UNITED
STATES


SECURITIES
AND EXCHANGE COMMISSION


Washington,
D.C. 20549





———————


FORM
10-Q


———————





þQUARTERLY REPORT
PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934




For the
quarterly period ended: March
31, 2010




or




 ̈TRANSITION REPORT
PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934




For the
transition period from: _____________ to _____________




Commission
File Number: 00-51354




AE BIOFUELS,
      INC.(Exact
      name of registrant as specified in its charter)
  Nevada
              
              26-1407544(State
      or other jurisdiction

                  of
      incorporation or organization)
              
              (I.R.S.
      Employer

                  Identification
      No.)




20400
Stevens Creek Blvd., Suite 700


Cupertino,
CA 95014


(Address
of Principal Executive Offices, including zip code)





(408)
213-0940


(Registrant’s telephone number,
including area code)


———————


Indicate
by check mark whether the registrant (1) has filed all reports required to be
filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.  Yes  þNo
 ̈




Indicate
by check mark whether the registrant has submitted electronically and posted on
its corporate Web site, 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
filed).   Yes   ̈No
 ̈




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




Large
accelerated filer  ̈Accelerated
filer   ̈     Non-accelerated
filer   ̈Smaller
reporting company þ




Indicate
by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act).  Yes  ̈No þ




The
number of shares outstanding of the registrant’s Common Stock on May 13, 2010
was 86,837,032.













AE
BIOFUELS, INC.


FORM
10-Q


Quarterly
Period Ended March 31, 2010




INDEX




SPECIAL
NOTE REGARDING FORWARD-LOOKING STATEMENTS


PART
      I.  FINANCIAL INFORMATIONItem 1.
            Financial
      Statements
            
            
            1Item
      2.
            Management's
      Discussion and Analysis of Financial Condition and Results of
      Operations
            
            
            25Item
      3.
            Quantitative
      and Qualitative Disclosures about Market
      Risk
            
            
            35Item 4.
            Controls
      and Procedures
            
            
            36PART II.  OTHER
INFORMATIONItem
      1.
            Legal
      Proceedings
            
            
            37Item
      1A.
            Risk
      Factors
            
            
            37Item
      2.
            Unregistered
      Sales of Equity Securities and use of
    Proceeds
            
            
            37Item
      3.
            Default on Senior
      Securities
            
            
            37Item
      5.
            Other
      Information
            
            
            37Item
      6.
            Exhibits
            
            
            38SIGNATURES
            
            
            
            39





SPECIAL
NOTE REGARDING FORWARD—LOOKING STATEMENTS




On one or
more occasions, we may make forward-looking statements in this Quarterly Report
on Form 10-Q regarding our assumptions, projections, expectations, targets,
intentions or beliefs about future events. Words or phrases such as
“anticipates,” “may,” “will,” “should,” “believes,” “estimates,” “expects,”
“intends,” “plans,” “predicts,” “projects,” “targets,” “will likely result,”
“will continue” or similar expressions identify forward-looking statements.
Readers are cautioned that these forward-looking statements are only predictions
and are subject to risks, uncertainties, and assumptions that are difficult to
predict, including those identified below, under “Part II — Other Information, Item
1A. Risk Factors” and elsewhere, and in other reports we file with the
Securities and Exchange Commission (“SEC”), specifically our most recent Annual
Report on Form 10-K. Therefore, actual results may differ materially and
adversely from those expressed in any forward-looking statements. We undertake
no obligation to publicly update or revise any forward-looking statements,
whether as a result of new information, future events or otherwise. However,
your attention is directed to any further disclosures made on related subjects
in our subsequent annual and periodic reports filed with the SEC on Forms 10-K,
10-Q and 8-K and Proxy Statements on Schedule 14A.




Unless
the context requires otherwise, references to “we,” “us,” “our,” and the
“Company” refer specifically to AE Biofuels, Inc.







PART
I - FINANCIAL INFORMATION




ITEM
1 - FINANCIAL STATEMENTS.


AE
BIOFUELS, INC.


CONSOLIDATED
BALANCE SHEETS







March
      31,
                
                
                December
      31,2010
                
                
                2009(Unaudited)AssetsCurrent
      assets:Cash
      and cash equivalents
                
                $
                332,049
                
                
                $
                52,178Accounts
      receivable
                
                
                177,372
                
                
                
                32,032Inventories
                
                
                940,252
                
                
                
                593,461Prepaid
      expenses
                
                
                48,740
                
                
                
                21,660Other
      current assets
                
                
                448,416
                
                
                
                369,668Total
      current assets
                
                
                1,946,829
                
                
                
                1,068,999Property,
      plant and equipment, net
                
                
                18,793,523
                
                
                
                18,447,875Other
      assets
                
                
                34,232
                
                
                
                49,344Total
      assets
                
                $
                20,774,584
                
                
                $
                19,566,218Liabilities
      and stockholders' deficitCurrent
      liabilities:Accounts
      payable
                
                $
                3,937,740
                
                
                $
                3,137,480Short
      term borrowings, net of discount
                
                
                6,974,801
                
                
                
                6,409,950Mandatorily
      redeemable Series B Preferred stock
                
                
                1,750,002
                
                
                
                1,750,002Other
      current liabilities
                
                
                3,706,124
                
                
                
                3,316,931Current
      portion of long term debt
                
                
                4,714,195
                
                
                
                4,391,512Total
      current liabilities
                
                
                21,082,862
                
                
                
                19,005,875Long
      term debt (related party)
                
                
                4,864,429
                
                
                
                4,250,031Commitments
      and contingencies (Notes 2,4,7,8,13,15 and 17 )Stockholders'
      deficit:AE
      Biofuels, Inc. stockholders' deficitSeries
      B Preferred Stock - $.001 par value - 7,235,565 authorized; 3,265,225 and
      3,320,725 shares issued and outstanding, respectively (aggregate
      liquidation preference of $9,795,675 and $9,962,175,
      respectively)
                
                
                3,265
                
                
                
                3,321Common
      Stock - $.001 par value 400,000,000 authorized; 86,237,032 and 86,181,532
      shares issued and outstanding, respectively
                
                
                86,237
                
                
                
                86,181Additional
      paid-in capital
                
                
                36,864,496
                
                
                
                36,763,984Accumulated
      deficit
                
                
                (40,744,928
                )
                
                
                (38,804,417
                )Accumulated
      other comprehensive income
                
                
                (948,582
                )
                
                
                (1,376,382
                )Total
      AE Biofuels, Inc. stockholders' deficit
                
                
                (4,739,512
                )
                
                
                (3,327,313
                )Noncontrolling
      interest
                
                
                (433,195
                )
                
                
                (362,375
                )Total
      stockholders' deficit
                
                
                (5,172,707
                )
                
                
                (3,689,688
                )Total
      liabilities and stockholders' deficit
                
                $
                20,774,584
                
                
                $
                19,566,218
 The
accompanying notes are an integral part of the financial
statements
  1


AE
BIOFUELS, INC.


CONSOLIDATED
STATEMENTS OF OPERATIONS


(Unaudited)


For
      the three months ended March 31,2010
              
              
              2009Sales
              
              $
              2,236,838
              
              
              $
              2,503,491Cost
      of goods sold
              
              
              2,209,593
              
              
              
              2,317,953Gross
      profit
              
              
              27,245
              
              
              
              185,538Research
      and development
              
              
              144,530
              
              
              
              191,614Selling,
      general and administrative expenses
              
              
              1,009,982
              
              
              
              1,703,209Operating
      loss
              
              
              (1,127,267
              )
              
              
              (1,709,285
              )Other
      income / (expense)Interest
      income
              
              
              180
              
              
              
              6,872Interest
      expense
              
              
              (909,018
              )
              
              
              (841,804
              )Other
      income, net of expenses
              
              
              27,974
              
              
              
              15,749Loss
      before income taxes
              
              
              (2,008,131
              )
              
              
              (2,528,468
              )Income
      taxes
              
              
              (3,200
              )
              
              
              -Net
      loss
              
              
              (2,011,331
              )
              
              
              (2,528,468
              )Less:
      Net loss attributable to the noncontrolling interest
              
              
              (70,820
              )
              
              
              (119,705
              )Net
      loss attributable to AE Biofuels, Inc.
              
              $
              (1,940,511
              )
              
              $
              (2,408,763
              )Other
      comprehensive loss, net of taxForeign
      currency translation adjustment
              
              
              427,800
              
              
              
              (674,917
              )Comprehensive
      loss, net of tax
              
              
              (1,583,531
              )
              
              
              (3,203,385
              )Comprehensive
      loss attributable to the noncontrolling interest
              
              
              -
              
              
              
              -Comprehensive
      loss attributable to AE Biofuels, Inc.
              
              $
              (1,583,531
              )
              
              $
              (3,203,385
              )Loss
      per common share attributable to AE Biofuels, Inc.Basic
      and dilutive
              
              $
              (0.02
              )
              
              $
              (0.03
              )Weighted
      average shares outstandingBasic
      and dilutive
              
              
              86,182,754
              
              
              
              84,641,642
    2




AE
BIOFUELS, INC.


CONSOLIDATED
STATEMENTS OF CASH FLOWS


(Unaudited)




For
      the three months ended March 31,2010
                
                
                2009Operating
      activities:Net
      loss
                
                $
                (2,011,331
                )
                
                $
                (2,528,468
                )Adjustments
      to reconcile net loss tonet
      cash used in operating activities:Stock
      based compensation
                
                
                100,512
                
                
                
                167,987Expired
      land options
                
                
                -
                
                
                
                40,000Amortization
      and depreciation
                
                
                140,761
                
                
                
                202,756Inventory
      provision
                
                
                44,310
                
                
                
                65,701Amortization
      of debt discount
                
                
                278,772
                
                
                
                330,625Changes
      in assets and liabilities:Accounts
      receivable
                
                
                (141,638
                )
                
                
                -Inventory
                
                
                (363,571
                )
                
                
                402,257Prepaid
      expenses
                
                
                (26,701
                )
                
                
                83,705Other
      current assets and other assets
                
                
                (50,034
                )
                
                
                235,873Accounts
      payable
                
                
                767,555
                
                
                
                231,784Accrued
      interest expense
                
                
                398,429
                
                
                
                -Other
      liabilities
                
                
                60,865
                
                
                
                417,586Income
      taxes payable
                
                
                -
                
                
                
                -Net
      cash used in operating activities
                
                
                (802,071
                )
                
                
                (350,194
                )Investing
      activities:Purchase
      of property, plant and equipment, net
                
                
                (12,043
                )
                
                
                48,152Net
      cash provided by (used in) investing activities
                
                
                (12,043
                )
                
                
                48,152Financing
      activities:Proceeds
      from borrowings under related party credit arrangements
                
                
                2,100,000
                
                
                
                191,000Payments
      of borrowings under related party credit arrangements
                
                
                (1,600,000
                )
                
                
                -Proceeds
      under working capital facility
                
                
                1,196,528
                
                
                
                -Payments
      under working capital facility
                
                
                (1,089,343
                )
                
                
                -Advances
      under lease agreement
                
                
                500,000
                
                
                
                -Net
      cash provided by financing activities
                
                
                1,107,185
                
                
                
                191,000Effect
      of exchange rate changes on cash and cash equivalents
                
                
                (13,200
                )
                
                
                (158,036
                )Net
      cash increase (decrease) for period
                
                
                279,871
                
                
                
                (269,078
                )Cash
      and cash equivalents at beginning of period
                
                
                52,178
                
                
                
                377,905Cash
      and cash equivalents at end of period
                
                $
                332,049
                
                
                $
                108,827Supplemental
      disclosures of cash flow information, cash paid:Interest
                
                
                7,943
                
                
                
                124,630Income
      taxes, net of refunds
                
                
                3,200
                
                
                
                -
   3
 AE
BIOFUELS, INC.


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
 (Unaudited)




1.  Nature
of Activities and Summary of Significant Accounting Policies




Nature of
Activities.  These consolidated financial statements include
the accounts of AE Biofuels, Inc., a Nevada corporation, and its wholly owned
subsidiaries: (i) American Ethanol, Inc., a Nevada corporation and its
subsidiaries; Sutton Ethanol, LLC, a Nebraska limited liability company,
Illinois Valley Ethanol, LLC, an Illinois limited liability company; Danville
Ethanol, Inc., an Illinois corporation; AE Biofuels, Inc., a Delaware
corporation and its subsidiary AE Renova, LLC, a Delaware limited liability
company; (ii) Biofuels Marketing, a Delaware corporation; (iii) International
Biodiesel, Inc., a Nevada corporation and its subsidiaries AE International
Biofuels, Ltd., a British Virgin Islands company, AE DAABON, Ltd., a British
Virgin Islands company, International Biofuels, Ltd, a Mauritius corporation and
its subsidiary Universal Biofuels Private Ltd, an India company; (iv) AE
Biofuels Americas, a Delaware corporation; (v) AE Biofuels Technologies, Inc., a
Delaware corporation and its majority-owned subsidiary Energy Enzymes LLC, a
Delaware limited liability company; (vi) AE Advanced Fuels, Inc., a Delaware
corporation; and (vii) AE Advanced Fuels Keyes, Inc., a Delaware corporation
(collectively, “AE Biofuels” or the “Company”).




We are an
international biofuels company focused on the development, acquisition,
construction and operation of next-generation fuel grade ethanol and biodiesel
facilities, and the distribution, storage, and marketing of
biofuels.  We began selling fuel grade biodiesel from our production
facility in Kakinada in November 2008.  We opened and began operating
a cellulosic ethanol commercial demonstration facility in Butte, Montana in
August 2008.  In March 2010, we took possession, through project and
lease agreements, of a 55 MGPY fuel grade ethanol facility in Keyes,
California.




Basis of Presentation and
Consolidation. The consolidated financial statements include the accounts
of AE Biofuels, Inc. and its majority-owned subsidiaries. All intercompany
balances and transactions have been eliminated in consolidation. The
accompanying consolidated balance sheets as of March 31, 2010, the consolidated
statements of operations for the three months ended March 31, 2010 and 2009, and
the consolidated statements of cash flows for the three months ended March 31,
2010 and 2009 are unaudited. The consolidated balance sheet as of December 31,
2009 was derived from the 2009 audited consolidated financial statements and
notes thereto. The consolidated financial statements in this report should be
read in conjunction with the 2009 audited consolidated financial statements and
notes thereto included in the Company’s annual report on Form 10-K for the year
ended December 31, 2009.




The
accompanying unaudited interim consolidated financial statements as of March 31,
2010 and 2009 and for the three months ended March 31, 2010 and 2009 have been
prepared in accordance with accounting principles generally accepted in the
United States (U.S. GAAP) and pursuant to the rules and regulations of the SEC.
Certain information and footnote disclosures normally included in financial
statements prepared in accordance with U.S. GAAP have been condensed or omitted
pursuant to such rules and regulations.




In the
opinion of management, the unaudited interim consolidated financial statements
for the three months ended March 31, 2010 and 2009 have been prepared on the
same basis as the audited consolidated statements as of December 31, 2009 and
reflect all adjustments, consisting primarily of normal recurring adjustments,
necessary for the fair presentation of its statement of financial position,
results of operations and cash flows. The results of operations for the three
months ended March 31, 2010 are not necessarily indicative of the operating
results for any subsequent quarter, for the full fiscal year or any future
periods.




Use of
Estimates.  The preparation of financial statements in
conformity with U.S. GAAP 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
revenues and expenses during the reporting period.  Significant
estimates, assumptions and judgments made by management include the
determination of impairment of long-lived assets, the valuation of equity
instruments such as options and warrants, the recognition and measurement of
current taxes payable and deferred tax assets or liabilities, and the accrual
for the payments under the Company’s registration rights agreement with certain
of its shareholders and management’s judgment about contingent
liabilities.  Management believes that the estimates and judgments
upon which they rely are reasonable based upon information available to them at
the time that these estimates and judgments are made.  To the extent
there are material differences between these estimates and actual results, the
Company’s consolidated financial statements will be
affected.   Refer to additional disclosures regarding the use of
estimates below under the caption Long-Lived
Assets.




4




AE BIOFUELS, INC. NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
 (Unaudited)




Reclassifications.Certain
prior period amounts were reclassified to conform to current period
presentation.  These reclassifications had no impact on previously
reported net loss or accumulated deficit.




Revenue
Recognition.  The Company recognizes revenue when there is
persuasive evidence of an arrangement, delivery has occurred, the price is fixed
or determinable and collection is reasonably assured.




Cost of Goods
Sold.  Cost of goods sold include those costs directly
associated with the production of revenues, such as raw material purchases,
factory overhead, and other direct production costs.




Research and
Development.Research and development costs are expensed as
incurred, unless they have alternative future uses to the Company.




General and
Administrative.  General and administrative expenses include
those costs associated with the general operations of our business such as
compensation, rent, consultants, and travel related to executive, legal and
financial functions.




Cash and Cash
Equivalents.  The Company considers all highly liquid
investments with an original maturity of three months or less to be cash
equivalents.  The Company maintains cash balances at various financial
institutions domestically and abroad.  Domestic accounts are insured
by the FDIC.  The Company’s accounts at these institutions may at
times exceed federally insured limits.  The Company has not
experienced any losses in such accounts.




Accounts
Receivable.  Accounts receivable consist of product sales made
to large credit worthy customers.




Inventories.  Inventories
are stated at the lower of cost, using the first-in and first-out (FIFO) method,
or market.




Property, Plant and
Equipment.  Property, plant and equipment are carried at cost
less accumulated depreciation after assets are placed in service and are
comprised primarily of land acquired for development of production facilities,
and the biodiesel plant in India.  The estimated useful life of this
plant is 20 years.  The estimated useful life for office equipment and
computers is three years and the useful life of machinery and equipment is seven
years.  Depreciation is provided using the straight line method over
the assets useful life.




Income Taxes.We
recognize income taxes in accordance with ASC 740 (formerly SFAS
No.  109, “Accounting for Income Taxes”), using an asset and liability
approach.  This approach requires the recognition of taxes payable or
refundable for the current year and deferred tax assets and liabilities for the
expected future tax consequences of events that have been recognized in our
consolidated financial statements or tax returns.  The measurement of
current and deferred taxes is based on provisions of enacted tax
law.




ASC 740
provides for recognition of deferred tax assets if the realization of such
assets is more likely than not to occur.  Otherwise, a valuation
allowance is established for the deferred tax assets which may not be
realized.  As of December 31, 2009, the Company recorded a full
valuation allowance against its net deferred tax assets due to operating losses
incurred since inception.  Realization of deferred tax assets is
dependent upon future earnings, if any, the timing and amount of which are
uncertain.  Accordingly, the net deferred tax assets were fully offset
by a valuation allowance.




We are
subject to income tax audits by the respective tax authorities in all of the
jurisdictions in which we operate.  The determination of tax
liabilities in each of these jurisdictions requires the interpretation and
application of complex and sometimes uncertain tax laws and
regulations.  The recognition and measurement of current taxes payable
or refundable and deferred tax assets and liabilities requires us to make
certain estimates and judgments.  Changes to these estimates or a
change in judgment may have a material impact on our tax provision in a future
period.




5




AE BIOFUELS, INC. NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
 (Unaudited)




Long - Lived
Assets.We evaluate the recoverability of long-lived assets
with finite lives in accordance with ASC Subtopic 360-10-35 (formerly SFAS
No.  144, “Accounting for the Impairment or Disposal of Long-Lived
Assets”) which requires recognition of impairment of long-lived assets whenever
events or changes in circumstances indicate that the carrying amount of an asset
may not be recoverable.  When events or changes in circumstances
indicate that the carrying amount of an asset may not be recoverable based on
estimated undiscounted cash flows, the impairment loss would be measured as the
difference between the carrying amount of the assets and its fair value based on
the present value of estimated future cash flows.




With
respect to our biodiesel facility in India, which comprises approximately 75% of
the carrying value of total assets, we develop various assumptions to estimate
the future cash flows that will be generated from this facility in order to test
the recoverability of this asset.   The determination of
estimated future cash flows is highly uncertain in the current economic
environment.   Further, as our biodiesel facility in India has
been in operation for less than 18 months and to date has operated at about 10%
of its production capacity, we believe our assumptions regarding future cash
flows and in turn the carrying value of its biodiesel facility represent a
significant estimate in the preparation of our consolidated financial
statements.  The revenues and gross profit generated at our biodiesel
facility in the first quarter ended March 31, 2010 was less than the revenue and
gross profit generated in the first quarter ended March 31, 2009 (prior
year).  Our 2010 internal forecast calls for revenues and gross profit
to increase significantly during the year as we seek to execute on our business
plan.  If we are unable to successfully execute on our business plan
by increasing our revenue and gross profit in 2010, we will need to revise
downward our assumptions regarding the estimated future cash flows expected to
be generated from this facility and such revisions could have a material effect
on our assessment of the recoverability of this asset.  It is at least
reasonably possible that changes to the assumptions regarding the estimated
future cash flows expected to be generated from this facility will result in an
impairment charge (write down) of the carrying value of the biodiesel facility
and such impairment charge could be material to our financial
statements.




Basic and Diluted Net Loss per
Share.Basic loss per share is computed by dividing loss
attributable to common shareholders by the weighted average number of common
shares outstanding for the period, net of shares subject to
repurchase.  Diluted loss per share reflects the dilution of common
stock equivalents such as options, convertible preferred stock and warrants to
the extent the impact is dilutive.  Basic loss per share includes the
vested portion of restricted stock grants.  The unvested restricted
stock grants are included only in the fully diluted net loss per share
calculation.  As we incurred net losses for the three months ended
March 31, 2010 and 2009, potentially dilutive securities have been excluded from
the diluted net loss per share computations as their effect would be
anti-dilutive.




The
following table shows the weighted-average number of potentially dilutive shares
excluded from the diluted net loss per share calculation for the three months
ended March 31, 2010, and 2009:




For
      the three months endedMarch
      31, 2010
            
            
            March
      31, 2009Series
      B preferred stock
            
            
            3,319,503
            
            
            
            3,361,829Series
      B warrants
            
            
            443,853
            
            
            
            443,853Common
      stock options and warrants
            
            
            5,179,609
            
            
            
            2,563,317Unvested
      restricted stock
            
            
            —
            
            
            
            33,333Total
      weighted average number of potentially dilutive shares
              excluded
      from the diluted net loss per share calculation
            
            
            8,942,965
            
            
            
            6,402,332




Comprehensive
Income.ASC 220 (formerly SFAS No.  130, "Reporting
Comprehensive Income"), requires that an enterprise report, by major components
and as a single total, the change in its net assets from non-owner
sources.  Our other comprehensive income consists solely of cumulative
currency translation adjustments resulting from the translation of the financial
statements of its foreign subsidiaries.  The investment in this
subsidiary is considered indefinitely invested overseas, and as a result,
deferred income taxes are not recorded related to the currency translation
adjustments.




6




AE BIOFUELS, INC. NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
 (Unaudited)




Foreign Currency
Translation/Transactions.Assets and liabilities of non-U.S.
subsidiaries that operate in a local currency environment, where that local
currency is the functional currency, are translated into U.S.  dollars
at exchange rates in effect at the balance sheet date; with the resulting
translation adjustments directly recorded to a separate component of accumulated
other comprehensive income.  Income and expense accounts are
translated at average exchange rates during the year.  Gains and
losses from foreign currency transactions are recorded in other income (loss),
net.  The functional currency is the local currency for all non-U.S.
subsidiaries.




Fair Value of Financial
Instruments.Our financial instruments include cash and cash
equivalents, mandatorily redeemable series B preferred stock, short and
long-term debt and long term debt (related party).   Cash and
cash equivalents are carried at fair value as discussed in Note
18.  The carrying value of our short-term debt approximates fair value
due to the short-term maturity of this instrument, which absent an
amendment to the existing loan agreement, matures  in June
2010.  Our long-term debt carrying value approximates fair value based
upon the borrowing rates currently available to the Company for bank loans in
India with similar terms and maturities.  We are unable to estimate
the fair value of the long term debt (related party) due to the lack of
comparable available credit facilities.




Stock-Based Compensation
Expense.Effective January 1, 2006, we adopted the fair value
recognition provisions of ASC 718 (formerly SFAS No.  123 (Revised
2004), “Share-Based Payment”), requiring us to recognize expense related to the
fair value of our stock-based compensation awards adjusted to reflect only those
shares that are expected to vest.  Our implementation of ASC Section
715-20-50 used the modified-prospective-transition method.




We made
the following estimates and assumptions in determining fair value of stock
options as prescribed by ASC 718:




·
            Valuation and amortization
      method — We estimate the fair value of stock options granted using
      the Black-Scholes-Merton option-pricing formula and a single option award
      approach.  This fair value is then amortized on a straight-line
      basis over the requisite service periods of the awards, which is generally
      the vesting period.




·
            Expected Term — The
      expected term represents the weighted-average period that our stock-based
      awards are expected to be outstanding.  We applied the
      “Simplified Method” as defined in the SEC’s Staff Accounting Bulletin
      No.  107 and 110.




·
            Expected Volatility —
      The Company’s expected volatilities are based on the historical volatility
      of comparable public companies’ stock for a period consistent with our
      expected term.




·
            Expected Dividend — The
      Black-Scholes-Merton valuation model calls for a single expected dividend
      yield as an input.  The Company currently pays no dividends and
      does not expect to pay dividends in the foreseeable
  future.




·
            Risk-Free Interest Rate
      — The Company bases the risk-free interest rate on the implied yield
      currently available on United States Treasury zero-coupon issues with an
      equivalent remaining term.




Commitments and
Contingencies.The Company records and/or discloses
commitments and contingencies in accordance with ASC 450, “Contingencies” (ASC
450).  ASC 450 applies to an existing condition, situation, or set of
circumstances involving uncertainty as to possible loss that will ultimately be
resolved when one or more future events occur or fail to occur.  As of
March 31, 2010, the Company is not aware of any material commitments or
contingencies other than those disclosed in “Note 17.  Contingent
Liabilities.”




Recent Accounting
Pronouncements.




We  adopted
the provisions of ASC 820-10, Fair Value Measurements and
Disclosures (formerly SFAS No.  157, Fair Value Measurements), with respect to
non-financial assets and liabilities effective January 1, 2009.  This
pronouncement defines fair value, establishes a framework for measuring fair
value and expands disclosures about fair value measurements.  The
adoption of ASC 820-10 did not have an impact on our consolidated financial
statements.




7




AE BIOFUELS, INC. NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
 (Unaudited)




We  adopted
ASC 805 (formerly SFAS No.  141(R), “Business Combinations”) for
business combinations.  This topic changes the accounting for
acquisition transaction costs by requiring them to be expensed in the period
incurred, and also changes the accounting for contingent consideration, acquired
contingencies and restructuring costs related to an acquisition.  We
also adopted ASC 810-10-65,Noncontrolling Interests in Consolidated Financial Statements—an amendment of
ARB No.  51 (formerly SFAS No.  160, “Non-controlling
Interests in Consolidated Financial Statements-an amendment of ARB
No.  51”).  This statement changes the accounting and
reporting for minority interests, which are re-characterized as non-controlling
interests, classified as a component of equity and accounted for at fair
value.  ASC 805 and ASC 810-10-65 are effective for the Company’s 2009
financial statements.  Early adoption is prohibited.  The
effect the adoption of ASC 805 has had and will have on our financial statements
will depend on the nature and size of acquisitions we complete after
adoption.  We adopted ASC 810-10-65-1 as of January 1,
2009.  As a result, we reclassified the 49% non-controlling interest
in our subsidiary Energy Enzymes, Inc., prospectively.  Had we
continued to apply the prior method of accounting for non-controlling interests,
losses incurred by this entity would have been fully attributed to
us.




We
adopted ASC 825-10 (formerly the Financial Accounting Standards Board (FASB)
issued Staff Position SFAS 107-1 and Accounting Principles Board (APB) Opinion
No.  28-1, “Interim Disclosures about Fair Value of Financial
Instruments”).  ASC 825-10 amends FASB Statement No.  107,
“Disclosures about Fair Values of Financial Instruments,” to require disclosures
about fair value of financial instruments in interim financial statements as
well as in annual financial statements.  APB 28-1 amends APB Opinion
No.  28, “Interim Financial Reporting,” to require those disclosures
in all interim financial statements.  ASC 825-10 is effective for
interim periods ending after June 15, 2009.  Adoption of this
statement did not have a material effect on our financial
statements.  See “Note 18.  Fair Value of Financial
Instruments and Related Measurement.”




We
adopted ASC 320-10 (formerly Staff Position SFAS 115-2 and SFAS 124-2,
“Recognition and Presentation of Other-Than-Temporary
Impairments”.  ASC 320 provides guidance in determining whether
impairments in debt securities are other than temporary, and modifies the
presentation and disclosures surrounding such instruments.  ASC 320 is
effective for interim periods ending after June 15, 2009.  Adoption of
this statement did not have a material effect on our financial
statements.




In June
2009, the FASB issued ASC 105 (formerly SFAS No.  168, "The FASB
Accounting Standards Codification (TM) ("Codification") and the Hierarchy of
Generally Accepted Accounting Principles - a replacement of FASB Statement
No.  162").  ASC 105 establishes the Codification as the
single official source of authoritative United States accounting and reporting
standards for all non-governmental entities (other than guidance issued by the
SEC).  The Codification changes the referencing and organization on
financial standards and is effective for interim and annual periods ending on or
after September 15, 2009.  ASC 105 is not intended to change the
existing accounting guidance and its adoption did not have an impact on our
financial statements.




In
October, the FASB issued Accounting Standard Update (“ASU”) 2009-13, Revenue
Recognition (Topic 605), Multiple Deliverable Revenue Arrangements, which
applies to multiple-deliverable revenue arrangements that are currently within
the scope of FASB ASC 605-25 (previously included in EITF Issue
no.  00-21, Revenue Arrangements with Multiple
Deliverables).  The EITF will be effective on a prospective basis for
revenue arrangements entered into or materially modified in fiscal years
beginning on or after June 15, 2010.  We have not fully assessed the
impact of this guidance, but at this time believe it will not have an impact on
our financial statements.




In August
2009, the FASB issued ASU 2009-5, “Fair Value Measurements and Disclosures
(Topic 820) – Measuring Liabilities at Fair Value” (“ASU
2009-5”).  This update provides clarification of the fair value
measurement of financial liabilities when a quoted price in an active market for
an identical liability (Level 1 input of the valuation hierarchy) is not
available.  ASU 2009-5 was effective in the fourth quarter of
2009.  This update did not have a material impact on our financial
statements or disclosures.




In
January 2010, the FASB issued ASU No.  2010-06, “Fair Value
Measurements and Disclosures (ASC 820): Improving Disclosures about Fair Value
Measurements,” which requires additional disclosures on transfers in and out of
Level I and Level II and on activity for Level III fair value
measurements.  The new disclosures and clarifications on existing
disclosures are effective for interim and annual reporting periods beginning
after December 15, 2009, except for the disclosures on Level III activity, which
are effective for fiscal years beginning after December 15, 2010 and for interim
periods within those fiscal years.  We do not expect the adoption of
ASU No.  2010-06 to have a material impact on our consolidated
financial condition or results of operations.




8




AE BIOFUELS, INC. NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
 (Unaudited)




2.
Ability to Continue as a Going Concern




The
accompanying financial statements have been prepared on the going concern basis,
which contemplates the realization of assets and satisfaction of liabilities in
the normal course of business. We have experienced losses and negative cash flow
since inception and currently have a working capital deficit and total
stockholders’ deficit. These factors raise substantial doubt about our ability
to continue as a going concern. The Company’s ability to continue as a going
concern is dependent on several factors, including the ability to raise a
significant amount of capital for operating expenses, capital expenses, current
liabilities and debt service.




We have
produced minimal gross profit, have less than one month of operating cash, have
incurred losses from inception through March 31, 2010 and have negative working
capital (current assets less current liabilities) of $19,136,033. We have raised
approximately $31.8 million to date through the sale of preferred stock and
approximately $16.5 million, including accrued interest, through debt
facilities. An additional $2 million of cash has been generated through the sale
of its subsidiary, Wahoo Ethanol, LLC, with an additional $8 million through the
dissolution of the Sutton Ethanol Joint venture. We will have to raise
significantly more capital and secure a significant amount of debt to complete
its business plan and continue as a going concern. We have one biodiesel
production facility in operation that began selling biodiesel into the domestic
Indian market in November 2008. Although the biodiesel plant provides some cash
flow to the Company it will likely be insufficient to allow for the completion
of our business plan in fiscal 2010.




Management
believes that it will be able to raise additional capital through equity
offerings and debt financings. Should we not be able to raise enough capital,
the Company may be forced to sell all or a portion of its existing biodiesel
facility or other assets at a discount to market value and may incur additional
impairment related to these assets to generate cash to continue our business
plan or possibly discontinue operations. Until such additional capital is
raised, we are dependent on financing from a related party. We have also
arranged extended terms with its trade creditors. Our goal is to raise
additional funds needed to construct and operate next generation ethanol and
biodiesel facilities through stock offerings and debt financings. There can be
no assurance that additional financing will be available on terms satisfactory
to us. The accompanying financial statements do not include any adjustments to
the classification or carrying values of our assets or liabilities that may
result should we be unable to continue as a going concern.




3.  Inventory




Inventory
consists of the following:




March
      31, 2010
            
            
            December
      31, 2009Raw
      materials
            
            $
            99,428
            
            
            $
            389,442Work-in-progress
            
            
            128,176
            
            
            
            77,123Finished
      goods
            
            
            712,648
            
            
            
            126,896Total
      inventory
            
            $
            940,252
            
            
            $
            593,461




For the
three months ended March 31, 2010 and 2009, we expensed $44,187 and $65,653,
respectively, in connection with the write-down of inventory to reflect market
value below cost.




9




AE BIOFUELS, INC.


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


(Unaudited)







4.  Property,
Plant and Equipment




Property,
plant and equipment consist of the following:




March
      31,
            
            
            December
      31,2010
            
            
            2009Land
            
            $
            3,386,395
            
            
            $
            3,358,569Buildings
            
            
            12,177,525
            
            
            
            11,828,545Furniture
      and fixtures
            
            
            100,508
            
            
            
            126,718Machinery
      and equipment
            
            
            976,092
            
            
            
            924,964Construction
      in progress
            
            
            3,319,441
            
            
            
            3,155,001Total
      gross property, plant & equipment
            
            
            19,959,961
            
            
            
            19,393,797Less
      accumulated depreciation
            
            
            (1,166,438
            )
            
            
            (945,922
            )Total
      net property, plant & equipment
            
            $
            18,793,523
            
            
            $
            18,447,875




For the
three months ended March 31, 2010 and 2009, we recorded $190,678 and $169,442,
respectively, in depreciation.  No interest was capitalized during the
three months ended March 31, 2010 or 2009.




Components
of construction in progress include $3,031,847 related to our India biodiesel
pretreatment and glycerin facility, and $287,594 related to the development of
our Sutton property (held for future development of a next generation cellulosic
ethanol facility).  The estimated cost to complete construction of the
pretreatment and glycerin facility is $1,000,000.  Commitments for
approximately $19,735 under construction contracts, purchase orders and other
short term contracts were outstanding at March 31, 2010.




Our
property, plant and equipment represent approximately 90% of the carrying value
of total assets.  Management is required to evaluate these long-lived
assets for impairment whenever events or changes in circumstances indicate that
their carrying amounts may not be recoverable.   With respect to
our biodiesel facility in India, which comprises approximately
75% of the carrying value of total assets, we develop various assumptions
to estimate the future cash flows that will be generated from this facility in
order to test the recoverability of this asset.  In our estimate we
have factored in the increasing demand for biodiesel in Europe and in India
based on government regulations requiring the use of renewable fuels by the
Government of India and many of the European Union member
states.   We have noted the increasing blending obligations in
2010 in some European counties including Bulgaria, France, Germany, Hungary,
Poland, Portugal, the Netherlands, Slovakia, Spain, Sweden and the United
Kingdom.   We have also made our forecast based on the current
prices of fuel and feedstock commodities which currently are forecasted to
provide gross production margins; however, our gross margins depend principally
on the spread between feedstock and biodiesel prices and this spread has
fluctuated significantly in recent months.  The determination of
estimated future cash flows is highly uncertain in the current economic
environment.   Further, as our biodiesel facility in India has
been in operation for less than 18 months and to date has operated at about 10%
of its production capacity, we believe our assumptions regarding future cash
flows and in turn the carrying value of its biodiesel facility represent a
significant estimate in the preparation of our consolidated financial
statements.  The revenues and gross profit generated at our biodiesel
facility in the first quarter ended March 31, 2010 was less than the revenue and
gross profit generated in the first quarter ended March 31, 2009 (prior
year).  Our 2010 internal forecast calls for revenues and gross profit
to increase significantly during the year as we seek to execute on our business
plan.  If we are unable to successfully execute on our business plan
by increasing our revenue and gross profit in 2010, we will need to revise
downward our assumptions regarding the estimated future cash flows expected to
be generated from this facility and such revisions could have a material effect
on our assessment of the recoverability of this asset.  It is at least
reasonably possible that changes to the assumptions regarding the estimated
future cash flows expected to be generated from this facility will result in an
impairment charge (write down) of the carrying value of the biodiesel facility
and such impairment charge could be material to our financial
statements.




In our
estimate we have factored in the increasing demand for biodiesel in Europe and
in India based on government regulations requiring the use of renewable fuels by
the Government of India and many of the European Union member
states.   We have noted the increasing blending obligations in
2010 in some European counties including Bulgaria, France, Germany, Hungary,
Poland, Portugal, the Netherlands, Slovakia, Spain, Sweden and the United
Kingdom.   We have also made our forecast based on the current
prices of fuel and feedstock commodities which currently are forecasted to
provide gross production margins; however, our gross margins depend principally
on the spread between feedstock and biodiesel prices and this spread has
fluctuated significantly in recent months.  The impact of changes in
our estimates of future cash flows and the related recoverability of the
carrying value of our biodiesel facility will likely be material to such
consolidated financial statements.




10




AE BIOFUELS, INC.
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
 (Unaudited)


5.  Other
Current Assets, Other Assets and Other Current Liabilities




Other
current assets and other assets consists of foreign input tax credits,
restricted cash, payments for land options for possible future ethanol plants,
supplier deposits and other prepayments.




March
      31,
              2010
            
            
            December
      31,
              2009CurrentShort
      term deposits
            
            $
            131,497
            
            
            $
            56,221Foreign
      input credits
            
            
            260,921
            
            
            
            256,124Other
            
            
            55,998
            
            
            
            57,323$
            448,416
            
            
            $
            369,668Long TermRestricted
      cash
            
            $
            11,137
            
            
            $
            10,744Deposits
            
            
            23,095
            
            
            
            38,600$
            34,232
            
            
            $
            49,344




We
acquired options to purchase land in various locations in Nebraska and
Illinois.  These options gave us the right to buy specific property
for a set price per acre and typically ended in one to two years.  As
of December 31, 2008, we had one option to purchase land in Illinois for
$934,000.  This option expired in May 2009, and was expensed
during the three months ended March 31, 2009 upon management’s
determination not to renew the option.  For the three months ended
March 31, 2010, and 2009, we expensed options that ended or were released
in the amount of $0 and $40,000, respectively.




Foreign
input and custom duty credits represent payment of tax to governmental agencies
where the Company expects to receive reimbursement upon the filing of returns or
the application of these funds to reduce the payment of future
taxes.




Other
current liabilities consist of accrued:




March
      31, 2010
            
            
            December
      31, 2009Vacation
      and wages
            
            $
            810,384
            
            
            $
            655,821Duty
      and service tax
            
            
            670,991
            
            
            
            660,571Termination
      fee
            
            
            600,000
            
            
            
            600,000Legal
      fees
            
            
            406,695
            
            
            
            425,475Repurchase
      obligations
            
            
            329,756
            
            
            
            265,581Accrued
      costs for issuance of stock
            
            
            81,000
            
            
            
            —Advances
      under lease agreement
            
            
            398,553
            
            
            
            —Other
            
            
            408,745
            
            
            
            709,483$
            3,706,124
            
            
            $
            3,316,931




6.  Intangible
Assets




Intangible
assets consist of purchased customer lists (acquired in 2007 in connection with
the acquisition of Biofuels Marketing, Inc. discussed in Note 12 below), which
have been amortized over an estimated useful life of 18 months.  The
intangible assets have a cost basis of $300,000 and a net carrying amount of $0
at March 31, 2010 and December 31, 2009.  For the three months
ended March 31, 2010 and 2009, we recorded amortization of $0 and $33,334,
respectively.




11




AE BIOFUELS, INC.
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
 (Unaudited)


7.  Debt




Debt
consists of the following:




March
      31, 2010
            
            
            December
      31, 2009Revolving
      line of credit (related party)
            
            $
            4,864,429
            
            
            
            4,250,031Note
      Payable (related party)
            
            
            —
            
            
            
            —Total
      long term debt
            
            
            4,864,429
            
            
            
            4,250,031Senior
      secured note, including accrued interest of $1,183,463 and $1,017,701 less
      deferred issuance costs of $305,213 and $583,985
            
            
            6,528,250
            
            
            
            6,083,716Unsecured
      working capital loan
            
            
            446,551
            
            
            
            326,234Current
      portion of secured term loan
            
            
            4,714,195
            
            
            
            4,391,512Total
      current debt
            
            
            11,688,996
            
            
            
            10,801,462Total
      debt
            
            $
            16,553,425
            
            
            $
            15,051,493




Senior secured
note.  On May 16, 2008, Third Eye Capital ABL Opportunities
Fund (“Purchaser”) purchased a 10% senior secured note in the amount of $5
million along with 5 year warrants exercisable for 250,000 shares of common
stock at an exercise price of $3.00 per share.  The note is secured by
first-lien deeds of trust on real property located in Nebraska and Illinois, by
a first priority security interest in equipment located in Montana, and a
guarantee of $1 million by McAfee Capital LLC (owned by Eric McAfee and his
wife).  Interest on the note accrues on the unpaid principal balance
and is payable on the first business day of each quarter beginning on July 1,
2008.  Prior to the note maturing on May 15, 2009, we entered into an
amendment and limited waiver (the “Amendment”) with Third Eye Capital
Corporation (“Agent”) on behalf of itself and the Purchaser dated March 31,
2009.  The Amendment did not become effective as we were unable to
meet the conditions of effectiveness set forth in the
Amendment.  Accordingly, the interest rate under this facility has
been accrued at the default interest rate, which was 18%, during the period of
default.  We have no cross default provisions in this or any other
debt agreement.  As a result, our inability to execute the conditions
of effectiveness of the effective Amendment did not have any adverse impact on
our other debt obligations.




On
December 10, 2009, we entered into an amendment to the note with Third Eye
Capital Corporation extending the note maturity date until June 30, 2010 and
waiving covenant defaults.   The amended note bears interest at
10%.  We evaluated the loan modification under ASC 470-50 and ASC
470-60 and determined that the amendment represented a non-troubled debt
modification under ASC 470- 50, in which the original and new debt instrument
are not substantially different, accordingly, fees between the debtor and
creditor have been reflected as a reduction to the carrying value of the debt
and will amortized ratably over the seven month term of the
debt.    Fees of $350,000 were incurred to extend the
maturity and fees of $300,000 were incurred to waive the financial covenant
defaults.  At March 31, 2010 and December 31, 2009, we recorded
deferred issuance costs of $305,213 and $583,985, respectively.




Secured term
loan.  On July 17, 2008, Universal Biofuels Private Limited
(“UBPL”), a wholly-owned subsidiary, entered into a six year secured term loan
with the State Bank of India in the amount of approximately $6
million.  The term loan matures in March 2014 and is secured by UBPL’s
assets, consisting of the biodiesel plant and land in Kakinada.




In July
2008 we drew approximately $4.6 million against the secured term
loan.  The loan principal amount is repayable in 20 quarterly
installments of approximately $270,000, using exchange rates on December 31,
2009, with the first installment due in June 2009 and the last installment
payment due in March 2014.  The interest rate under this facility is
subject to adjustment every two years, based on 0.25% above the Reserve Bank of
India advance rate and is currently 12.00%.




The
principal payment scheduled for June, September and December 2009, and March
2010 were not made and in the event of default of payment of any installment of
principal payments, the term loan provides for liquidating damages at a rate of
2% per annum for the period of default.




12




AE BIOFUELS, INC.
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
 (Unaudited)


On
October 7, 2009, UBPL received a demand notice from the State Bank of
India.  The notice informs UBPL that an event of default has occurred
for failure to make an installment payment on the loan due in June, 2009 and
demands repayment of the entire outstanding indebtedness of 19.60 crores
(approximately $4 million) together with all accrued interest thereon and any
applicable fees and expenses by October 10, 2009.  As of March 31,
2010, UBPL was in default on seven months of interest, four principal
repayments, asset coverage ratio and debt service coverage
ratio.  Additional provisions of default include the bank having the
unqualified right to disclose or publish our company name and our directors
names as defaulter in any medium or media.  At the bank’s option, it
may also demand payment of the balance of the loan since the principal payments
are in default in June 2009.  As a result we have classified the
entire loan amount as current.  We are currently in discussions with
the bank with regards to an amendment to the Agreement of Loan for Overall Limit
for the modification of terms.




Revolving line of credit –
related party.  On August 17, 2009, International Biodiesel,
Inc., a wholly owned subsidiary of AE Biofuels, Inc., entered into a Revolving
Line of Credit Agreement with Mr.  Cagan, (the “Lender”), for
$5,000,000.  The $5,000,000 Revolving Line of Credit is secured by
accounts, investments, intellectual property, securities and other collateral of
AE Biofuels, Inc. excluding the collateral securing our obligations under the
Note and Warrant Purchase Agreement with Third Eye Capital Corporation and Third
Eye Capital ABL Opportunities Fund and the collateral securing our obligations
under the Secured Term Loan with the State Bank of India.  The
$5,000,000 Revolving Line of Credit bears interest at the rate of 10% per annum
and matures on July 1, 2011, at which time the outstanding advances under the
Revolving Line of Credit together with any accrued interest and other unpaid
charges or fees will become due.  Upon certain events, one of which is
the default on certain other debt facilities, the Lender may declare a
default upon 10 days prior written notice.  Upon an event of default,
the Lender may accelerate the outstanding indebtedness together with all accrued
interest thereon and demand immediate repayment.  We used the new
Revolving Line of Credit Agreement to satisfy the outstanding balance under the
unsecured revolving line of credit facility with a limit of $3,500,000 in August
2009.   At March 31, 2010, a total of $4,864,429, including
accrued interest, was outstanding under the $5,000,000 Revolving Line of Credit,
dated August 17, 2009.  All outstanding principal and accrued interest
is due and payable on July 1, 2011.




Note payable. – related
party.  On January 30, 2010, AE Advanced Fuels Keyes, Inc., a
wholly owned subsidiary of AE Biofuels, Inc., entered into an Unsecured
Promissory Note with Mr. Cagan for $1,600,000 as bridge financing for the repair
and retrofit activities at the Keyes plant.  The note bears no
interest.  In partial consideration for this loan, we agreed to issue
600,000 shares of common stock to Mr. Cagan.  At our option, this note
is payable in whole or part at any time.  During the three months
ended March 31, 2010, we borrowed and repaid $1,600,000 under this credit
facility.




Operating
agreement.In November
2008, we entered into an operating agreement with Secunderabad Oils Limited
(“Secunderabad”).  Under this agreement Secunderabad agreed to provide
us with working capital, on an as needed basis, to fund the purchase of
feedstock and other raw materials for our Kakinada biodiesel
facility.  Working capital advances bear interest at the actual bank
borrowing rate of Secunderabad, currently at 15%.  During the three
months ended March 31, 2010 and 2009, we paid Secunderabad approximately $31,692
and $89,200, respectively, under the agreement and approximately $7,217 and
$1,200, respectively, in interest for working capital funding.  At
March 31, 2010 and December 31, 2009 we had $446,551 and $326,234 outstanding
under this agreement, respectively, and included as current short term
borrowings on the balance sheet.




8.  Operating
Leases




We,
through our subsidiaries, have non-cancelable operating leases for office space
in Cupertino and India as well as the property housing our cellulosic
demonstration facility in Butte.  These leases expire at various dates
through May 31, 2012.  The Company records rent expense on a straight
line basis.




13


AE BIOFUELS, INC.
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
 (Unaudited)


Future
minimum operating lease payments as of March 31, 2010, are:




Rental
              Payments2010
            
            $
            200,0512011
            
            
            272,5212012
            
            
            115,475Total
            
            $
            588,047




For the
three months ended March 31, 2010 and 2009, we paid rent under operating leases
of $59,381 and $67,562, respectively.




In July,
2009, we entered into a sublease agreement with Solargen Energy, Inc. for
approximately 3,000 square feet of leased space.  For the three months
ended March 31, 2010, we invoiced, collected and offset as rent expense $21,418
under this agreement.  The future minimum lease payments above exclude
collections of rent under this sublease agreement.  See “Note
15.  Related Party Transactions.”




On
December 1, 2009, we entered into a  project agreement and lease for a
55 million gallon nameplate ethanol facility located in Keyes, California with a
lease term of 36 months at a monthly lease payment of $250,000 (an aggregate of
$9,000,000 over the expected lease term).  Under the project
agreement, we received a contribution of $500,000 towards certain costs of the
project and are required to complete certain repair and retrofit activities
prior to commencement of the lease.  We anticipate substantial
completion of the repair and retrofit activities on or before July 31,
2010.




We occupy
our Butte, MT facility under a month-to-month lease agreement.  See
“Note 19. Subsequent Events.”




9.  Stockholder’s
Equity




We are
authorized to issue up to 400,000,000 shares of common stock, $0.001 par value
and 65,000,000 shares of preferred stock, $0.001 par value.




Convertible
Preferred Stock




The
following is a summary of the authorized, issued and outstanding convertible
preferred stock:




Shares
      Issued and
              Outstanding
      December 31,Authorized
      Shares
            
            
            2009
            
            
            2008Series
      B preferred stock
            
            
            7,235,565
            
            
            
            3,320,725
            
            
            
            3,451,892Undesignated
            
            
            57,764,435
            
            
            
            —
            
            
            
            —65,000,000
            
            
            
            3,320,725
            
            
            
            3,451,892




Our
Articles of Incorporation authorize our board to issue up to 65,000,000 shares
of preferred stock, $0.001 par value, in one or more classes or series within a
class upon authority of the board without further stockholder
approval.




Significant
terms of the designated preferred stock are as follows:




Voting.Holders of
our Series B preferred stock are entitled to the number of votes equal to the
number of shares of Common Stock into which the shares of Series B preferred
stock held by such holder could be converted as of the record
date.  Cumulative voting with respect to the election of directors is
not allowed.  Currently each share of Series B preferred stock is
entitled to one vote per share of Series B preferred stock.  In
addition, without obtaining the approval of the holders of a majority of the
outstanding preferred stock, the Company cannot:




14




AE BIOFUELS, INC.
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
 (Unaudited)


·
            Increase
      or decrease (other than by redemption or conversion) the total number of
      authorized shares of Series B preferred
stock;




·
            Effect
      an exchange, reclassification, or cancellation of all or a part of the
      Series B preferred stock, including a reverse stock split, but excluding a
      stock split;




·
            Effect
      an exchange, or create a right of exchange, of all or part of the shares
      of another class of shares into shares of Series B preferred stock;
      or




·
            Alter
      or change the rights, preferences or privileges of the shares of Series B
      preferred stock so as to affect adversely the shares of such
      series.




Dividends.  Holders
of all of our shares of Series B preferred stock are entitled to receive
non-cumulative dividends payable in preference and before any declaration or
payment of any dividend on common stock as may from time to time be declared by
the board of directors out of funds legally available for that purpose at the
rate of 5% of the original purchase price of such shares of preferred
stock.  No dividends may be made with respect to our common stock
until all declared dividends on the preferred stock have been paid or set aside
for payment to the preferred stock holders.  To date, no dividends
have been declared.




Liquidation
Preference.In the event of any voluntary or involuntary
liquidation, dissolution or winding up of the Company, the holders of the Series
B preferred stock are entitled to receive, prior and in preference to any
payment to the holders of the common stock, $3.00 per share plus all declared
but unpaid dividends (if any) on the Series B preferred stock.  If the
assets legally available for distribution to the holders of the Series B
preferred stock are insufficient to permit the payment to such holders of their
full liquidation preference, then our entire assets legally available for
distribution are distributed to the holders of the Series B preferred stock in
proportion to their liquidation preferences.  After the payment to the
holders of the Series B preferred stock of their liquidation preference, our
remaining assets legally available for distribution are distributed to the
holders of the common stock in proportion to the number of shares of common
stock held by them.  A liquidation, dissolution or winding up includes
(a) the acquisition of the Company by another entity by means of any transaction
or series of related transactions to which the Company is party (including,
without limitation, any stock acquisition, reorganization, merger or
consolidation but excluding any sale of stock for capital raising purposes) that
results in the voting securities of the Company outstanding immediately prior
thereto failing to represent immediately after such transaction or series of
transactions (either by remaining outstanding or by being converted into voting
securities of the surviving entity or the entity that controls such surviving
entity) a majority of the total voting power represented by the outstanding
voting securities of the Company, such surviving entity or the entity that
controls such surviving entity, or (b) a sale, lease or other conveyance of all
or substantially all of the assets of the Company.




Conversion.Holders
of Series B preferred stock have the right, at their option at any time, to
convert any shares into common stock.  Each share of preferred stock
will convert into one share of common stock, at the current conversion
rate.  The conversion ratio is subject to adjustment from time to time
in the event of certain dilutive issuances and events, such as stock splits,
stock dividends, stock combinations, reclassifications, exchanges and the
like.  In addition, at such time as the Registration Statement
covering the resale of the shares of common stock is issuable, then all
outstanding Series B preferred stock shall be automatically converted into
common stock at the then effective conversion rate.  For the year
ended December 31, 2009, holders of 131,167 shares of Series B preferred stock
elected to convert their shares of Series B preferred stock into 131,167 shares
of common stock.  During the three months ended March 31, 2010,
holders of 55,500 shares of Series B preferred stock elected to convert their
shares of Series B preferred stock into 55,500 shares of common
stock.




Registration Rights Agreement
liquidated damages for certain common and Series B preferred stock
holders.Certain holders of shares of our common stock and
holders of shares of our Series B preferred stock were entitled to have their
shares of common stock (including common stock issuable upon conversion of
Series B preferred stock) registered under the Securities Act within but no
later than 30 days after the Reverse Merger Closing date, December 7, 2007,
pursuant to the terms and subject to the conditions set forth in a Registration
Rights Agreement entered into among the Company and such
holders.  Registration of these shares under the Securities Act would
result in these shares becoming freely tradable without restriction under the
Securities Act.




15




AE BIOFUELS, INC.
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
 (Unaudited)


We were
required to make pro rata payments to each eligible stock investor as liquidated
damages and not as a penalty, in the amount equal to 0.5% of the aggregate
purchase price paid by such investor for the preferred stock for each thirty
(30) day period or pro rata for any portion thereof following the date by which
or on which such Registration Statement should have been filed or effective, as
the case may be.  Payments are in full compensation to the investors,
and constitute the investor's exclusive remedy for such events.  The
amounts payable as liquidated damages were payable in cash or shares of common
stock at the Company’s election.  In lieu of registering the
securities, the Company elected to issue shares of its common stock to eligible
stockholders in full compensation to such stockholders.   The
liquidated damages ceased accruing in December 2008 when the shares became
available for trading in compliance with Rule 144.  We elected to pay
these liquidated damages through the issuance of 406,656 shares of common stock
to the holders of shares of our Series B preferred stock.




In
February 2009, in full settlement of the $1,807,748 registration right
liability, we issued a total of 406,656 shares of our common stock to eligible
shareholders resulting in a reduction of the liability and a corresponding
increase in additional paid in capital and common stock.




Mandatorily Redeemable Series B
preferred stock.In connection with the election of
dissenters’ rights by the Cordillera Fund, L.P., at December 31, 2008 we
reclassified 583,334 shares with an original purchase price of $1,750,002 out of
shareholders’ equity to a liability called “mandatorily redeemable Series B
preferred stock” and accordingly reduced stockholders equity by the same amount
to reflect our estimated obligations with respect to this matter.  See
“Note 17. Contingent Liabilities.”




Common
Stock




On
October 6, 2008, the Company and TIC cancelled their Strategic Alliance
Agreement and TIC agreed to return 4,000,000 shares of our common stock for a
total payment of $500,000 of which $234,419 was paid to TIC upon the parties’
entry into the agreement and $265,581 was payable on or before December 30,
2008.  Upon cancellation of the agreement, TIC returned 1,880,000
shares and will return the remaining 2,120,000 shares upon the receipt of the
final payment.  In the event the final payment is not received on or
before December 30, 2009, interest shall begin to accrue at the annual rate of
18% until paid in full.  At March 31, 2010, the Company had not made
the payment required under the agreement.




10.  Private
Placement of Preferred Stock and Warrants




In
connection with the sale of our Series A and B preferred stock, we issued to our
placement agent warrants to purchase a number of shares of our Common Stock
representing up to 8% of the shares of Series A and Series B preferred stock
sold.  The warrants are exercisable for a period of seven years from
the date of issuance, have a net exercise provision and are
transferable.  The shares of our common stock issuable upon exercise
of the warrants must be included in any Registration Statement filed by us with
the Securities and Exchange Commission.  Further, subject to certain
conditions, we have indemnified the placement agents and affiliated
broker-dealers against certain civil liabilities, including liabilities under
the Securities Act.




A summary
of warrant activity for placement warrants for the three months ended March 31,
2010 is as follows:




Number
      of
              Warrants
            
            
            Weighted-
              Average
              Exercise
              Price
            
            
            Warrants
              Exercisable
            
            
            Remaining
              Term
              (years)Outstanding,
      December 31, 2009
            
            
            666,587
            
            
            $
            3.00
            
            
            
            666,587
            
            
            
            2.56Granted
            
            
            —
            
            
            
            —
            
            
            
            —Exercised
            
            
            —
            
            
            
            —
            
            
            
            —Outstanding,
      March 31, 2010
            
            
            666,587
            
            
            
            3.00
            
            
            
            666,587
            
            
            
            2.31




The
warrants are considered equity instruments.  Since they were issued as
a cost of the issuance of the Series A and B preferred stock, the fair value of
these warrants has effectively been netted against the preferred stock sale
proceeds.




16




Warrants




In May
2008, we issued 250,000 common stock warrants to Third Eye Capital in connection
with our sale of a 10% senior secured note.  These warrants are
immediately exercisable at $0.12 per share.




In
February 2007, we issued 5,000 warrants to a consultant as compensation for
services rendered.  These warrants are immediately exercisable at
$3.00 per share.




11.  Stock-Based
Compensation




Common
Stock Reserved for Issuance




AE
Biofuels authorized the issuance of 4,000,000 shares under the 2007 Stock Plan
for stock option awards, which includes both incentive and non-statutory stock
options.  These options generally expire five years from the date of
grant and are exercisable at any time after the date of the grant, subject to
vesting.  Shares issued upon exercise before vesting are subject to a
right of repurchase, which lapses according to the vesting schedule of the
original option.




The
following is a summary of options granted under the 2007 Stock
Plan:




Shares
              Available
      For
              Grant
            
            
            Number
      of
              Shares
            
            
            Weighted-Average
              Exercise
      PriceBalance
      as of December 31, 2008
            
            
            1,490,500
            
            
            
            2,509,500
            
            
            $
            3.24Authorized
            
            
            882,410Granted
            
            
            (2,884,000
            )
            
            
            2,884,000
            
            
            
            0.16Exercised
            
            
            —
            
            
            
            —
            
            
            
            —Forfeited
            
            
            696,500
            
            
            
            (696,500
            )
            
            
            3.14Balance
      as of December 31, 2009
            
            
            185,410
            
            
            
            4,697,000
            
            
            
            1.37Authorized
            
            
            908,734Granted
            
            
            (1,290,000
            )
            
            
            1,290,000
            
            
            
            0.21Exercised
            
            
            —
            
            
            
            —
            
            
            
            —Forfeited
            
            
            200,000
            
            
            
            (200,000
            )
            
            
            2.82Balance
      as of March 31, 2010
            
            
            4,144
            
            
            
            5,787,000
            
            
            
            1.11




The
weighted average remaining contractual term at March 31, 2010 was 4.22
years.  The aggregate intrinsic value of the shares outstanding at
March 31, 2010 is $0.  The aggregate intrinsic value represents the
total pretax intrinsic value, based on the excess of the Company’s closing stock
price at March 31, 2010 of $0.19, over the options holders’ strike price, which
would have been received by the option holders had all option holders exercised
their options as of that date.  The weighted average grant date fair
value of these awards issued during the three months ended March 31, 2010 is
$0.08.




Included
in the table above are 857,000 options issued to consultants in
November 2007, June 2008, May 2009, August 2009 and March
2010.  These options had an exercise price of $3.00, $3.70,
$0.16,  $0.15, and $0.21, respectively, and generally vest over 3
years.  At December 31, 2009 the weighted average remaining
contractual term was 3.18 years.  We recorded an expense for the three
months ended March 31, 2010 and 2009 in the amount of $11,455 and $27,
respectively, which reflects periodic fair value remeasurement of outstanding
consultant options under ASC 505-50-30 (formerly Emerging Issues Task Force, or
EITF, No.  96-18, “Accounting for Equity Instruments that are issued
to Other Employees for Acquiring, or in Conjunction with Selling, Goods or
Services,”).  The valuation using the Black-Scholes-Merton model is
based upon the current market value of our common stock and other current
assumptions, including the expected term (contractual term for consultant
options).  We record the expense related to consultant options using
the accelerated expense pattern prescribed in ASC 505-50-30.  Options
outstanding that have vested or are unvested of March 31, 2010 are as
follows:




17




AE BIOFUELS, INC.
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
 (Unaudited)


Number
      of
              Shares
            
            
            Weighted
              Average
              Exercise
              Price
            
            
            Remaining
              Contractual
              Term
              (In
      Years)
            
            
            Aggregate
              Intrinsic
              Value1Vested
            
            
            3,649,625
            
            
            $
            1.21
            
            
            
            2.03
            
            
            $
            —Unvested
            
            
            2,137,375
            
            
            $
            0.54
            
            
            
            2.17
            
            
            
            —Total
            
            
            5,787,000
            
            
            $
            1.75
            
            
            
            2.10
            
            
            $
            —


———————


(1)       Based
on the $0.19 closing price of AE Biofuels stock on March 31, 2010, as reported
on the Over-the-Counter Bulletin Board, options had no aggregate intrinsic
value.




Valuation
and Expense Information




The
Company incurred non-cash stock compensation expense of $100,512
and $167,987 during the three months ended March 31, 2010 and 2009,
respectively, for options granted to our general and administrative employees
and consultants.  All stock option expense was classified as general
and administrative expense.




As of
March 31, 2010 and 2009, we held $366,190 and $758,198, respectively, of total
unrecognized compensation expenses under ASC Section 715-20-50, net of estimated
forfeitures, related to stock options that the Company will amortize over the
next four fiscal years.




12.  Acquisitions,
Divestitures and Joint Ventures




Marketing Company
Acquisition.On September 1, 2007, we acquired Biofuels
Marketing, Inc., a Nevada corporation, in exchange for 200,000 shares of common
stock valued at $3.00 per share.  Of the shares issued, 50% were
contingent upon the continued employment of the President of Biofuels Marketing
through August 31, 2009, and are accounted for as compensation expense as
earned.  Of the purchase price, $300,000 was assigned to the primary
asset acquired, which was a customer list, which was amortized over 18
months.




Technology Company
Formation.On February 28, 2007, we acquired a 51% interest in
Energy Enzymes, Inc.  We have the right to acquire the remaining 49%
for 1,000,000 shares of our common stock upon the fulfillment of certain
performance milestones or at our option to waive certain performance
milestones.  The performance milestones had not been met as of March
31, 2010.  In accordance with ASC Section 810-10-65, we attributed net
loss to Energy Enzymes, Inc. beginning at the date of adoption of ASC Section
810-10-65 in our consolidated statement of operations and recorded the minority
interest to non-controlling interest in the stockholders equity section of our
balance sheet.  The equity attributable to the Company and to the
non-controlling interest in Energy Enzymes, Inc. for the three months ended
March 31, 2010 and 2009 are as follows:




18




AE BIOFUELS, INC.
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
 (Unaudited)


For
      the three months ended March 31, 2010
            
            
            For
      the three months ended March 31, 2009Parent
            
            
            Noncontrolling
      Interest
            
            
            Consolidated
            
            
            Parent
            
            
            Noncontrolling
              Interest
            
            
            ConsolidatedDecember
      31,
              Accumulated
      deficit
            
            $
            (1,803,799
            )
            
            $
            (362,375
            )
            
            $
            (2,166,174
            )
            
            $
            (1,426,633
            )
            
            $
            ––
            
            
            $
            (1,426,633
            )Attributable
      net loss
            
            
            (73,710
            )
            
            
            (70,820
            )
            
            
            (144,530
            )
            
            
            (124,590
            )
            
            
            (119,705
            )
            
            
            (244,295
            )March
      31,
              Accumulated
              deficit
            
            $
            (1,877,509
            )
            
            $
            (433,195
            )
            
            $
            (2,310,704
            )
            
            $
            (1,551,223
            )
            
            $
            (119,705
            )
            
            $
            (1,670,928
            )




Operating
Agreement.In November 2008, we entered into an operating
agreement with Secunderabad Oils Limited (“Secunderabad”).  Under this
agreement Secunderabad agreed to provide us with plant operational expertise on
an as-needed basis and working capital, on an as needed basis, to fund the
purchase of feedstock and other raw materials for our Kakinada biodiesel
facility.  Working capital advances bear interest at the actual bank
borrowing rate of Secunderabad.  In return, we agreed to pay
Secunderabad an amount equal to 30% of the plant’s monthly net operating
profit.  In the event that our biodiesel facility operates at a loss,
Secunderabad owes us 30% of the losses.  The agreement can be
terminated by either party at any time without penalty.  During the
three months ended March 31, 2010 and 2009, we paid Secunderabad approximately
$31,692 and $89,200, respectively, under the agreement and approximately $7,217
and $1,200, respectively, in interest for working capital funding.  At
March 31, 2010 and December 31, 2009 we had $446,551 and $326,234 outstanding
under this agreement, respectively, and included as current short term
borrowings on the balance sheet.




On
January 23, 2008, International Biofuels, Ltd. agreed to end the joint venture
with Acalmar Oils and Fats, Ltd.  including termination of Acalmar’s
right to own or receive any ownership interest in the joint
venture.  The total cancellation price payable by International
Biofuels was $900,000 and is classified in our Statement of Operations as a
shareholder agreement cancellation payment.  For the year ended
December 31, 2008, $300,000 was paid to Acalmar by the Company, reducing the
remaining balance due to Acalmar to $600,000 at December 31,
2008.   The balance remained at $600,000 as of March 31,
2009.




13.  Commitments




We
contracted with Desmet Ballestra India Pvt.  Ltd.  to build
a glycerin refinery and pre-treatment plant at our existing biodiesel plant in
Kakinada.  At March 31, 2010 and December 31, 2009, commitments under
construction contracts were outstanding for approximately $60,871 and $60,654,
respectively.  Commitments under purchase orders and other short term
construction contracts were $19,735 at March 31, 2010.




14.  Segment
Information




Operating
segments are defined as components of an enterprise about which separate
financial information is available that is evaluated regularly by the chief
operating decision maker (“CODM”), or decision-making group, in deciding how to
allocate resources and in assessing performance.  Currently, the CODM
is the Chief Financial Officer.  In the prior year the Company
considered itself to operate within a single operating segment.  The
commencement of operations in India as well as the opening of the demonstration
facility in Butte, MT resulted in the Company’s reevaluation of its management
structure and reporting around business segments




AE
Biofuels recognized three reportable segments: “India”, “North America” and
“Other.”




The
“India” operating segment encompasses the Company’s 50 MGY nameplate capacity
biodiesel manufacturing plant in Kakinada, the administrative offices in
Hyderabad, India, and the holding companies in Nevada and
Mauritius.  The Company’s biodiesel is marketed and sold primarily to
customers in India through brokers and by the Company directly.  For
the year ended December 31, 2008, revenues from our Indian operations were 100%
of total net revenues.  Indian revenues consist of sales of biodiesel
produced by our plant in Kakinada to customers in India.  The majority
of the Company’s assets as of December 31, 2008 were attributable to its Indian
operations.




19




AE BIOFUELS, INC.
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
 (Unaudited)


The
“North America” operating segment includes our leased plant in Keyes, CA, our
cellulosic ethanol commercial demonstration facility in Butte, MT, and our land
held for future ethanol plant development in Sutton, NE and in Danville,
IL.  The Company is utilizing the Montana demonstration facility to
commercialize its proprietary enzymatic and cellulosic technology.  As
our technology gains market acceptance, this business segment will include our
domestic commercial application of the cellulosic technology, our plant
construction projects and any acquisitions of ethanol or ethanol related
technology facilities in North America.




The
“Other” segment encompasses the Company’s costs associated with new market
development, company-wide fund raising, formation, executive compensation and
other corporate expenses.




Summarized
financial information by reportable segment for the three months ended March 31,
2010 and 2009, based on the internal management system, is as
follows:




Statement
      of Operations Data
            
            Three
      months ended March 31,2010
            
            
            2009RevenuesIndia
            
            $
            2,236,838
            
            
            $
            2,503,491North
      America
            
            
            —
            
            
            
            —Other
            
            
            —
            
            
            
            —Total
      revenues
            
            $
            2,236,838
            
            
            $
            2,503,491Cost
      of goods soldIndia
            
            $
            2,209,593
            
            
            
            2,317,953North
      America
            
            
            —
            
            
            
            —Other
            
            
            —
            
            
            
            —Total
      cost of goods sold
            
            $
            2,209,593
            
            
            $
            2,317,953Gross
      profitIndia
            
            $
            27,245
            
            
            $
            185,538North America
            
            
            —
            
            
            
            —Other
            
            
            —
            
            
            
            —Total gross profit
            
            $
            27,245
            
            
            $
            185,538




For the
three months ended March 31, 2010 and 2009 all of our revenues were from sales
to external customers in our India segment.  During the three months
ended March 31, 2010, one customer accounted for approximately 11% of our
consolidated revenue.  During the three months ended March 31, 2009,
one customer accounted for approximately 27% of our consolidated
revenue.   No other single customer accounted for more than 10%
of our consolidated revenues.  All sales during the three months ended
March 31, 2010 and 2009 were made into the domestic India market.




Balance
      Sheet Data
            
            Year
      Ended
              December
      31March
      31, 2010
            
            
            December
      31, 2009Total
      AssetsIndia
            
            $
            17,089,196
            
            
            $
            16,224,300North
      America (United States)
            
            
            3,604,536
            
            
            
            3,250,827Other
            
            
            80,852
            
            
            
            91,091Total
      Assets
            
            $
            20,774,584
            
            
            $
            19,566,218




20




AE BIOFUELS, INC.
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
 (Unaudited)


15.  Related
Party Transactions




Laird
Cagan, a former member of the Company’s board of directors and a significant
stockholder, provides us with a $5,000,000 secured revolving line of credit. The
secured revolver line of credit was entered into on August 17, 2009 and the
initial draw was made to pay off an existing unsecured revolving line of credit.
At March 31, 2010 and December 31, 2009, a total of $4,342,992 and $3,842,992,
respectively, plus accrued interest of $521,437 and $407,039, respectively, was
outstanding under these credit facilities.  These credit facilities
accrue interest at 10% interest per annum. All outstanding principal and accrued
interest under the secured revolving line of credit is due and payable on July
1, 2011.




On
January 30, 2010, AE Advanced Fuels Keyes, Inc., a wholly owned subsidiary of AE
Biofuels, Inc., entered into an Unsecured Promissory Note with Mr. Cagan for
$1,600,000 as bridge financing for the repair and retrofit activities at the
Keyes plant.  The note bears no interest.  In partial
consideration for this loan, we agreed to issue 600,000 shares of common stock
to Mr. Cagan.  At our option, this note is payable in whole or part at
any time.  During the three months ended March 31, 2010, we borrowed
and repaid $1,600,000 under this credit facility.




We pay
Eric A. McAfee, the Company’s Chief Executive Officer and Chairman of the board
of directors, a salary of $10,000 per month for services rendered as our
President and CEO.  For the three months ended March 31, 2010 and 2009, we
paid or accrued $30,000 pursuant to this agreement.  As of March 31, 2010,
the Company owed Mr. McAfee $190,000 under the terms of this
agreement.




The
Company and Cagan McAfee Capital Partners are parties to an agreement pursuant
to which Cagan McAfee Capital Partners provides administrative and advisory
services for a monthly fee of $15,000 plus expense reimbursement to the
Company.  For the three months ended March 31, 2010 and 2009, we paid Cagan
McAfee Capital Partners $0 and $55,371, respectively. Eric A. McAfee, an officer
and member of the Company’s board of directors and Laird Cagan, a former member
of the Company’s board of directors, together own 100% of Cagan McAfee Capital
Partners.  As of March 31, 2010, the Company owed CMCP $119,866 under the
terms of this agreement.




We are
billed by McAfee Capital for certain expense reimbursements, principally in
connection with services provided by Eric A. McAfee and his administrative
personnel.  For the three months ended March 31, 2010 and 2009, we
paid McAfee Capital $6,159 and $0, respectively.   Eric A. 
McAfee, an officer and member of our board of directors, owns 100% of McAfee
Capital.   The Company owes McAfee Capital $31,307 under the terms of
this agreement.




In July,
2009, we entered into a sublease agreement with Solargen Energy, Inc. for
approximately 3,000 square feet of leased space. Eric McAfee is a member of the
board of directors and a significant shareholder of Solargen, Energy, Inc.
Michael Peterson, a member of our board of directors is also the Chief Executive
Officer and Chairman of the board of directors of Solargen, Energy, Inc. For the
three months ended March 31, 2010 and 2009, we invoiced, collected and offset as
rent expense and utilities $32,510 and $0 under this agreement in addition to a
prepayment of $11,876 we received for April 2010 rent.   The future
minimum lease payments above exclude collections of rents under this sublease
agreement. See “Note 8. Operating Leases.”




16.  Income
Tax




We file a
consolidated federal income tax return.  This return includes all
corporate subsidiaries 80% or more owned by the Company as well as the Company’s
pro-rata share of taxable income from pass-through entities in which Company
holds an ownership interest.  The Company owns 51% of Energy Enzymes,
Inc., which files a separate federal income tax return and is 100% consolidated
for financial reporting.  State tax returns are filed on a
consolidated, combined or separate basis depending on the applicable laws
relating to the Company and its subsidiaries.




Based on
our evaluation of current and anticipated future taxable income, we believe it
is more likely than not that insufficient taxable income will be generated to
realize the net deferred tax assets, and accordingly, a valuation allowance has
been set against these net deferred tax assets.




21




AE BIOFUELS, INC.
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
 (Unaudited)


We do not
provide for U.S. income taxes for any undistributed earnings of our foreign
subsidiaries, as we consider these to be permanently reinvested in the
operations of such subsidiaries and have a cumulative foreign
loss.   At March 31, 2010, these undistributed earnings (losses)
totaled approximately $5,226,914.  Some countries in which our
subsidiaries are located may impose withholding taxes on distributed
earnings.  However, due to our overall deficit in foreign cumulative
earnings and our U.S. loss position, we do not believe a material net
unrecognized U.S. deferred tax liability exists.




We recognize
the tax benefits from uncertain tax positions in our financial statements
only if the position is more-likely-than-not of being sustained on audit, based
on the technical merits of the position.  Tax positions that meet the
recognition threshold are reported at the largest amount that is
more-likely-than-not to be realized.  This determination requires a
high degree of judgment and estimation.  We periodically analyze and
adjust amounts recorded for our uncertain tax positions, as events occur to
warrant adjustment, such as when the statutory period for assessing tax on a
given tax return or period expires or if tax authorities provide administrative
guidance or a decision is rendered in the courts.  We do not
reasonably expect the total amount of uncertain tax positions to significantly
increase or decrease within the next 12 months.  As of March 31, 2010,
our uncertain tax positions were not significant.




We
conduct business globally and, as a result, one or more of our subsidiaries file
income tax returns in the U.S. federal jurisdiction and various state and
foreign jurisdictions.  In the normal course of business, we are
subject to examination by taxing authorities throughout the world, including
such major jurisdictions as India, Mauritius, and the United
States.  With few exceptions, we are no longer subject to U.S.
federal, state and local, or non-U.S. income tax examinations for years before
2006.




17.  Contingent
Liabilities




On March
28, 2008, the Cordillera Fund, L.P. filed a complaint in the Clark County
District Court of the State of Nevada against American Ethanol, Inc. and the
Company.  The complaint sought a judicial declaration that Cordillera
has a right to payment from the Company for its American Ethanol shares at fair
market value pursuant to Nevada’s Dissenters’ Rights Statute, a judicial
declaration that Cordillera is not a holder of Series B preferred stock in the
Company under the provisions of the statute; and a permanent injunction
compelling the Company to apply the Dissenters’ Rights Statute to Cordillera’s
shares and reimburse Cordillera for attorneys fees and costs.




On
June 2, 2008 the case was transferred to the Second Judicial Court of the
State of Nevada, located in Washoe County, Nevada.  On or about
October 7, 2009, the Court entered a judgment awarding damages in the amount of
$1,750,002 plus accrued interest to Cordillera.  On October 19, 2009,
the Company filed a Notice of Appeal of the judgment.  This appeal is
still pending.   The amount of the judgment was accrued at
December 31, 2009.  See “Note 9. Stockholder’s Equity.”




On May 1,
2009 our transfer agent, Corporate Stock Transfer, Inc., filed a Complaint for
Interpleader in the United States District Court for the District of Colorado.
The interpleader action was based on the Company’s and CST’s refusal to remove
the restrictive legend from a certificate representing 5,600,000 shares of the
Company's restricted common stock held by Surendra Ajjarapu and sought judicial
determination as to whether the legend could lawfully be removed from the
Certificate. On July 1, 2009 Ajjarapu answered the Complaint and
cross-claimed against the Company and CST for breach of fiduciary duty,
conversion, violation of Section 10(b) of the Exchange Act and
Rule 10b-5 and injunctive relief. The Ajjarapus also counter-claimed
against CST for declaratory judgment.  The interpleader action was
rendered moot when the legends were lifted from the Ajjarapu’s certificates and
the Ajjarapus’ filed an Amended Complaint reciting the same claims set forth in
their original Cross-Complaint against the Company and CST. Company does not
believe it has any liability for the matters described in this litigation and
intends to defend itself vigorously. However, there can be no assurance
regarding the outcome of the litigation. An estimate of possible loss, if any,
or the range of loss cannot be made and therefore we have not accrued a loss
contingency related to these actions.




22




AE BIOFUELS, INC.
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
 (Unaudited)


18.  Fair
Value of Financial Instruments and Related Measurement




Fair
value, as defined in ASC Topic 820-10, is the price that would be received to
sell an asset or paid to transfer a liability in an orderly transaction between
market participants at the measurement date.  The fair value of an
asset should reflect its highest and best use by market participants, whether
using an in-use or an in-exchange valuation premise.  The fair value
of a liability should reflect the risk of nonperformance, which includes, among
other things, the Company’s credit risk.




Valuation
techniques are generally classified into three categories: the market approach;
the income approach; and the cost approach.  The selection and
application of one or more of the techniques requires significant judgment and
are primarily dependent upon the characteristics of the asset or liability, the
principal (or most advantageous) market in which participants would transact for
the asset or liability and the quality and availability of
inputs.  Inputs to valuation techniques are classified as either
observable or unobservable within the following hierarchy:




Level 1
Inputs




These
inputs come from quoted prices (unadjusted) in active markets for identical
assets or liabilities.




Level 2
Inputs




These
inputs are other than quoted prices that are observable, for an asset or
liability.   These include 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, inputs other than quoted prices that
are observable for the asset or liability, and inputs that are derived
principally from or corroborated by observable market data by correlation or
other means.




Level 3
Inputs




These are
unobservable inputs for the asset or liability which require the Company’s own
assumptions.




As
required by SFAS 157, financial assets and liabilities are classified based on
the lowest level of input that is significant to the fair value
measurement.  Our assessment of the significance of a particular input
to the fair value measurement requires judgment, and may affect the valuation of
the fair value of assets and liabilities and their placement within the fair
value hierarchy levels.  Our only financial asset carried at fair
value is cash held in commercial bank accounts with short term
maturities.  We consider the statement we receive from the bank as a
quoted price (Level 1 measurement) for cash and measure the fair value of these
assets using the bank statements.




As
required by ASC Topic 820-10, financial assets and liabilities are classified
based on the lowest level of input that is significant to the fair value
measurement.  Our assessment of the significance of a particular input
to the fair value measurement requires judgment, and may affect the valuation of
the fair value of assets and liabilities and their placement within the fair
value hierarchy levels.




Our Level
1 financial assets reflect the fair value of cash held in commercial
bank accounts with short term maturities. We consider the statement we receive
from the bank as a quoted price for cash and measure the fair value of these
assets using the bank statement.




The
carrying amounts and fair values of the Company’s financial instruments at March
31, 2010, are as follows:




Fair
Value Measurement - Recurring Basis




Fair
      Value MeasurementsCarrying
              Amount
              at
      March 31, 2010
            
            
            Level
      1
            
            
            Level
      2
            
            
            Level
      3AssetsCash
      and time deposits
            
            $
            332,049
            
            
            $
            332,049
            
            
            $
            ––
            
            
            $
            ––Other
      assets - restricted cash
            
            
            11,137
            
            
            
            ––
            
            
            
            11,137
            
            
            
            ––Total
            
            $
            343,186
            
            
            $
            332,049
            
            
            $
            11,137
            
            
            $
            ––




23




AE BIOFUELS, INC.
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
 (Unaudited)


Fair
Value Measurement - Nonrecurring Basis




The
Company performs impairment tests under the guidance of ASC 360-10, Property,
Plant, and Equipment, whenever there are indicators of
impairment.  The Company would recognize an impairment loss only if
the carrying value of a long-lived asset or group of assets is not recoverable
from undiscounted cash flows, and would measure an impairment loss as the
difference between the carrying value and fair value of the assets based on
discounted cash flows projections.  The Company estimated the fair
value of its idle land holdings in Illinois and Nebraska by using available
market prices based on recent market appraisals (level 2 inputs).




As
of  March 31, 2010, certain long lived assets consisting of idle
landholdings in Illinois and Nebraska (which were previously written down in
2009 to their estimated fair value of $2,885,000) were carried at their
impaired value which approximates their fair value of $2,885,000.




Fair
      Value MeasurementsCarrying
              Amount
              at
      March 31, 2010
            
            
            Level
      1
            
            
            Level
      2
            
            
            Level
      3AssetsLandholdings
      in Illinois and Nebraska
            
            $
            2,885,000
            
            
            $
            ––
            
            
            $
            2,885,000
            
            
            $
            ––




19.  Subsequent
Events




On May
13, 2010, the landlord for our Butte, MT facility delivered a notice to vacate
due to the sale of the property.  We anticipate moving our operations
from Butte, MT to our leased facility in Keyes, CA. At March 31, 2010, the
net book value of capitalized assets at this facility was $341,122.




On May
11, 2010, we issued to Laird Cagan 600,000 shares in partial consideration for
entering into an Unsecured Promissory Note for $1,600,000 as bridge financing
for the repair and retrofit activities at the Keyes plant.




24




ITEM
      2.
              MANAGEMENT'S
      DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
      OPERATIONS.


Our
Management’s Discussion and Analysis of Financial Condition and Results of
Operations (MD&A) is provided in addition to the accompanying consolidated
financial statements and notes to assist readers in understanding our results of
operations, financial condition, and cash flows. MD&A is organized as
follows:




·
            Overview. Discussion of our business
      and overall analysis of financial and other highlights affecting the
      Company to provide context for the remainder of
      MD&A.




·
            Results
      of Operations. An
      analysis of our financial results comparing the three months ended March
      31, 2010 to the three months ended March 31,
  2009.




·
            Liquidity
      and Capital Resources. An analysis of changes in
      our balance sheets and cash flows, and discussion of our financial
      condition.




·
            Critical
      Accounting Estimates. Accounting estimates that we
      believe are important to understanding the assumptions and judgments
      incorporated in our reported financial results and
      forecasts.




The
following discussion should be read in conjunction with the AE Biofuels, Inc.
consolidated financial statements and accompanying notes included elsewhere in
this report. The following discussion contains forward-looking statements that
reflect the plans, estimates and beliefs of AE Biofuels, Inc. The actual results
could differ materially from those discussed in the forward-looking statements.
Factors that could cause or contribute to these differences include those
discussed below and elsewhere in this Report, particularly under “Part II —
Other Information, Item 1A. Risk Factors”, and in other reports we file with the
SEC, specifically our most recent Annual Report on Form 10-K.” All
references to years relate to the calendar year ended December 31 of the
particular year.




Overview




The
Company’s goal is to be a leader in the production of next-generation fuels to
meet the increasing demand for renewable transportation fuels, and to reduce
dependence on petroleum-based energy sources in an environmentally responsible
manner. We have raised approximately $31.8 million to date through the
sales of our preferred stock and approximately $13 million through debt
facilities to fund our operations since our inception in late 2005. To date, we
have used these funds to (i) construct and operate a 50 MGY biodiesel
manufacturing facility in Kakinada, India, (ii) purchase land and land options
for the development of ethanol and/or next generation ethanol plants in the
United States, (iii) develop, draft and submit three patents on proprietary,
patent-pending enzyme technology, (iv) construct a portion of a glycerin
refining and vegetable oil pretreatment facility at our Kakinada plant, (v)
commercialize our proprietary, patent-pending enzyme technology, including the
construction and operation of our next-generation cellulose ethanol
demonstration facility in Butte, MT, and (vi) signed a lease and began a repair
and retrofit of a 55 MGPY ethanol plant in Keyes, CA.




We
completed construction of both our biodiesel plant and our cellulosic ethanol
demonstration plant in 2008 and we have been selling biodiesel since
November 2008. We, however, currently do not have sufficient cash reserves
to meet our anticipated operating and capital obligations. As a result, we are
in the process of seeking additional capital for operation of our Kakinada
refinery at full capacity, for continuing the construction of the glycerin
refining and vegetable oil pretreatment plant, for funding continuing
development of our cellulosic ethanol technology, for operating an ethanol plant
in Keyes, California, and for paying ongoing corporate overhead expenses. The
amount of additional capital we raise will have to be sufficient to fund the
working capital of the biodiesel plant until the plant generates sufficient cash
flow from operations, if ever. Further, we have been operating at a loss and
expect to increase our operating expenses significantly as we expand our
operations.




Our
integrated technology addresses the requirement for commercially viable uses of
non-food feedstock to complement existing feedstock sources to meet the
worldwide demand for ethanol. Our strategy for the commercialization of our
integrated cellulose and starch process includes: (i) acquiring existing starch
(corn) ethanol plants and retrofitting them with our cellulosic technology, (ii)
establishing joint ventures with existing ethanol plants (including corn ethanol
plants in the U.S. and sugarcane ethanol plants in Brazil and India), (iii)
constructing and operating standalone cellulosic ethanol facilities, and (iv)
licensing our proprietary technology to ethanol plants in the U.S., Brazil and
India.




25




We began
our operations and sales of biodiesel into the domestic Indian market in
November 2008. Our revenues during the period covered by this Report
consist of sales of biodiesel to retail distributor, fleet customers and to
governmental agencies in India.  We also sold glycerin and excess
stearin to customers in India. We receive the order and payment on the majority
of our sales before distribution of the product. Payment on sales to customers
outside of India is in the form of non-recourse secured letters of credit. We
sell our product primarily through our inside sales force and through outside
sales brokers. We have not sold products on a consignment basis. We have the
ability to generate additional revenue through the sale of crude glycerin, the
by-product from the biodiesel production process. During the three months ended
March 31, 2010, we sold 369 metric tons of crude glycerin compared to no sales
of glycerin during the three months ended March 31, 2009. Our cost of revenues
consists of feedstock, chemicals and plant overhead. Depending upon the costs of
these products in comparison to the sales price of the biodiesel, our gross
margins can vary from positive to negative. Overhead expenses include direct and
indirect costs associated with the biodiesel production at our Kakinada plant,
plant utilities, maintenance, insurance, depreciation and freight. We produced
3,408 metric tons of biodiesel during the first three months of 2010 and sold
2,696 metric tons of biodiesel which was 8% of our total plant capacity for the
three months ended March 31, 2010.




During
the three months ended March 31, 2010, we operated our biodiesel plant in India;
however, our current operations are constrained by limited working capital and
the lack of widespread market acceptance of biodiesel in India. We believe that
we can continue to increase sales of biodiesel in 2010; however, the domestic
Indian market must continue to increase acceptance of biodiesel our and the
margins between the feedstock costs and the biodiesel sales price must remain
positive in order for us to have positive gross margins in 2010. Our primary
export market is Europe.  As the summer months approach, our ability
to sell palm-based biodiesel with its high temperature flow point relative to
other feedstock biodiesel increases.  We are currently pursuing orders
in this region, but do no have any firm order at this time. As a result, it is
difficult to predict timing or size of product sales on a quarterly
basis.


Our
ability to sell biodiesel in the India market is hampered by a disparity between
the national biofuels policy and State of Andhra Pradesh’ tax
policy.  Although the Indian national biofuels policy sets the tax
rate of biodiesel at 4%, the State of Andrah Pradish does not recognize this
policy when the biodiesel is blended with petroleum based diesel and taxes the
blended diesel at the same rate as petroeum based diesel. Upon the adoption of
the national law by the state, we anticipate the tax disparity will be
eliminated thereby reducing the price of biodiesel relative to petroleum
based diesel and allowing for economic blending of biodiesel with petroleum
based diesel.  We are currently working with the national government
to rationalize this tax structure, but cannot predict the timing or outcome of
these governmental policy changes.  We expect the market for next
generation cellulosic ethanol to continue to grow in the United States due to a
focus toward reducing reliance on petroleum based fuel and due to increased
cellulosic ethanol mandates specified by the updated Renewable Fuel Standard
(RFS 2). At the outset of 2009, we believed that we could begin generating
revenues through the commercialization of our cellulosic ethanol technology and
associated Renewable Identification Number (RIN’s) in 2009; however, we have not
been able to generate revenues from this technology thus far.




Our cash
and cash equivalents balance was $332,049 as of March 31, 2010, of which
$306,804 was held in our domestic entities and $25,245 was held in foreign
subsidiaries. Our current ratio as of March 31, 2010 was 0.09 compared to a
current ratio of 0.06 as of December 31, 2009. We ended March 31, 2010 with
limited working capital resources and we will need to raise additional working
capital in 2010 in order to achieve our goals in India and the U.S. Due to the
global financial crisis during the past twelve months, obtaining working capital
through commercial banks or through other means is a significant challenge and
we cannot be assured we will be able to obtain additional working capital and
therefore be successful in 2010. Should the Company not be able to raise enough
equity or debt financing, it may be forced to sell all or a portion of its
existing biodiesel facility or other assets to generate cash to continue the
Company’s business plan or possibly discontinue operations.




Results
of Operations




Three
Months Ended March 31, 2010 Compared to Three Months Ended March 31,
2009




Revenues




For the
three months ended March 31, 2010, substantially all of our revenues were
derived from the sale of biodiesel from our India segment.




26


We
recognize revenue upon shipment of product as payments are generally made in
advance and we do not offer any right of return. On export orders, we deliver
our product FOB shipping point and receive a non-recourse letter of credit at
delivery. At March 31, 2010 we held accounts receivable of $177,372 from three
of our largest customers. Our average domestic sales transaction consists of a
customer taking delivery of several metric tons of biodiesel by loading it into
their tanker truck at our plant site. We have several domestic customers who
take delivery of biodiesel on a daily basis. During the three months ended March
31, 2010 we made all of our sales to customers within India. Due to the
seasonality of sales into the international markets, we expect that other
international regions may place orders for summer delivery, however, at this
time we have no firm orders. As a result, it is difficult to predict timing or
size of product sales on a quarterly basis.


Cost
of Revenues




Our cost
of revenues consists of fixed costs, including utilities, supplies, insurance,
property taxes, depreciation and indirect labor compensation. Variable costs
include direct labor compensation and direct material costs. The largest
component of the cost of revenues is the palm oil or palm stearin feedstock for
the biodiesel production process. The price of palm oil and palm stearin is
influenced by general economic, market and regulatory factors. These factors
include local and global supply and demand, weather conditions, farmer planting
decisions, government policies and subsidies with respect to agriculture and
international trade. The price at which we sell our biodiesel in India is
generally indexed to the price of petroleum diesel, which is set by the Indian
government, the lack of correlation between production costs and product prices
means that we are generally unable to pass increased feedstock costs on to our
customers. The cost of palm oil or palm stearin has fluctuated significantly in
recent periods; however, for the three months ended March 31, 2010, the
commodity markets proved to be reasonably stable.  During this
quarter, the India government raised the price of petroleum diesel, however, we
experienced an increased price for our stearin resulting in a lower gross margin
than in the three months ended March 31, 2009. The price pressure of stearin
increasing faster than the price of petroleum diesel, and likewise, the price we
receive in the market caused our gross margin to fall from $185,538 for the
three months ended March 31, 2009 to $27,245 for the three months ended March
31, 2010.




We exited
the three months ended March 31, 2010 with 1,011 metric tons of biodiesel, which
at current sales levels represents approximately three weeks of sales. During
the three months ended March 31, 2010, we recognized $44,187 in inventory
adjustments attributable to lower of cost or market valuation. All of our cost
of revenues was located in our India segment.




Expenses




Research and Development Expenses.The principal area of spending for research and development is our
integrated cellulose and starch ethanol commercial demonstration facility in
Butte, MT. We incurred expenses of $144,530 and $191,614 during the three months
ended March 31, 2010 and 2009, respectively. The largest component of the
expenses for the three months ended March 31, 2010 was $104,132 for salaries,
wages and compensation as compared to $0 for the three months ended March 31,
2009. The second largest component for the three months ended March 31, 2010 was
$22,708 for rent, taxes and insurance compared to $19,234 for the three months
ended March 31, 2009.  We charged $17,571 of depreciation to research
and development for the three months ended March 31, 2010, as compared to
$17,571 in the prior year. All of our research and development expenses were
incurred in the North America segment.




Selling, General and Administrative
Expenses.Principal areas of spending for general and administrative
expenses are in the areas of employee compensation, professional services,
travel, depreciation, and office expenses, including rent.




27





We
summarize our spending within the North America segment into eight components as
follows:




For
      the Three Months Ended
              March
      31,2010
            
            
            2009%
            
            
            %Salaries,
      wages and compensation
            
            
            48
            
            
            
            46Supplies
      and services
            
            
            1
            
            
            
            5Repair
      and maintenance
            
            
            ––
            
            
            
            ––Taxes,
      insurance, rent and utilities
            
            
            17
            
            
            
            11Professional
      services
            
            
            33
            
            
            
            33Depreciation
      and amortization
            
            
            ––
            
            
            
            3Travel
      and entertainment
            
            
            1
            
            
            
            2Miscellaneous
      expense
            
            
            ––
            
            
            
            ––Total
            
            
            100
            
            
            
            100




The
single largest component of selling, general and administrative expense is
employee compensation, including related stock compensation. For the three
months ended March 31, 2010 and 2009, the number of United States employees
increased from 13 to 14 employees. Compensation expense decreased from
$614,563 for the three months ended March 31, 2009 to $394,841 for the three
months ended March 31, 2010. The decrease was principally driven by a change in
the mix of employees that includes fewer executive level employees and by lower
non-cash, stock compensation of $100,512 for the three months ended March 31,
2010 compared to non-cash, stock compensation of $167,959 recorded during the
same period of 2009.




The
second largest component of selling, general and administrative expense is
professional services, which include legal, accounting, financial advisory,
board compensation, security filings, and transfer agent fees along with
associated non-cash stock compensation expense. For the three months ended March
31, 2010, we spent $281,576 on professional services including a non-cash stock
compensation charge of $11,465 for stock grants to key consultants and advisors.
For the three months ended March 31, 2009, we spent approximately $459,962 on
professional services of which $27 was posted as non-cash stock-based
compensation. The decrease from the prior year is attributable to a reduction in
spending on all professional fees, including legal and financial advisory
fees.




The third
largest component of selling, general and administrative expense is taxes,
insurance, rent and utilities. This category also includes licenses and permits
as well as penalties and interest. The taxes included in this item are
non-income based taxes. For the three months ended March 31, 2010 most of the
$148,211 was spent on rent, utilities and insurance. This level of spending is
slightly lower than the $155,866 spent during the three months ended March 31,
2009 due to the closure of our office in Houston, Texas.




During
the three months ended March 31, 2010, we incurred some selling and marketing
expenses related to our biodiesel sales, which consisted primarily of salaries,
commissions and benefits related to sales and marketing personnel and sales
brokers; travel and other out-of-pocket expenses, and facilities costs and other
related overhead. Commissions on biodiesel sales are typically accrued and
expensed or paid when the respective products are sold. We intend to hire
additional sales personnel, initiate additional marketing programs and build
additional relationships with resellers and strategic partners on a global
basis. Accordingly, we expect that our sales and marketing expenses will
increase for the foreseeable future in absolute dollars. At this time, these
costs are small and accordingly we have included them in general and
administrative.




28


We
summarize our spending within the India segment into eight components as
follows:




For
      the Three Months Ended
              March
      31,2010
            
            
            2009%
            
            
            %Salaries,
      wages and compensation
            
            
            7
            
            
            
            4Supplies
      and services
            
            
            2
            
            
            
            31Repair
      and maintenance
            
            
            5
            
            
            
            3Taxes,
      insurance, rent and utilities
            
            
            7
            
            
            
            24Professional
      services
            
            
            53
            
            
            
            33Depreciation
      and amortization
            
            
            6
            
            
            
            ––Travel
      and entertainment
            
            
            14
            
            
            
            5Miscellaneous
      expense
            
            
            6
            
            
            
            ––Total
            
            
            100
            
            
            
            100




Our India
segment incurred selling, general and administrative expenses of $125,033 for
the three months ended March 31, 2010.  The largest component of
selling, general and administrative expense is attributable to costs associated
with the operational support agreement with Secunderabad Oil, which were $67,198
for the three months ended March 31, 2010. The second largest component is
depreciation expense attributable to our biodiesel plant.




Other
Income/Expense




Other income (expense)
consisted of the following items:




·
            Interest
      expense attributable to debt facilities acquired by our parent company,
      our subsidiaries Universal Biofuels Pvt. Ltd., International Biofuels,
      Inc., AE Advanced Fuels Keyes, Inc. and interest accrued on the complaint
      filed by Cordillera Fund, L.P. These debt facilities included warrant
      coverage and discount fees which are amortized as part of interest
      expense. Currently, the debt facility for Universal Biofuels Pvt. Ltd.
      accrues interest at the default rate of interest. We incurred interest
      expense of $909,018 for the three months ended March 31, 2010 compared to
      $841,804 for the three months ended March 31, 2009.  We did not
      capitalize any interest during the three months ended March 31, 2010 and
      2009.




·
            Interest
      income is earned on excess cash. Due to low levels of cash during the
      three months ended March 31, 2010, and 2009, our interest income remained
      at low levels of $180 and $6,872,
respectively.




·
            Other
      income, for both years, is attributable to renting portions our land
      holdings in Sutton and Danville to local farmers and renting portions of
      our tank storage at our plant in
India.




Liquidity
and Capital Resources




Contractual
Obligations


In
June 2009, our India subsidiary exited from the Export Oriented Unit
taxation status and became a domestic producer. As part of the governmental
agreements, the Company is required to export approximately $4,000,000 of
biodiesel into the international markets before June 2017 or pay the tax as
though the exported biodiesel was sold within the country of
India.  In December, 2009, we recognized the tax on this export
obligation as a liability and related expense.




On
December 1, 2009, we entered into a lease and project agreement for a 55 million
gallon nameplate ethanol facility located in Keyes, California for a term of 36
months at a monthly lease payment of $250,000 (an aggregate of $9,000,000 over
the expected lease term).   Lease term and rental begin upon
substantial completion of the repair and retrofit activities, determined by the
mutual agreement of the parties, as required under the project
agreement.  We anticipate completion of the repair and retrofit
activities on or before July 31, 2010, the deadline specified in the project
agreement.  In connection with this agreement, we received a payment
of $500,000 representing a contribution to the project company.  Upon
completion of the repair and retrofit activities, we receive an additional
$500,000 contribution to the project company.  During the term of the
lease, we are responsible for the costs and expenses associated with leasing and
operating this facility.




29




Upon
substantial completion of the repair and retrofit activities, we intend to
operate the plant. Once operations commence, our liquidity requirements will
increase dramatically as our operating plant will require us to make feed stocks
purchases, monthly lease payments, debt service of principle and interest,
utility payments, and other operating payments.  These payments are
expected to be offset by the collection of revenue from ethanol and distillers
grains resulting in a positive cash flow from operations.  Although we
expect the cash from operations of this plant will be sufficient, we can provide
no assurance that our liquidity from our operation will be sufficient to offset
the cost of operation.  As a result of changes in the price of
ethanol, feedstock and distillers grains, there may be periods of time when the
cash from operations will be insufficient to meet our operating
costs.  During these times, we may require other sources of cash to
offset the liquidity shortfalls




We do not
have any other material off-balance sheet arrangements nor do we have any other
material changes with respect to our contractual obligations.




Liquidity


Cash and
cash equivalents, current assets, current liabilities and debt at the end of
each period were as follows:


March
      31,
              2010
            
            
            March
      31,
              2009Cash
      and cash equivalents
            
            $
            332,049
            
            
            $
            52,178Current
      assets (including cash and cash equivalents)
            
            
            1,946,829
            
            
            
            1,068,999Current
      liabilities (including short term debt)
            
            
            21,082,862
            
            
            
            19,005,875Short
      and long term debt
            
            $
            16,553,425
            
            
            $
            15,051,493




The
Company continued to experience losses and negative cash flows from operations
through March 31, 2010. As noted in the table above, the Company has negative
working capital (current assets less current liabilities). To date, our
operating biodiesel plant has provided us with only minimal cash flow, and it
will likely be insufficient to allow for the completion of our business plan in
2010. As the development of our business plan has taken longer to develop than
we had forecasted, we may have to review our long lived assets for impairment at
a future date. Funds available at March 31, 2010 are sufficient to cover less
than one month of our domestic operating costs.




In order
for us to continue as a going concern, we require a significant amount of
additional working capital to fund our ongoing operating expenses and future
capital requirements. The use of additional working capital is primarily for
general and administrative expenses, the purchase of feedstock and other raw
materials to operate our existing facilities, to repair and restart the Keyes,
CA plant, and debt interest and principal payments. Our ability to identify and
enter into commercial arrangements with feedstock suppliers in India depends on
maintaining our operations agreement with Secunderabad, who is currently
providing us with working capital for our Kakinada facility. If we are unable to
maintain this strategic relationship, our business may be negatively affected.
In addition, the ability of Secunderabad to continue to provide us with working
capital depends in part on the financial strength of Secunderabad and its
banking relationships. If Secunderabad is unable or unwilling to continue to
provide us with working capital, our business may be negatively
affected.




On
October 7, 2009, UBPL received a demand notice from the State Bank of
India. The notice informed UBPL that an event of default has occurred for
failure to make an installment payment on the loan due in June, 2009 and demands
repayment of the entire outstanding indebtedness of 19.60 crores (approximately
$4 million) together with all accrued interest thereon and any applicable
fees and expenses by October 10, 2009. Upon the occurrence and during the
continuance of an Event of Default, interest accrues at the default interest
rate of 2% above the State Bank Advance Rate. The default period began on
July 1, 2009 when the principal payment was deemed past due; and we have
accrued interest at the default rate since the beginning of the default period.
Additional provisions of the loan agreement give the bank the right to disclose
or publish our company name and the names of our directors as defaulter in any
medium or media. In addition, since the bank demanded payment of the balance in
July 2009, we have classified the entire loan amount as current. We are
currently in discussions with the State Bank of India for a modification of the
loan terms. If we are unsuccessful with our negotiations and there is an
immediate acceleration of the payment of the entire principal balance, it would
have a significant adverse impact on the Company’s near term liquidity and
ability to operate our business in India.




30




Effective
for the pay period ended February 28, 2009, two of our executive officers
and five other employees voluntarily accepted a significant compensation
reduction. As of March 31, 2010, the reduction of their salaries has provided us
with approximately $761,000 of reduced cash flow. We accrued this reduction in
cash flow as we intend to pay these executives and employees for accrued
salaries as our cash flow allows. The repayment of these amounts will be a use
of cash in the future.




Planned
capital expenditures include an expected $1,000,000 to complete the
pre-treatment facility and glycerin refinery at our Kakinada plant. At March 31,
2010 commitments under construction contracts were outstanding for approximately
$60,871, while commitments under purchase orders and other short term
construction contracts were $19,735. We anticipate that the cash flow from our
India operations will fulfill the current commitments.  Completion of
our pre-treatment facility and glycerin refinery is on hold until we can obtain
a source of funding.  The completion of this facility is entirely
dependent upon our ability to raise additional capital or debt.




On
August 17, 2009, International Biodiesel, Inc., a wholly owned subsidiary
of AE Biofuels, Inc., entered into a Revolving Line of Credit Agreement with
Laird Q. Cagan, a former member of the Company’s board of directors and a
significant stockholder, for $5,000,000. The Revolving Line of Credit is secured
by accounts, investments, intellectual property, securities and other collateral
of AE Biofuels, Inc. excluding the collateral securing the Company’s obligations
under the Note and Warrant Purchase Agreement with Third Eye Capital Corporation
and Third Eye Capital ABL Opportunities Fund. The Revolving Line of Credit bears
interest at the rate of 10% per annum and matures on July 1, 2011, at which
time the outstanding advances under the Revolving Line of Credit together with
any accrued interest and other unpaid charges or fees will become due. Upon
certain events, one of which is the default on any other debt facility, the
Lender may declare a default upon 10 days prior written notice. Upon an event of
default, the Lender may accelerate the outstanding indebtedness together with
all accrued interest thereon and demand immediate repayment. The Company used
the new Revolving Line of Credit Agreement to pay down a preexisting revolving
line of credit facility with a limit of $3,500,000. The result of obtaining the
new Revolving Line of Credit Agreement, dated August 17, 2009, was a
$1,500,000 increase in the amount available to the Company, net of the pay down
of the previous revolving line of credit, dated November 16,
2006.




We may
continue to deploy our management team’s combined industry, technical, merger
and acquisition, restructuring and corporate finance expertise to target and
acquire undervalued and/or distressed assets, and then apply our technology to
improve the performance of those assets. We believe that our strategy offers
substantial opportunity to build capital value in the current climate,
particularly given (a) the present opportunity to acquire undervalued and/or
underperforming assets and improve them; and (b) the medium to longer term
outlook for ethanol and cellulosic ethanol as an alternative form of energy is
likely to lead to under supply in 2010. To implement our strategy, we require
access to substantial financial resources, both in the form of advisor
relationships and additional financing.  We are currently working on
the development of these relationships to build value through industry and/or
financial partnerships and joint ventures, special purpose financing vehicles,
structured acquisition finance arrangements, private placements of equity, debt
and blended debt and equity instruments. In addition, we anticipate that we may
issue share and/or loan capital to vendors as a means of securing target
acquisitions and to fund development.




We intend
to raise additional working capital in 2010 through some of all of the
following: operating cash flows, working capital lines of credit, long-term debt
facilities, joint venture arrangements, sale of existing assets and the sale of
additional equity by us or our subsidiaries. We continue to explore different
funding sources, but because of the continued unsettled state of the capital
markets around the globe, we currently lacks any defined capital raising
projects or specific sources of capital or commitments for the required capital.
We, in common with most enterprises that require capital to develop and
implement their strategy, are challenged by the impact the crisis in the global
capital markets is having on its ability to finance its plans. To a significant
degree, our business success will depend on the state of the capital markets,
and investors in our securities should take into account the macro-economic
impact of the availability of credit and capital funding when assessing our
business development. If we cannot raise enough capital we may be forced to sell
all or a portion of its existing biodiesel facility or other assets at a
discount to market value and incur impairment related to these assets to
generate cash to continue the Company’s business plan or possibly discontinue
operations. To continue operations we need to secure additional near term equity
or debt financing. Until such additional capital is raised, we are dependent on
financing from this related party and the arrangement of extended term with our
trade creditors. There can be no assurance that additional financing will be
available on satisfactory terms. The accompanying financial statements do not
include any adjustments that may result should we find ourselves unable to
continue as a going concern.




31




Historical
Sources and Uses of Cash




Operating
Activities




Net cash
used in operating activities for the three months ended March 31, 2010 was
$802,071 primarily from cash based selling, general and administrative expenses
and research and development expenses, offset by gross profits from operations
of $27,245 and increase in working capital of $492,891. The generation of cash
from working capital arose principally from the aging of our accounts payable
and aging of interest and accruing fees on our debt facilities. Net cash used in
operating activities for the same three months of fiscal 2009 was $350,194
primarily to develop our business, including general and administrative and
research and development costs. Net cash used in operating activities was higher
in the current year as compared to the prior year period due to increased needs
for working capital from the operation of our business, principally in India,
which was partially offset by reduced spending in all areas including
professional services, salaries, supplies and services and travel.




Investing
Activities




Net cash
used in investing activities during the three months ended March 31, 2010 and
2009 was $12,043, and $48,152, respectively, which consisted primarily of
purchases of property, plant and equipment relating to our biodiesel facility in
India.




Financing
Activities




Net cash
provided by financing activities during the three months ended March 31, 2010
and 2009 was $1,107,185, and $191,000, respectively, which consisted primarily
of the proceeds from our working capital line with Secunderabad, the proceeds
from the Revolving Line of Credit Agreement, dated August 17, 2009 provided
by a related party (a former director and significant shareholder) and from an
advance against operating expenses received as part of the Project Agreement
with Cilion, Inc., dated December 1, 2009.




Critical
Accounting Policies




Our
discussion and analysis of our financial condition and results of operations are
based upon our consolidated financial statements, which have been prepared in
accordance with accounting principles generally accepted in the United States of
America. The preparation of these financial statements requires us to make
estimates and judgments 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 amount of net sales and expenses for
each period. The following represents a summary of our critical accounting
policies, defined as those policies that we believe are the most important to
the portrayal of our financial condition and results of operations and that
require management’s most difficult, subjective or complex judgments, often as a
result of the need to make estimates about the effects of matters that are
inherently uncertain.




Impairment of Long-Lived
Assets




Our
long-lived assets are primarily associated with our plant in Kakinada, India. In
fiscal 2008, we began operation of our biodiesel plant and we continued the
construction of our glycerin refinery and pre-treatment plant. The refinery and
pre-treatment plant are expected to be fully operational by the third quarter of
2010. Costs for building these assets remain in construction-in-progress at
December 31, 2009, and will be reclassified once the refinery and pre-treatment
plant are fully operational and placed in service.  The completion of
this facility is entirely dependent upon our ability to raise additional capital
or debt.




Additional
long-lived assets consist of our two land sites in Illinois and Nebraska. The
land and land improvements are held for development of production
facilities.




We
evaluate impairment of long-lived assets in accordance with ASC Subtopic 360-10
(formerly SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived
Assets.”). We assess the impairment of long-lived assets, including property and
equipment and purchased intangibles subject to amortization, when events or
changes in circumstances indicate that these assets have been impaired and we
accordingly write them down to their new fair value. Forecasts of future cash
flows are critical judgments in this process and are based on our experience and
knowledge of our operations and the industries in which we operate and are
critical to our impairment assessments. These forecasts could be significantly
affected by future changes in market conditions, the economic environment, and
capital spending decisions of our customers and inflation and are significantly
dependent on our ability to secure additional working capital to allow us to
achieve our forecasted results.




32




With
respect to our biodiesel facility in India, which comprises approximately 75% of
the carrying value of total assets, we develop various assumptions to estimate
the future cash flows that will be generated from this facility in order to test
the recoverability of this asset.   The determination of
estimated future cash flows is highly uncertain in the current economic
environment.   Further, as our biodiesel facility in India has
been in operation for less than 18 months and to date has operated at about 10%
of its production capacity, we believe our assumptions regarding future cash
flows and in turn the carrying value of its biodiesel facility represent a
significant estimate in the preparation of our consolidated financial
statements.  The revenues and gross profit generated at our biodiesel
facility in the first quarter ended March 31, 2010 was less than the revenue and
gross profit generated in the first quarter ended March 31, 2009 (prior
year).  Our 2010 internal forecast calls for revenues and gross profit
to increase significantly during the year as we seek to execute on our business
plan.  If we are unable to successfully execute on our business plan
by increasing our revenue and gross profit in 2010, we will need to revise
downward our assumptions regarding the estimated future cash flows expected to
be generated from this facility and such revisions could have a material effect
on our assessment of the recoverability of this asset.  It is at least
reasonably possible that changes to the assumptions regarding the estimated
future cash flows expected to be generated from this facility will result in an
impairment charge (write down) of the carrying value of the biodiesel facility
and such impairment charge could be material to our financial statements.




With
respect to our landholdings in Illinois and Nebraska within our North American
segment we considered whether these assets were impaired by looking at the
undiscounted cash flows compared to our carrying values in accordance with ASC
Subtopic 360-10 and concluded that these assets were impaired. As a result, we
charged $2,086,350 to expense to recognize the difference between our estimated
fair value after considering available information including appraisals of the
respective properties and the current capitalized carrying value. The
determination of estimated future undiscounted cash flows is highly uncertain in
the current economic environment. Our estimated undiscounted cash flows
considered principally the current value of the underlying land assuming a
near-term sale in an orderly market, as well as anticipated cash flows from
executing our planned development activities (development of cellulosic ethanol
plants). These cash flow estimates, while they represent our best estimate of
future undiscounted cash flows, are highly uncertain and could be negatively
affected by the continued erosion of the capital markets, availability of
capital negating the company’s ability to generate cash flows as planned from
the development and operation of ethanol facilities at these locations or
forcing the Company to liquidate these assets to generate working capital in a
manner that is not consistent with an orderly sale. As of September 30, 2009,
the Company, influenced in part by the recent default of the loans by the senior
lender, which could force us to sell these properties rather than to execute on
our planned development activities, determined that the landholdings were
impaired because of our revise estimate of future undiscounted cash flows was
less than the landholdings’ carrying values. As a result, we computed the amount
of impairment by comparing their estimated fair values assuming an orderly sale
to their respective carrying values and recorded an asset impairment charge of
$2,086,350 in the three months ended September 30, 2009. As of December 31,
2009, the default was cured. No further impairment charges were recorded during
the three months ended March 31, 2010. No impairment losses were recorded for
the three months ended March 31, 2009. We will continue to assess the factors
above and their impact on the cash flow estimates. Upon continued degradation of
the economic factors effecting cash flow estimates, knowledge of other prevalent
indicators, or actions that we believe would force liquidation, we will reassess
the value of these assets in accordance with ASC Subtopic 360-10.




Inventories




Inventories
are stated at the lower of cost, using the first-in and first-out (FIFO) method,
or market. In assessing the ultimate realization of inventories, we perform a
periodic analysis of market prices and compare that to our weighted-average FIFO
cost to ensure that our inventories are properly stated at the lower of cost or
market




33




Stock-Based
Compensation




Stock-Based Compensation
Expense.  Effective January 1, 2006, we adopted the fair
value recognition provisions of ASC Section 715-20-50 (formerly SFAS
No. 123 (Revised 2004), “Share-Based Payment”),
requiring us to recognize expense related to the fair value of our stock-based
compensation awards adjusted to reflect only those shares that are expected to
vest. Our implementation of ASC Section 715-20-50 used the
modified-prospective-transition method.




We made
the following estimates and assumptions in determining fair value of stock
options as prescribed by ASC Section 715-20-50:




·
            Valuation and Amortization
      Method — The Company estimates the fair value of stock options
      granted using the Black-Scholes-Merton option-pricing formula and a single
      option award approach. This fair value is then amortized on a
      straight-line basis over the requisite service periods of the awards,
      which is generally the vesting
period.




·
            Expected Term — The
      expected term represents the weighted-average period that our stock-based
      awards are expected to be outstanding. We applied the “Simplified Method”
      as defined in the SEC’s Staff Accounting Bulletin No. 107 and
      110.




·
            Expected Volatility —
      The Company’s expected volatility is based on the historical volatility of
      comparable public companies’ stock for a period consistent with our
      expected term.




·
            Expected Dividend — The
      Black-Scholes-Merton valuation model calls for a single expected dividend
      yield as an input. The Company currently pays no dividends and does not
      expect to pay dividends in the foreseeable
  future.




·
            Risk-Free Interest Rate
      — The Company bases the risk-free interest rate on the implied yield
      currently available on United States Treasury zero-coupon issues with an
      equivalent remaining term.




Recently
Issued Accounting Pronouncements




The
Company adopted the provisions of ASC Topic 820-10, Fair Value Measurements and
Disclosures (formerly SFAS No. 157, Fair Value Measurements), with respect to
non-financial assets and liabilities effective January 1, 2009. This
pronouncement defines fair value, establishes a framework for measuring fair
value and expands disclosures about fair value measurements. The adoption of ASC
820-10 did not have an impact on the Company’s consolidated financial
statements.




The
Company adopted ASC 805 (formerly SFAS No. 141(R), “Business Combinations”)
for business combinations. This topic changes the accounting for acquisition
transaction costs by requiring them to be expensed in the period incurred, and
also changes the accounting for contingent consideration, acquired contingencies
and restructuring costs related to an acquisition. The Company also adopted ASC
Section 810-10-65,Noncontrolling Interests in Consolidated Financial Statements—an amendment of
ARB No. 51 (formerly SFAS No. 160, “Non-controlling Interests
in Consolidated Financial Statements-an amendment of ARB No. 51”). This
statement changes the accounting and reporting for minority interests, which are
re-characterized as non-controlling interests, classified as a component of
equity and accounted for at fair value. ASC 805 and ASC 810-10-65-1 were
effective beginning with the Company’s 2009 financial statements. Early adoption
is prohibited. The effect the adoption of ASC 805 has had and will have on the
Company’s financial statements will depend on the nature and size of
acquisitions we complete after adoption. We adopted ASC 810-10-65-1 as of
January 1, 2009. As a result, we reclassified the 49% non-controlling
interest in our subsidiary Energy Enzymes, Inc., prospectively. Had we continued
to apply the prior method of accounting for non-controlling interests, losses
incurred by this entity would have been fully attributed to us.




The
Company adopted ASC 825-10 (formerly the Financial Accounting Standards Board
(FASB) issued Staff Position SFAS 107-1 and Accounting Principles Board (APB)
Opinion No. 28-1, “Interim Disclosures about Fair Value of Financial
Instruments”). ASC 825-10 amends FASB Statement No. 107, “Disclosures about
Fair Values of Financial Instruments,” to require disclosures about fair value
of financial instruments in interim financial statements as well as in annual
financial statements. APB 28-1 amends APB Opinion No. 28, “Interim Financial
Reporting,” to require those disclosures in all interim financial statements.
ASC 825-10 is effective for interim periods ending after June 15, 2009.
Adoption of this statement did not have a material effect on the Company’s
financial statements. See “Note 18. Fair Value of Financial Instruments and
Related Measurement.”




34




The
Company adopted ASC 320-10 (formerly Staff Position SFAS 115-2 and SFAS 124-2,
“Recognition and Presentation of Other-Than-Temporary Impairments”. ASC 320
provides guidance in determining whether impairments in debt securities are
other than temporary, and modifies the presentation and disclosures surrounding
such instruments. ASC 320 is effective for interim periods ending after
June 15, 2009,. Adoption of this statement did not have a material effect
on the Company’s financial statements.




In
June 2009, the FASB issued ASC 105 (formerly SFAS No. 168, "The FASB
Accounting Standards Codification (TM) ("Codification") and the Hierarchy of
Generally Accepted Accounting Principles - a replacement of FASB Statement
No. 162" ("SFAS No. 168"). ASC 105 establishes the Codification as the
single official source of authoritative United States accounting and reporting
standards for all non-governmental entities (other than guidance issued by the
SEC). The Codification changes the referencing and organization on financial
standards and is effective for interim and annual periods ending on or after
September 15, 2009. ASC 105 is not intended to change the existing
accounting guidance and its adoption did not have an impact on our financial
statements.




In
October, the FASB issued EITF Issue no. 2009-13, Revenue Recognition (Topic
605), Multiple Deliverable Revenue Arrangements, which applies to
multiple-deliverable revenue arrangements that are currently within the scope of
FASB ASC 605-25 (previously included in EITF Issue no. 00-21, Revenue
Arrangements with Multiple Deliverables). The EITF will be effective on a
prospective basis for revenue arrangements entered into or materially modified
in fiscal years beginning on or after June 15, 2010. The Company has not
fully assessed the impact of this guidance, but at this time believes it will
not have an impact on our financial statements.




ITEM
      3.
              QUANTITATIVE
      AND QUALITATIVE DISCLOSURES ABOUT MARKET
RISK.


We are
exposed to various market risks, including changes in commodity prices and
foreign currency exchange rates. Market risk is the potential loss arising from
adverse changes in market rates and prices.




Commodity
Risk




We are
subject to market risk with respect to the price and availability of refined
palm oil and palm stearin, the principal raw materials we use to produce
biodiesel and biodiesel by-products. In general, rising feedstock prices result
in lower profit margins and, therefore, represent unfavorable market conditions.
This is especially true when market conditions do not allow us to pass along
increased feedstock costs to our customers. The availability and price of
feedstock for our biodiesel plant is subject to wide fluctuations due to
unpredictable factors such as weather conditions, governmental policies with
respect to agriculture and international trade, and global demand and
supply.




At March
31, 2010 we did not have any firm-price purchase commitments with our feedstock
suppliers or off-take arrangements with our customers.




Foreign
Currency Risk




Our
foreign subsidiaries use local currencies as their functional currency. Our
primary exposure with respect to foreign currency exchange rate risk is the
change in the dollar/INR (Indian rupee) exchange rate. For consolidation
purposes, assets and liabilities are translated at month-end exchange rates.
Items of income and expense are translated at average exchange rates.
Translation gains and losses are not included in determining net income (loss)
but are accumulated as a separate component of shareholders’ equity. Gains
(losses) arising from foreign currency transactions are included in determining
net income (loss). During the three months ended March 31, 2010, we recognized a
gain of $427,800 arising from foreign currency translation. At March 31, 2010 we
did not have any outstanding derivative financial instruments, off-balance sheet
guarantees, interest rate swap transactions or foreign currency
contracts.




Interest
Rate Risk




Our
market risk is also affected by changes in interest rates. At March 31, 2010, we
had $16,553,425 in total debt outstanding, of which $11,839,231 was fixed-rate
debt and $4,714,194 was floating-rate debt. The interest rate under the
floating-rate debt facility is subject to adjustment based on the Reserve Bank
of India advance rate.




Based on
the amount of our floating-rate debt as of March 31, 2010, each 100 basis point
increase or decrease in interest rates increases or decreases our annual
interest expense and cash outlay by approximately $47,000. This potential
increase or decrease is based on the simplified assumption that the level of
floating-rate debt remains constant with an immediate across-the-board increase
or decrease as of March 31, 2010 with no subsequent change in rates for the
remainder of the period.




35




ITEM
      4.
              CONTROLS
      AND PROCEDURES.


Evaluation
of Disclosure Controls and Procedures
  We
carried out an evaluation, under the supervision and with the participation of
our management, including our principal executive officer and principal
financial officer, of the effectiveness of the design and operation of our
disclosure controls and procedures, as defined in Rules 13a-15(e) and 15d-15(e)
of the Securities Exchange Act of 1934, as amended, (the “Exchange Act”). Based
on this evaluation, our principal executive officer and principal financial
officer concluded that, as of the end of the period covered in this report, with
respect to our internal control over financial reporting, our disclosure
controls and procedures were effective to ensure that information required to be
disclosed by us in reports that we file or submit under the Exchange Act is
recorded, processed, summarized, and reported within the time periods specified
in Securities and Exchange Commission rules and forms and is accumulated and
communicated to our management, including our principal executive officer and
principal financial officer, as appropriate to allow timely decisions regarding
required disclosure.
  Changes
in Internal Controls over Financial Reporting
  There
have been no changes in our internal control over financial reporting (as
defined in Rules 13a-15(f) and 15d-15(f) of the Exchange Act) during the period
covered by this report that have materially affected, or are reasonable likely
to materially affect, our internal control over financial
reporting.
  Inherent
Limitations on the Effectiveness of Controls
  Our
management, including the Chief Executive Officer (“CEO”) and Chief Financial
Officer (“CFO”), does not expect that our disclosure controls or our internal
control over financial reporting will prevent or detect all error and all fraud.
A control system, no matter how well designed and operated, can provide only
reasonable, not absolute, assurance that the control system’s objectives will be
met. Our controls and procedures are designed to provide reasonable assurance
that our control system’s objective will be met.. The design of a control system
must reflect the fact that there are resource constraints, and the benefits of
controls must be considered relative to their costs. Further, because of the
inherent limitations in all control systems, no evaluation of controls can
provide absolute assurance that misstatements due to error or fraud will not
occur or that all control issues and instances of fraud, if any, within the
company have been detected. These inherent limitations include the realities
that judgments in decision-making can be faulty and that breakdowns can occur
because of simple error or mistake. Controls can also be circumvented by the
individual acts of some persons, by collusion of two or more people, or by
management override of the controls. The design of any system of controls is
based in part on certain assumptions about the likelihood of future events and
there can be no assurance that any design will succeed in achieving its stated
goals under all potential future conditions. Projections of any evaluation of
the effectiveness of controls in future periods are subject to risks. Over time,
controls may become inadequate because of changes in conditions or deterioration
in the degree of compliance with policies or procedures.
 36


PART II -- OTHER INFORMATION


ITEM
      1.
              LEGAL
      PROCEEDINGS


No change
in legal proceedings since the Company’s Annual Report on Form 10-K filed
with SEC on March 15, 2010.




ITEM
      1A.
              RISK
      FACTORS.


No change
in risk factors since the Company’s Annual Report on Form 10-K filed with
SEC on March 15, 2010.


ITEM
      2.
              UNREGISTERED
      SALES OF EQUITY SECURITIES AND USE OF
PROCEEDS.


None.




ITEM
      3.
              DEFAULTS
      ON SENIOR SECURITIES.


No
additional defaults on senior securities other than those reported in the
Companies current report on Form 8-K filed with the SEC on August 17,
2009 and October 13, 2009.




ITEM
      5.
              OTHER
      INFORMATION.


None


37
  ITEM
      6.
              EXHIBITS.


31.1
            Certifications
      pursuant to Rule 13a-14(a) or 15d-14(a) under the Securities Exchange
      Act of 1934, as amended, as adopted pursuant to Section 302 of the
      Sarbanes-Oxley Act of 2002.31.2
            Certifications
      pursuant to Rule 13a-14(a) or 15d-14(a) under the Securities Exchange
      Act of 1934, as amended, as adopted pursuant to Section 302 of the
      Sarbanes- Oxley Act of 2002.32.1
            Certifications pursuant to 18 U.S.C.
      Section 1350, as adopted pursuant to Section 906 of the
      Sarbanes-Oxley Act of 2002.32.2
            Certifications
      pursuant to 18 U.S.C. Section 1350, as adopted pursuant to
      Section 906 of the Sarbanes-Oxley Act of
  2002.





38


SIGNATURES






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.






AE
      BIOFUELS, INC.By:
              /s/ Eric A. McAfeeEric
      A. McAfeeChief
      Executive Officer
                (Principal
      Executive Officer)


Date: May
17, 2010




39