
flows.  Entities are required to provide enhanced disclosures about:
(a) how and why an entity uses derivative instruments; (b) how derivative
instruments and related hedged items are accounted for under Statement 133 and
its related interpretations; and (c) how derivative instruments and related
hedged items affect an entity’s financial position, financial performance, and
cash flows.   The adoption of this statement did not have a material
effect on the Company’s consolidated financial statements.
 
 Effective
January 1, 2009 the Company adopted SFAS No. 160 (“SFAS 160”), “Non-Controlling Interests in
Consolidated Financial Statements—an amendment of ARB
No. 51”.  SFAS 160 establishes accounting and
reporting standards for non-controlling interests in subsidiaries. This
statement requires the reporting of all non-controlling interests as a separate
component of stockholders’ equity, the reporting of consolidated net income
(loss) as the amount attributable to both the parent and the non-controlling
interests and the separate disclosure of net income (loss) attributable to the
parent and to the non-controlling interests.  In addition, this
statement provides accounting and reporting guidance related to changes in
non-controlling ownership interests.  The adoption of SFAS 159 did not
have an impact on the Company’s consolidated financial statements.
 
 Effective
January 1, 2009 the Company adopted SFAS No. 141R (“SFAS 141R”),
“Business
Combinations,” which replaces FASB Statement
No. 141.  SFAS 141R establishes principles and requirements for
how an acquirer recognizes and measures in its financial statements the
identifiable assets acquired, the liabilities assumed any non-controlling
interest in the acquiree and the goodwill acquired. The Statement also
establishes disclosure requirements which will enable users to evaluate the
nature and financial effects of the business combination.  The impact
of adopting SFAS 141R will depend on the future business combinations the
Company may pursue after the adoption date.
 
 Effective
January 1, 2009 the Company adopted FASB Staff Position (FSP) FAS 142-3,
“Determination of the Useful
Life of Intangible Assets” (“FSP FAS 142-3”).  FSP
FAS 142-3 amends the factors that should be considered in developing
renewal or extension assumptions used to determine the useful life of a
recognized intangible asset under FASB Statement No. 142, “Goodwill and Other Intangible
Assets.”  The adoption of this statement did not have a
material impact on the Company’s consolidated financial statements.
 
 Cash
and Cash Equivalents
 
 For
financial statement purposes, the Company considers all highly liquid
investments with an original maturity of three months or less to be cash
equivalents.  The Company maintains its cash in bank deposit accounts,
which at times exceed federally insured limits.  The Company has not
experienced any losses in such accounts and believes it is not exposed to any
significant credit risk on cash. The Company held cash in excess of federally
insured limits of approximately $1,802,000 (unaudited) and $419,000 as of March
31, 2009 and December 31, 2008, respectively.
  -
9 -
  KL
Energy Corporation
 Notes
to Consolidated Financial Statements
 (unaudited)
  Note 1 – Nature of Business and Significant
Accounting Policies (continued)
 
 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.
 
 Concentration of Credit Risk
 
 The
Company had no revenue in the three months ended March 31, 2009 and had three
customers who accounted for approximately 97% of revenues for the three months
ended March 31, 2008.  At March 31, 2009 and December 31, 2008, one
and two customers accounted for approximately 98% and 79% of accounts
receivable, respectively.
 
 Inventories
 
 Inventories
are stated at the lower of cost (first-in, first-out method) or
market.
 
 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 carrying value of a long-lived asset is considered impaired
when the anticipated fair value is less than its carrying value.  In
assessing the recoverability of our long-lived assets, we must make assumptions
regarding estimated future cash flows and other factors to determine the fair
value of the respective assets.  In addition, we must make assumptions
regarding the useful lives of these assets.  As of March 31, 2009, we
evaluated our long-lived assets for potential impairment.  Based on our
evaluation, no impairment charge was recognized.
 
 Deferred
Issuance Costs
 
 Deferred
issuance costs at December 31, 2008 represent placement agency fees and other
direct expenses of raising financing.  Upon the successful financing
in February 2009, these costs were netted against the proceeds in
equity.
 
 Revenue
and Cost Recognition
 
 Revenue
from fixed price contracts is recognized on the percentage-of-completion method,
measured by the percentage of costs incurred to date to estimated total costs
for each contract.  This method is used because management considers
expended costs to be the best available measure of progress on these
contracts.  Due to uncertainties inherent in the estimation process,
it is at least reasonably possible that the completion costs for contracts in
progress at March 31, 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.
  -
10 -
  
 KL
Energy Corporation
 Notes
to Consolidated Financial Statements
 (unaudited)
  Note 1 – Nature of Business and Significant
Accounting Policies (continued)
 
 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.
 
 The
Company had other long-term contracts whereby it is paid monthly for services
provided. The Company recognized revenue when persuasive evidence of an
arrangement exists, the price is fixed and determinable, and collectability was
reasonably assured.
 
 Research
and Development Costs
 
 Research
and development costs consist of direct labor, depreciation, and other direct
expenses incurred in the operations of the CBE plant in Upton, Wyoming and are
expensed as incurred.
 
 Advertising
Costs
 
 The
Company follows the policy of charging the costs of advertising to expense as
incurred.  Included in operating expenses are advertising and
promotion expenses of $8,420 and $6,457 for the three months ended March 31,
2009 and 2008, respectively.
 
 Warranty
Costs
 
 The
Company provides warranties on the engineering and construction management
services it provides.  The Company has not had to provide warranty
services in the past, and management does not anticipate significant warranty
liability for work performed through March 31, 2009.  Therefore, no
allowance for warranty costs has been recorded.
 
 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.
  -
11 -
  
 KL
Energy Corporation
 Notes
to Consolidated Financial Statements
 (unaudited)
 
 Note 1 – Nature of Business and Significant
Accounting Policies (continued)
 
 Fair
Value of Financial Instruments
 
 The
following methods and assumptions were used to estimate the fair value of each
class of financial instruments for which it is practicable to estimate that
value.  Fair values of receivables, other current assets, accounts
payable, accrued liabilities and other current liabilities are assumed to
approximate carrying values for these financial instruments since they are
short-term in nature and are receivable or payable on demand.
 
 Effective
January 1, 2008, the Company adopted the provisions of SFAS No. 157
for all financial instruments. The valuation techniques required by SFAS
No. 157 are based upon observable and unobservable inputs. Observable
inputs reflect market data obtained from independent resources, while
unobservable inputs reflect the Company’s market assumptions. The standard
established the following fair value hierarchy:
  Level 1 —
              Quoted
      prices for identical assets or liabilities in active
      markets.Level 2 —
              Quoted
      prices for similar assets or liabilities in active markets; quoted prices
      for identical or similar assets or liabilities in markets that are not
      active; and model-derived valuations whose inputs or significant value
      drivers are observable.Level 3 —
              Significant inputs to the valuation model are
      unobservable.
 
 
 Note
2 - Financing
  In July
2008, the Company received financing from Niton Capital (formerly PPM Holdings
LTD) asister
company of Fair Energy S.A. totaling $3,100,000 at 10% per annum interest. In
connection with the Merger, the notes were converted into an aggregate of
1,162,500 shares of our common stock at $4 per share.  At the time of
the Merger these notes had accrued interest of approximately $77,500 which was
converted into approximately 20,667 shares of common stock.  The
Company paid $155,000 to a placement agency for this financing.  This
fee was recorded as debt issuance costs and amortized to interest expense to the
conversion date.  Upon the conversion of the notes the Company
incurred an additional $155,000 of placement fees which were recorded as a
reduction of equity.
 
 On
September 5, 2008, the Company received a financing commitment in the form of
redeemable convertible promissory notes from The GreenFund,a divisionof Pluris Sustainable of
$3,000,000 at 10% per annum interest. In connection with the merger, the
notes were converted into an aggregate of 1,125,000 shares of our common
stock.  At the time of the   Merger these notes had accrued
interest of approximately $25,000 which was converted into approximately 6,667
shares of common stock.  The Company paid $150,000 to a placement
agent for this financing.  This fee was recorded as debt issuance
costs and amortized to interest expense to the conversion date.  Upon
conversion of the notes the Company incurred an additional $150,000 of placement
fees which were recorded as a reduction to equity.
 
 Contemporaneously
with the closing of the merger transaction, the Company issued an aggregate of
3,125 units of its securities in a private placement, with each unit comprised
of two shares of common stock and a warrant to purchase one share of common
stock pursuant to the terms of the Securities Purchase Agreement dated September
30, 2008 among the Company and certain investors.  The purchase price
per unit was $8.00 per unit for an aggregate purchase price of
$25,000.  The Company incurred an additional $2,558 of placement fees
which were recorded as a reduction to equity.
  -
12 -
  
 KL
Energy Corporation
 Notes
to Consolidated Financial Statements
 (unaudited)
 
 Note
2 – Financing (continued)
 
 On
February 24, 2009, the Company consummated a Securities Purchase Agreement (the
“Purchase Agreement”) with certain investors listed on the signature pages of
the Purchase Agreement (the “Investors”).  Pursuant to the terms of
the Purchase Agreement, the Company issued to the Investors 18,181,818 shares of
the Company’s common stock (the “Shares”), representing approximately 60% of the
total number of issued and outstanding shares of the Company’s common stock, for
a purchase price of $4,000,000. The Company paid $400,000 to a placement
agent for this financing.
 
 Note
3 – Net Loss Per Common Share
  SFAS
No. 128, “Earnings Per
Share” provides for the calculation of “Basic” and “Diluted” earnings per
share. Basic earnings per share 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 earnings per share reflect
the potential dilution of securities that could share in the earnings of an
entity, similar to fully diluted earnings per share.
 
 For the
three months ended March 31, 2009 and 2008, stock warrants for 3,125 and 0
shares were not included in the computation of diluted loss per share because
their effect was anti-dilutive.
 
 Note 4 - Operations
  Continuing
Operations
  During
the period from its inception to March 31, 2009, the Company has incurred
significant annual net losses and at March 31, 2009 and December 31, 2008, the
Company has negative working capital (i.e. current assets less current
liabilities) of approximately $6.0 million (unaudited) and $5.2 million,
respectively.  At March 31, 2009, total liabilities exceeded total
assets by approximately $1.6 million.  The grain based ethanol
industry, the industry in which the Company has historically operated, has also
begun to face new challenges including the rising cost of raw materials (corn),
increased construction costs, and a reduction in public and governmental
support. Engineering and construction management represents a substantial
amount of the Company’s business and the grain based ethanol industry challenges
may be an impediment to new grain based ethanol
construction.  Furthermore, the Company has used cash flows generated
by management contracts to fund the construction of a demonstration cellulose
based ethanol plant which is considered to be the Company’s future within the
ethanol industry.  Certain contractual payments that have been paid to
the engineering and construction management business may have to be returned to
two customers.  Furthermore, there is a risk that the product produced
at the demonstration cellulose based ethanol plant may not be immediately
commercially viable, or the Company may not be able to produce sufficient
saleable ethanol at this facility to cover the costs of plant operations or to
repay its loans from outside debtors and affiliated
companies.
 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.  Management is continuing its efforts to raise additional
capital through various methods and is refocusing its business to cellulose
based ethanol.
  -
13 -
   
 KL
Energy Corporation
 Notes
to Consolidated Financial Statements
 (unaudited)
 
 Note 4 – Operations
(continued)
 
 Discontinued
Operations
 
 Through
its subsidiary Patriot Motor Fuels, LLC (Patriot), the Company distributed
ethanol blended fuel to two service stations located in South Dakota and
Nebraska.  As a result of pricing and other competitive factors, the
Patriot business was discontinued in January 2009.  This business had
no assets and very slim operating margins and, as such, the income (loss) from
these discontinued operations did not have an impact on earnings per share
(basic or diluted).
 
 Note
5 - Costs and Estimated Earnings on Uncompleted Contracts
  Costs and
estimated earnings on uncompleted long-term contracts consist of the
following as of:
 
 March
      31,
                                        
                                        
                                        December
      31,2009
                                        
                                        
                                        2008(unaudited)
                                        
                                        
                                        (audited)Costs
      Incurred on Uncompleted Contracts
                                        
                                        $
                                        5,112,225
                                        
                                        
                                        $
                                        5,112,225Estimated
      Earnings
                                        
                                        
                                        2,023,012
                                        
                                        
                                        
                                        2,023,0127,135,237
                                        
                                        
                                        
                                        7,135,237Less
      Billings to Date
                                        
                                        
                                        (9,174,733
                                        )
                                        
                                        
                                        (9,174,733
                                        )$
                                        (2,039,496
                                        )
                                        
                                        $
                                        (2,039,496
                                        )Included
      in the Balance Sheet Under the Following Captions:Costs
      and Estimated Earnings in ExcessBillings
      on Uncompleted Contracts
                                        
                                        $
                                        ---
                                        
                                        
                                        $
                                        ---Billings
      in Excess of Costs and EstimatedEarnings
      on Uncompleted Contracts
                                        
                                        
                                        (2,039,496
                                        )
                                        
                                        
                                        2,039,496$
                                        (2,039,496
                                        )
                                        
                                        $
                                        (2,039,496
                                        )
  A former
officer of the Company was a member of the board of directors for, and held an
ownership interest in, one customer (“Customer A”) during this
period.  The Company was providing construction management and
engineering services for the construction of an addition to Customer A’s
existing facility for a total estimated cost to the customer of
$5,600,000.  Due to Customer A’s inability to meet contractual
obligations, KLPDG issued a stop work order on the construction project in March
2008 and has not committed to completing the construction project.  If
the contract is terminated prior to completion, the Company may be liable to
return excess billings.
  -
14 -
  KL
Energy Corporation
 Notes
to Consolidated Financial Statements
 (unaudited)
 
 Note
6 - Costs and Estimated Earnings on Uncompleted Contracts
(continued)
 
 The
Company provided construction management and engineering services for the
construction of a new biofuels production facility for a total estimated cost to
Customer B of $5,980,000.   There was no billing or cost activity
on this project during the first quarter of 2009.  Billings on this
contract exceed costs and estimated earnings by approximately $399,000 at March
31, 2009 and December 31, 2008.  The contract was 53.1% complete at March 31, 2009
and December 31, 2008 based on costs incurred to date compared to total
estimated costs.  During 2008, Customer B has proposed a change order
to revise the scope of the work to include only engineering services and to
reduce the total contract to $4,660,000.  As of the date of this
report, the change order has not been signed; however, it is likely that the
scope of services will be reduced in the near term.  If the change
order were to take effect, revenue would be increased by approximately $170,000
and billings in excess of revenue would be reduced by approximately $170,000 at
March 31, 2009.  If the project is terminated prior to completion, the
Company may be liable to return excess billings.
 
 Note
7 – Property, Plant, and Equipment
 
 Property,
plant, and equipment consist of the following as of:
 
 March
      31,
                          
                          
                          December
      31,2009
                          
                          
                          2008(unaudited)
                          
                          
                          (audited)Plant
      and plant equipment
                          
                          $
                          7,400,087
                          
                          
                          $
                          7,348,028Office
      furnishings and equipment
                          
                          
                          243,709
                          
                          
                          
                          187,801Vehicles
      and airplane
                          
                          
                          51,698
                          
                          
                          
                          51,6987,695,494
                          
                          
                          
                          7,587,527Less
      accumulated depreciation
                          
                          
                          (2,806,559
                          )
                          
                          
                          (2,333,611
                          )Total
      Property, Plant, and Equipment, Net
                          
                          $
                          4,888,935
                          
                          
                          $
                          5,253,916
  Construction
costs associated with CBE 1 are stated at cost (including direct construction
costs, and capitalized interest).  Depreciation expense, excluding
depreciation expenses charged to research and development, was approximately
$16,000 and $32,000 for the three months ended March 31, 2009 and 2008,
respectively.  Included in research and development expense is
depreciation expense of approximately $470,000 and $428,000 for the three months
ended March 31, 2009 and 2008, respectively.
  -
15 -
  
 KL
Energy Corporation
 Notes
to Consolidated Financial Statements
 (unaudited)
 
 
 
 Note
8 –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, which accrued interest payable
monthly at the prime rate plus .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 March 2009 by a
Company payment of $175,000 plus interest and the proceeds from a management
shareholder line of credit of $75,000.  This shareholder line of
credit is expected to be paid in full in May 2009.  In addition, the
Company had approximately $63,000 and $95,000 in credit card liability at March
31, 2009 and December 31, 2008, respectively, which are also guaranteed by
certain shareholders. These credit card liability balances are included in other
liabilities in the accompanying balance sheets.
 
 Subordinated
Debt – Related Parties
 
 The
Company has a subordinated unsecured note payable to a Company shareholder
totaling $600,000 at March 31, 2009 and December 31, 2008.  This note
includes interest at a variable rate, which was 5.0% at March 31, 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 $70,000 are due on this note in the next twelve
months and therefore have been classified as current.  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 financing, the Company is obligated to pay 5% of the proceeds towards
principal payments on this note.
 
 -
16 -
 
 KL
Energy Corporation
 Notes
to Consolidated Financial Statements
 (unaudited)
   Long-Term
Debt
 
 Long-term
debt consists of the following as of:
 
 March
      31,
                                                          
                                                          
                                                          December
      31,2009
                                                          
                                                          
                                                          2008(unaudited)
                                                          
                                                          
                                                          (audited)Note
      payable of WBE 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, secured by substantially all assets of WBE and guaranteed by the
      Company and certain WBE members.
                                                          
                                                          $
                                                          1,480,048
                                                          
                                                          
                                                          $
                                                          1,984,949Note
      payable to Lansing Securities Corp., the interest rate is at 10% and the
      maturity date has passed and has been temporarily waived by the note
      holder until further notice.
                                                          
                                                          
                                                          250,000
                                                          
                                                          
                                                          
                                                          250,000Note
      payable to Avid Solutions for centrifuge equipment of $195,000, payable in
      monthly principal and interest installments of $10,000, including interest
      at 20%, secured by equipment.
                                                          
                                                          
                                                          102,623
                                                          
                                                          
                                                          
                                                          116,000Notes
      to Allegiance Insurance for payment of insurance premiums, interest at
      9.8%, payable in monthly principal and interest installments of
      $4,437.
                                                          
                                                          
                                                          21,651
                                                          
                                                          
                                                          
                                                          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%.
                                                          
                                                          
                                                          21,574
                                                          
                                                          
                                                          
                                                          32,000Subtotal
                                                          
                                                          $
                                                          1,875,896
                                                          
                                                          
                                                          $
                                                          2,416,765Less
      current maturities of long-term debt
                                                          
                                                          
                                                          (1,875,896
                                                          )
                                                          
                                                          
                                                          (1,015,482
                                                          )Net
      Long-Term Debt
                                                          
                                                          $
                                                          -
                                                          
                                                          
                                                          $
                                                          1,401,283
  
 Note
9 – Income Taxes
 
 The
Company has not recorded a provision for federal or state income taxes related
to continuing operations for the periods ended March 31, 2008 and 2007, due to
continuing operating losses.  The Company has recorded a full
valuation allowance against the deferred tax assets due to the uncertainty of
realizing these benefits.  As of December 31, 2008 the Company had net
operating loss carry forwards of approximately $1.1
million.  Significant components related to permanent differences
include losses incurred prior to the Merger and non-deductible registration
statement penalties.
 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.
 
 The
Company adopted the provisions of FIN 48 on January 1, 2007. FIN 48 prescribes a
recognition threshold and measurement attribute for the financial statement
recognition and measurement of a tax position taken or expected to be taken in a
tax return.  FIN 48 requires that the Company recognize in its
consolidated financial statements only those tax positions that are
“more-likely-than-not” of being sustained as of the adoption date, based on
technical merits of the position.  As a result of the implementation
of FIN 48, the Company performed a comprehensive review of its material tax
positions in accordance with recognition and measurement standards established
by FIN 48.  No unrecognized tax positions were recorded as of the date
of adoption.  For each of the three months ended March 31, 2009 and
2008, the current and deferred provision for income taxes was $0
(unaudited).
 
 Note
10 – Escrow Shares
  On
September 30, 2008, four management stockholders entered into a Performance
Escrow Agreement (“Agreement”) in conjunction with the Reverse Merger and
Securities Purchase Agreement.  The Agreement calls for 9,900,765 of
these stockholders’ common stock to be placed in escrow.  The stock is
maintained in escrow until certain operational benchmarks are met and following
aggregate funding of $23,000,000 (the “Funding”).  The operational
benchmarks require certain performance measures within twelve (12) months
following the Funding and twenty-four (24) months following the
Funding.  In both of those measurement periods, 10% of the total
escrowed shares shall be cancelled and will no longer be outstanding if the
performance measures are not met.  As a result of the settlement
agreement related to the resignation of the Company’s President in February
2009, that former officer’s 4,356,337 shares were released from the escrow
agreement.
  -
17 -
  KL
Energy Corporation
 Notes
to Consolidated Financial Statements
 (unaudited)
 
 Note 11 -Segment
Information
  As of
December 31, 2008 the Company consisted of three segments, as defined by SFAS
No. 131, “Disclosures about
Segments of an Enterprise and Related Information,” identified as
contract revenue, fuel sales, and biofuel.  The fuel sales segment,
which provided ethanol fuel blends to retail users, was discontinued in January
2009 as a result of competition and pricing factors.  The biofuel
segment is expected to begin operations starting in late 2009.  As of
March 31, 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.  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.   Management assesses performance and
allocates resources based on discrete 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 EndedEnded
      March 31,2009
                                    
                                    
                                    2008(unaudited)
                                    
                                    
                                    (unaudited)Revenue:Engineering
      and management contract
                                    
                                    $
                                    -
                                    
                                    
                                    $
                                    1,918Total
      Revenue
                                    
                                    $
                                    -
                                    
                                    
                                    $
                                    1,918Operating
      Expenses:Cost
      of engineering and management contract
                                    
                                    $
                                    -
                                    
                                    
                                    $
                                    805General
      and administrative
                                    
                                    
                                    2,215
                                    
                                    
                                    
                                    1,811Biofuel
      research and development
                                    
                                    
                                    761
                                    
                                    
                                    
                                    677Total
      Operating Expenses
                                    
                                    $
                                    2,976
                                    
                                    
                                    $
                                    3,293Loss
      from Operations:
                                    
                                    $
                                    (2,976
                                    )
                                    
                                    $
                                    (1,375
                                    )Depreciation
      Expense:Engineering
      and management contract
                                    
                                    $
                                    16
                                    
                                    
                                    $
                                    32Biofuel
      research and development
                                    
                                    
                                    470
                                    
                                    
                                    
                                    428Total
      Depreciation Expense
                                    
                                    $
                                    486
                                    
                                    
                                    $
                                    460March
      31, 2009
                                    
                                    
                                    December
      31, 2008(unaudited)
                                    
                                    
                                    (audited)Identifiable
      Fixed Assets:Engineering
      and management contract
                                    
                                    $
                                    295
                                    
                                    
                                    $
                                    240Biofuel
      research and development
                                    
                                    
                                    7,400
                                    
                                    
                                    
                                    7,348Total
                                    
                                    
                                    7,695
                                    
                                    
                                    
                                    7,588Accumulated
      depreciation
                                    
                                    
                                    (2,806
                                    )
                                    
                                    
                                    (2,334
                                    )Total
      Identifiable Fixed Assets
                                    
                                    $
                                    4,889
                                    
                                    
                                    $
                                    5,254
 -
18 -
 
 KL
Energy Corporation
 Notes
to Consolidated Financial Statements
 (unaudited)
 
 Note
12 – Shareholders’ Deficit
 
 On
January 1, 2009, we adopted the provisions of SFAS No. 160, “Noncontrolling Interests in
Consolidated Statements – an Amendment of ARB no. 51” (“SFAS 160”) which
requires that amounts attributable to a minority interest in subsidiaries are
now recognized as noncontrolling interests.  As such, historically
presented financial statements have been restated to include noncontrolling
interests in stockholders’ deficit.  Components of noncontrolling
interests as of March 31, 2009 (unaudited) and December 31, 208 (audited) are as
follows:
 Noncontrolling
      InterestsBalance
      at January 1, 2008
                        
                        $
                        292,990Net
      loss attributable to minority interests
                        
                        
                        (99,591
                        )Balance
      at December 31, 2008
                        
                        $
                        193,399Balance
      at January 1, 2009
                        
                        $
                        193,399Net
      loss attributable to minority interests
                        
                        
                        -Balance
      at March 31, 2009
                        
                        $
                        193,399
 Note
13 - Commitments and Contingencies
 
 Leases
 
 The
Company leases its office space. Total rent expense under this lease was
approximately $15,000 and $14,000 for the three months ended March 31, 2009 and
2008, respectively.  The Company has office lease obligations that
expire September 30, 2011, of approximately $65,000 for 2009, $69,000 for 2010,
and $52,000 for 2011.
 
 The
Company leases land in Upton, WY for CBE 1.  In March 2009, the
Company signed a lease for a 2 year term with an option to extend the lease to
2013 at a lease rate of $30,000 per year.  Prior to that, the land was
leased on a month-to-month basis.  Total rent expense under this
agreement was approximately $31,000 and $6,000 for the three months ended March
31, 2009 and 2008, respectively.
 
 WBE
Ownership
 
 WBE has
an agreement with a wood residue supplier to supply CBE 1 with raw materials in
exchange for an ownership interest in WBE.  The agreement between the
two entities allows  the supplier to receive a 1% ownership interest
in WBE for every 625 tons of wood residue delivered each year, up to 4% and
2,500 tons.   During 2007, approximately 660 tons were delivered
and the supplier was granted a 1% ownership interest in WBE.  The
contribution of wood feed stock for ownership was valued at the fair market
value of wood feedstock of approximately $13,000 and $22,000 at March 31, 2009
and December 31, 2008, respectively.
  -
19 -
  
 
 KL
Energy Corporation
 Notes
to Consolidated Financial Statements
 (unaudited)
 
 Note
13 - Commitments and Contingencies (continued)
 
 Licensing
Agreement
 
 The
Company has an agreement with the South Dakota School of Mines and Technology
whereby the school granted the Company all intellectual property rights
associated with joint discovery and development of any CBE technology. If a
technology license is generated from this research and later sold, the Company
is committed to paying a licensing fee to the school.  No licenses
have been sold to date and no amounts have been recorded in the consolidated
financial statements related to this agreement.
  Note 14 – Subsequent
Events
  Arbitration
 
 As
described in Note 6, the Company provided construction management and
engineering services for the construction of a new biofuels production facility
for Customer B.  Several disputes arose in connection with this
project and, as a result of the parties’ inability to reach a settlement,
Customer B filed a request for arbitration, as provided in the construction
contract, on May 1, 2009.
 
 Issuance
of Stock
 
 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.
 
 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.
  -
20 -
 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 designing cellulose based ethanol
("CBE") facilities for, and licensing our proprietary CBE technology to,
third-party participants in the CBE industry.  We also intend to own
and operate CBE facilities that utilize our technology.
 
 Initially,
KLPDG created expansion programs for grain-based ethanol (“GBE”)
facilities. While we will continue to provide design and engineering
services to build new, or 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 motor efficiency.
 
 Our
engineers continue to optimize our technology both independently and in
collaboration 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 capable of producing 80 gallons/dry ton.  We currently are
capable of producing 65 gallons/dry ton in a laboratory setting.  We
believe that in order to compete with other fuel alternatives
currently, enzyme cost, enzyme efficiency, ethanol price, feedstock cost,
and other factors will determine the amount of gallons/dry ton required to be
produced.
  We,
through Western Biomass Energy, LLC (“WBE” or “CBE 1”), a majority owned
affiliate of ours, have designed, constructed and currently operate what we
believe to be the first commercial, modern-era, 2nd 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 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. We intend to develop a modular, portable design that can be efficiently
constructed and tailored to the geographic area and particular
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 allows for 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 relating 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
modular, decentralized design also offers us better access to synergistic
opportunities, such as co-locating modular CBE facilities with wood pellet
production plants or biomass utilities.
  -
21 -
  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 premium wood pellet
product.
 
 Our CBE
process also produces a liquid co-product that contains high nutritional value
for livestock, much like the syrup product from a corn ethanol
plant.  The liquid co-product can be used as a feed supplement for
cattle.
 
 Although
we do not have any of these synergistic projects currently underway, we are
actively pursuing the construction of a wood pellet plant in conjunction with
our CBE plant.
 
 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/gasification methods. Gasification methods present a number of
challenges, including the capital intensity of the process, selectivity of the
syngas conversion to ethanol, and alcohol tolerance of the organisms capable of
converting syngas to ethanol. Furthermore, unlike other cellulosic ethanol
technology, we use insignificant amounts of acid (less than 0.1 %) in our
process, eliminating the environmental hazards that result with acid, and
producing valuable by-products from the resulting lignin. Our process has
minimal process water discharge. Other technologies discharge waste water back
into local streams or municipal waste water systems.
  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”;
  -
22 -
  
 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
      residue from distillation, or stillage, is burned, yielding steam for the
      process;
  9.
              High-grade
      ethanol is ready for shipment to
market.
 
 Business
Strategies
 
 For the
coming year, we plan to continue to optimize our technology and to design our
second CBE facility. In addition, we intend to license our technology and
contract our design engineering to third parties, as well as build and operate
our own plants. 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.
   -
23 -
  
 ·
              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 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 has
      been 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 research and development 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.
  Significant
Developments
 
 Recent
Financing
 
 Our
recent financing is described in Note 2 of the Notes to Consolidated Financial
Statements included in this Report.
  -
24 -
   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 carrying value of a long-lived asset is considered
impaired when the anticipated fair value is less than its carrying
value.  In assessing the recoverability of our long-lived assets, we
must make assumptions regarding estimated future cash flows and other factors to
determine the fair value of the respective assets.  In addition, we
must make assumptions regarding the useful lives of these assets.  As
of December 31, 2008, we evaluated our long-lived assets for potential
impairment.  Based on our evaluation, no impairment charge was
recognized.
 
 Revenue
 
 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 December 31, 2008 and 2007 will be revised significantly in the near
term.
 
 Income
Taxes
 
 The
Company accounts for income taxes under the liability method, which requires an
entity to recognize deferred tax assets and liabilities.  Temporary
differences are differences between the tax basis of assets and liabilities and
their reported amounts in the financial statements that will result in taxable
or deductible amounts in future years. An income tax valuation allowance has
been established to reduce the Company’s deferred tax asset to the amount that
is expected to be realized in the future. KL Energy, LLC (KLEN), KL Management,
LLC (KLM), Western Biomass Energy, LLC (WBE), and Patriot Motor Fuels, LLC
(Patriot) are Limited Liability Companies for income tax purposes. Accordingly,
taxable income or losses of these companies are reported on the income tax
returns of the members.
  Liquidity
and Capital Resources
 
 At March
31, 2009, the Company had approximately $2.3 million of total current assets
which primarily consisted of $2.1 million in cash and cash
equivalents.  In addition, we had approximately $4.9 million of net
property, plant and equipment.  Our total assets as of March 31, 2009
were approximately $7.2 million.   With $8.5 million of total
current liabilities, the Company had negative working capital of approximately
$6.2 million at March 31, 2009.
  -
25 -
 
 
 In
February 2009, we received additional capital of approximately $4.0 million, or
$3.6 million after placement fees, 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 have no specific
arrangements for any external financing of debt or equity and 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
without any adequate fund-raising. 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 $1,480,047 at March 31, 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, which
may be extended on an annual basis if the Company is in compliance with the note
terms. This note bears interest at 6.5% and is secured by substantially all of
the assets of WBE including the CBE1 plant.
 
 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
..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.  We expect to pay this
shareholder line of credit in full by May 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 March 31, 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
we receive future equity financing, we are 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.
 
 Additional
current liabilities include approximately $2.0 million 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 $2.5
million (of which approximately $179,000 was to related parties), and accrued
liabilities of $1.7 million (of which approximately $384,000 was payroll
related, approximately $365,000 represented accrued issuance costs and
approximately $510,000 is for consulting and engineering services provided by
Niton Capital).
 
 Long-term
liabilities of approximately $530,000 at March 31, 2009 represents long-term
subordinated debt - related party.  Our total liabilities were
approximately $9.0 million as of March 31, 2009.
  -
26 -
   On
October 9, 2008, we entered into a term loan agreement (“O2D Loan”) with
O2Diesel Corporation (“O2D”), a publically traded company (OTC: OTOD.PK),
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.  The O2D Loan provides an initial loan of $250,000 in the
form of a secured promissory note (the “Note”) with an annual interest rate of
10%.  The interest rate will increase to 12% in any period in which
there is a continuing default.  O2D may make additional draws upon the
delivery of written
requests to us specifying the amount and use of the funds, which requests we may
accept or deny in our discretion. The O2D Loan matures on March 31, 2009
(“Maturity Date”). Interest accruing on the loan will be paid on the Maturity
Date. On the Maturity Date, we have the option of converting the outstanding
loan obligation into shares of common stock of O2Dat a conversion rate
equal to the price of the O2D’s stock on the Maturity Date. If O2D fails to pay
the loan on the Maturity Date, O2D will pay us an indemnification fee equal to
20% of the maximum principal amount outstanding during the term of the O2D Loan.
As security for the loan, O2D has provided us with a security interest in its
intellectual property relating to the oxygenating of diesel fuel, including its
proprietary fuel additive, O2DieselTM.  The O2D Loan and related note
also contain customary events of default. There are no financial covenants
related to this loan.  As of the date of this report, O2D has not paid
the principal or interest on the OTD Loan.  Due to O2Diesel’s financial
condition, the Company does not intend to make any additional loans to O2D
and the Company has reserved for the entire amount of the note receivable
as of March 31, 2009.
 We have
provided substantial funding for WBE, a 61% owned subsidiary of ours, relating
to the development of our cellulosic technology.  As of March 31, 2009
and December 31, 2008, WBE owed us approximately $5.9 million and $2.3 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 in the last half 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.
  We are in
the process of implementing cost control measures that should help us reach our
technology and business goals more efficiently. We have implemented a strict
budgetary and financial control process.  We have also re-focused our
human and financial resources towards the goal of being a technology provider
and eliminated positions that are not critical to this business
mission.
 
 During
the three months ended March 31, 2009, our operating activities used a net of
approximately $1.0 million of cash. This reflected a loss of $3.0 million from
continuing operations which was largely offset by depreciation of approximately
$484,000, allowances for doubtful accounts of approximately $454,000 and an
increase of approximately $886,000 in accrued payroll and other
liabilities.  The increase in accrued payroll and other liabilities is
attributable to the $160,000 in severance associated with the resignation of our
former President as well as additional accruals for financial and advisory fees
($45,000), consulting and engineering service fees ($510,225) and audit and
legal fees ($98,000).
  During
the three months ended March 31, 2008, our operating activities used a net of
approximately $206,000 of cash. This primarily reflected a loss of approximately
$1.4 million from continuing operations and a decrease of approximately $266,000
in net excess of billings over costs and estimated earnings on uncompleted
contracts offset by an increase of approximately $346,000 in net trade
receivables, approximately $460,000 of depreciation and allowances for doubtful
accounts of approximately $405,000.
 
 Net
Cash Flow - Investing Activities
 
 Net cash
used in investing activities during the three months ended March 31, 2009 of
approximately $121,000 increased by approximately $178,000 over investing
activities in the three months ended March 31, 2008.  This increase
was the result of purchases of property, plant, and equipment, primarily for the
WBE plant and was offset by approximately $110,000 of proceeds from the sale of
assets during the three months ended March 31, 2008.
 -
27 -
 
 Net
Cash Flow – Financing Activities
  Net cash
provided by our financing activities was $2.5 million for the three months ended
March 31, 2009. During this period, we received approximately $3.25 million (net
of $750,000 in issuance fees) from the private placement of common
stock.  This amount was increased by proceeds from short-term
borrowings, primarily due to the restructuring of loan terms, offset by
approximately $791,000 of payments on long-term debt principal and short-term
borrowings.  Net cash used in our financing activities was
approximately $33,000 for the three months ended March 31, 2008 primarily due to
the restructuring of bank loans and subordinated debts to related
parties.
 
 Results
of Operations for the Three Months Ended March 31, 2009 and 2008
 
 Revenue
 
 The
Company did not record any revenue for the three months ended March 31, 2009
which was approximately $1.9 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.
 Operating
Expenses
 
 Operating
expenses of approximately $3.0 million, in the three months ended March 31,
2009, were approximately $317,000 (or 9.6%) 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 first quarter of 2009
(compared to approximately $805,000 of such costs in the first three months 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.  This decrease was
substantially offset by higher general and administrative and research and
development expenses.
 
 General and Administrative
expense of $2.2 million increased approximately $404,000 (or 22%) in the
three months ended March 31, 2009 compared to the $1.8 million in the three
months ended March 31, 2008.  This increase was primarily attributable
to the $510,225 increase in consulting and engineering services as well as
higher audit and legal costs offset by lower expenses at KL Management LLC and
KL Energy LLC, which were unfavorably impacted by the slowdown and/or work
stoppage on existing contracts in the grain based ethanol business, as well as
lower airplane operating costs.
 Research and Development
expense of $761,000 increased approximately $84,000 (or 12%) in the three
months ended March 31, 2009 compared to the $677,000 in the three months ended
March 31, 2008.  The increase is primarily related to continued
efforts to enhance the operating performance of the WBE plant and achieve the
yields required by potential licensees of our technology.
 Other
Income (Expense)
 
 Other expense of
approximately $18,000 for the three months ended March 31, 2009, primarily
consisting of taxes related to earlier sale of the Company’s airplane, was
approximately $26,000 unfavorable to the $8,000 of other income for the three
months ended March 31, 2008.
  Interest income of
$43,000 for the three months ended March 31, 2009 was substantially higher than
the $8 in the comparable period in 2008 primarily as a result of interest earned
on overdue customer balances.
  -
28 -
  Interest expense of
$75,000 decreased approximately $24,000 (or 24%) in the three months ended March
31, 2009 compared to the $99,000 in the three months ended March 31, 2008. This
decrease was primarily due to the repayment of approximately $1.1 million in
bank debt and loans from related parties.
 
 Item 4T.  Controls
and Procedures
 
 (a) Disclosure Controls and
Procedures. In connection with the preparation of this Quarterly Report
on Form 10-Q, our Company’s management, with the participation of our Chief
Executive Officer and Chief Financial Officer, evaluated the effectiveness of
the design and operation of our Company’s “disclosure controls and procedures”
(as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934, as
amended) as of the end of the period covered by this report. Based on that
evaluation, our Chief Executive Officer and Chief Financial Officer concluded
that, as of March 31, 2009, the Company’s disclosure controls and procedures
were not effective.
 
 The
Company’s process for internally reporting material information in a systematic
manner, to allow for timely filing of material information, was flawed and there
existed material weaknesses in internal control over financial reporting that
contributed to the weaknesses in our disclosure controls and
procedures.  These weaknesses include the lack of:
 
 ·
              appropriate
      segregation of duties;
 
 ·
              appropriate
      oversight and review;
 
 ·
              internal
      technical expertise, both from a GAAP and SEC
  perspective;
 
 ·
              preparation,
      review and verification of internally developed
    documentation;
 
 ·
              controls
      in place to insure that all material developments impacting the financial
      statements are reflected; and
 
 ·
              executed
      agreements for significant
contracts.
  To
      remediate these weaknesses, the Company has:·
              mandated
      the segregation of duties regarding cash transactions;·
              increased
      the oversight and review functions over internally developed
      documentation;·
              formed
      a Disclosure Committee that will meet no less than on a quarterly basis to
      review material developments at the Company, as well as the effectiveness
      of the Company’s disclosure controls and procedures;·
              hired
      a Chief Financial Officer and outside securities counsel, both with SEC
      reporting experience; and·
              as
      needed, engaged 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.
 
 (b) Internal Controls. There were
no changes in our internal control over financial reporting during the quarter
ended March 31, 2009, that have materially affected, or are reasonably likely to
materially affect, our internal control over financial
reporting.  However, as noted above, several significant changes
subsequent to March 31, 2009 have been made that have materially affected, or
are reasonably likely to materially affect, our internal control over financial
reporting.
  -
29 -
  PART
II – OTHER INFORMATION
 
 Item 1.  Legal
Proceedings
 
 The
Company is named in a personal injury claim relating to an individual working
for a subcontractor who was injured while working on the construction of a
grain-based ethanol plant. The Company was hired for the plant construction. The
individual 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 individual is s eeking to
subrogate its workers compensation claim. At this time, the Company is unable to
predict the outcome of the case. The amount of liability, if any, is not
determinable.
 
 The
Company provided construction management and engineering services for the
construction of a new biofuels production facility for Willmark Energy, Inc.
(“Willmark”).  Several disputes arose in connection with this project and,
as a result of the parties’ inability to reach a settlement, Willmark filed a
request for arbitration, as provided in the construction contract, on May 1,
2009.  Willmark alleges that the Company failed to perform its design and
project management duties under the construction contract, as amended, and is
seeking approximately $1.5 million in damages and the release of liens the
Company has placed on Willmark assets.
  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
 
 On
February 24, 2009, the Company consummated a Securities Purchase Agreement (the
“Purchase Agreement”) with certain investors listed on the signature pages of
the Purchase Agreement (the “Investors”).  Pursuant to the terms of
the Purchase Agreement, the Company issued to the Investors 18,181,818 shares of
the Company’s common stock (the “Shares”), representing approximately 60% of the
total number of issued and outstanding shares of the Company’s common stock, for
a purchase price of $4,000,000. We made no general solicitation and we believe
that the issuance of the Shares met the standards for purchases under an
exemption for a non-public offering.
 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.
  -
30 -
   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.
   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, 200731.1*
                          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.
 
  -
31 -
  Signature
 
 Pursuant
to the requirements of the Securities Exchange Act of 1934, the registrant has
duly caused this report to be signed on its behalf by the undersigned thereunto
duly authorized.
  May
      15, 2009
                By:
                /s/ THOMAS
      J. BOLANThomas
      J. Bolan
                  Acting
      Chief Financial Officer
   - 32-