**UNITED
      STATES**


**SECURITIES
      AND EXCHANGE COMMISSION**


**Washington,
      DC 20549**





**FORM
      10-Q**





x
      QUARTERLY REPORT
      PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 for
      the
      quarterly period ended June 30, 2008





o
      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**
            **84-0925128**(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)





**(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 x No o





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        o
            
            Accelerated
                filer oNon-accelerated
                filer          o
            
            Smaller
                reporting company x





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





The
      number of shares outstanding of the registrant’s common stock as
      of August 4, 2008 was 84,956,020 shares.








**AE
      BIOFUELS, INC.**


**FORM
      10-Q**


Quarter
      Ended June 30, 2008





Page**INDEX****PART
                I— FINANCIAL INFORMATION**Item
                1.
            Financial
                StatementsConsolidated
                Balance Sheets as of June 30, 2008 and December 31, 2007
            
            2Consolidated
                Statements of Operations for Three and Six Months Ended June 30,
                2008 and
                2007 and for the period from November 29, 2005 (inception) to June
                30,
                2008
            
            3Consolidated
                Statements of Cash Flows for the Six Months Ended June 30, 2008 and
                2007
                and for the period from November 29, 2005 (inception) to June 30,
                2008
            
            4Notes
                to Consolidated Financial Statements
            
            5Item
                2.
            Management’s
                Discussion and Analysis of Financial Condition and Results of
                Operations
            
            25Item
                3.
            Quantitative
                and Qualitative Disclosures About Market Risk
            
            32Item
                4T.
            Controls
                and Procedures
            
            33**PART
                II— OTHER INFORMATION**Item
                1.
            Legal
                Proceedings
            
            34Item
                1A.
            Risk
                Factors
            
            34Item
                2.
            Unregistered
                Sales of Equity Securities and Use of Proceeds
            
            34Item
                3.
            Defaults
                Upon Senior Securities
            
            34Item
                4.
            Submission
                of Matters to a Vote of Security Holders
            
            34Item
                5.
            Other
                Information
            
            35Item
                6.
            Exhibits
            
            35SIGNATURES


1


**PART
      I - FINANCIAL INFORMATION**


**Item
      1 - Financial Statements**




**AE
      BIOFUELS, INC.**


**(A
      Development Stage Company)**


**CONSOLIDATED
      BALANCE SHEETS**


June
                  30,
                2008
              
              December
                  31,
                2007(Unaudited)**Assets**Current
                  assets:Cash
                  and cash equivalents
              
              $
              636,654
              
              $
              720,402Marketable
                  securities
              
              
              -
              
              
              2,635,892Accounts
                  receivable
              
              
              -
              
              
              3,447,039Accounts
                  receivable - related party
              
              
              -
              
              
              6,127,727Prepaid
                  expenses
              
              
              120,029
              
              
              58,872Other
                  current assets
              
              
              1,235,837
              
              
              674,235Total
                  current assets
              
              
              1,992,520
              
              
              13,664,167Property,
                  plant and equipment, net
              
              
              22,354,249
              
              
              19,585,087Intangible
                  assets
              
              
              133,334
              
              
              233,334Other
                  assets
              
              
              483,193
              
              
              68,488**Total
                  assets**
              
              **$**
              **24,963,296**
              
              **$**
              **33,551,076****Liabilities
                  and Stockholders' Equity**Current
                  liabilities:Accounts
                  payable and accrued liabilities
              
              $
              1,857,401
              
              $
              9,985,639Income
                  taxes payable
              
              
              37,040
              
              
              36,750Short
                  term borrowings (related party)
              
              
              600,000
              
              
              -Short
                  term borrowings, net of discount
              
              
              3,788,962
              
              
              -Other
                  current liabilities
              
              
              3,745,060
              
              
              -Total
                  current liabilities
              
              
              10,028,463
              
              
              10,022,389Commitments
                  and contingencies (Notes 6, 7, 8, 13, 14 and 16)Stockholders'
                  equity:Series
                  B preferred stock, $0.001 par value - 40,000,000 authorized; 6,149,821
                  and
                  6,487,491 shares issued and outstanding, respectively (aggregate
                  liquidation preference of $18,811,473 and $19,462,473)
              
              
              6,149
              
              
              6,487Common
                  Stock, $0.001 par value - 400,000,000 authorized; 84,916,020 and
                  84,557,462 shares issued and outstanding, respectively
              
              
              84,915
              
              
              84,557Additional
                  paid-in capital
              
              
              36,066,476
              
              
              33,707,953Deficit
                  accumulated during the development stage
              
              
              (21,501,134
              )
              
              (11,995,395
              )Accumulated
                  other comprehensive income
              
              
              278,427
              
              
              1,725,085Total
                  stockholders' equity
              
              
              14,934,833
              
              
              23,528,687**Total
                  liabilities and stockholders' equity**
              
              **$**
              **24,963,296**
              
              **$**
              **33,551,076**





*The
      accompanying notes are an integral part of the financial
      statements*


2


**AE
      BIOFUELS, INC.**


**(A
      Development Stage Company)**


**CONSOLIDATED
      STATEMENTS OF OPERATIONS**


(Unaudited)





For
                the six months ended
            
            For
                the three monthsended
            
            Period
                from
              November
                29,
              2005
                (Date of
              Inception)
                toJune
                30,
              2008
            
            June
                30,
              2007
            
            June
                30,
              2008
            
            June
                30,
              2007
            
            June
                30,
              2008Sales
            
            $
            -
            
            $
            -
            
            $
            -
            
            $
            -
            
            $
            744,450Cost
                of Goods Sold
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            735,000Gross
                Profit
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            9,450Research
                and Development
            
            
            512,056
            
            
            120,000
            
            
            387,708
            
            
            60,000
            
            
            769,817General
                and Administrative Expenses
            
            
            5,619,348
            
            
            3,254,514
            
            
            3,657,343
            
            
            1,874,068
            
            
            26,433,814Operating
                Loss
            
            
            (6,131,404
            )
            
            (3,374,514
            )
            
            (4,045,051
            )
            
            (1,934,068
            )
            
            (27,194,181
            )Other
                Income (Expense)Interest
                income
            
            
            32,486
            
            
            6,170
            
            
            18,945
            
            
            2,640
            
            
            130,235Interest
                expense
            
            
            (253,019
            )
            
            (55,060
            )
            
            (253,019
            )
            
            (13,394
            )
            
            (253,019
            )Other
                income, net of expenses
            
            
            42,161
            
            
            16,670
            
            
            6,200
            
            
            16,670
            
            
            230,477Gain
                from dissolution of joint venture
            
            
            -
            
            
            1,491,742
            
            
            -
            
            
            637,047
            
            
            9,061,141Gain
                on foreign currency exchange
            
            
            -
            
            
            52,116
            
            
            -
            
            
            52,116
            
            
            497,954Shareholder
                agreement cancellation payment
            
            
            (900,000
            )
            
            -
            
            
            -
            
            
            -
            
            
            (900,000
            )Registration
                rights payment
            
            
            (2,274,402
            )
            
            -
            
            
            -
            
            
            -
            
            
            (2,274,402
            )Income
                related to 50/50 joint venture
            
            
            -
            
            
            155,626
            
            
            -
            
            
            155,626
            
            
            182,923Loss
                before income taxes
            
            
            (9,484,178
            )
            
            (1,707,250
            )
            
            (4,272,925
            )
            
            (1,083,363
            )
            
            (20,518,872
            )Income
                Taxes
            
            
            (21,560
            )
            
            -
            
            
            -
            
            
            -
            
            
            (100,145
            )Net
                Loss
            
            $
            (9,505,738
            )
            $
            (1,707,250
            )
            $
            (4,272,925
            )
            $
            (1,083,363
            )
            $
            (20,619,017
            )Loss
                per common shareBasic
                and diluted
            
            $
            (0.11
            )
            $
            (0.02
            )
            $
            (0.05
            )
            $
            (0.01
            )
            $
            (0.27
            )Weighted
                average shares outstandingBasic
                and diluted
            
            
            84,717,979
            
            
            74,611,093
            
            
            84,870,320
            
            
            74,354,167
            
            
            76,480,633





*The
      accompanying notes are an integral part of the financial
      statements*


3


**AE
      BIOFUELS, INC.**


**(A
      Development Stage Company)**





**CONSOLIDATED
      STATEMENTS OF CASH FLOWS**


**(Unaudited)**




For the six months ended
            
            Period from
              November 29,
              2005 (Date of
              Inception) toJune 30,
              2008
            
            June 30,
              2007
            
            June 30,
              2008**Operating
                activities:**Net
                loss
            
            $
            (9,505,738
            )
            $
            (1,707,250
            )
            $
            (20,619,016
            )Adjustments
                to reconcile net loss tonet
                cash provided by (used in) operating activities:Stock
                based compensation
            
            
            1,561,043
            
            
            60,409
            
            
            3,199,002Expired
                land options
            
            
            124,536
            
            
            -
            
            
            569,660Amortization
                and depreciation
            
            
            108,977
            
            
            -
            
            
            178,752Amortization
                of debt discount
            
            
            165,317
            
            
            
            
            
            165,317Registration
                rights payment
            
            
            2,274,402
            
            
            -
            
            
            2,274,402Gain
                on sale of subsidiary
            
            
            -
            
            
            (854,695
            )
            
            (854,695
            )Loss
                on impairment of assets
            
            
            -
            
            
            -
            
            
            5,114,236Gain
                on dissolution of joint venture
            
            
            -
            
            
            -
            
            
            (8,206,446
            )Gains
                on forward currency contracts
            
            
            -
            
            
            -
            
            
            (436,154
            )Changes
                in assets and liabilities:Accounts
                receivable
            
            
            9,490,481
            
            
            (105,290
            )
            
            557,206Prepaid
                expenses
            
            
            (91,190
            )
            
            163,500
            
            
            (151,987
            )Other
                assets
            
            
            (1,586,041
            )
            
            (2,516,396
            )
            
            (1,169,274
            )Accounts
                payable
            
            
            (8,924,355
            )
            
            959,322
            
            
            450,577Other
                liabilities
            
            
            2,362,968
            
            
            399,644
            
            
            2,305,937Income
                taxes payable
            
            
            290
            
            
            -
            
            
            37,040**Net
                cash used in operating activities**
            
            
            (4,019,310
            )
            
            (3,600,756
            )
            
            (16,585,443
            )**Investing
                activities:**Purchases
                of property, plant and equipment
            
            
            (4,155,864
            )
            
            (5,936,212
            )
            
            (30,996,967
            )Purchases
                of marketable securities
            
            
            -
            
            
            -
            
            
            (2,459,292
            )Sales
                of marketable securities
            
            
            2,568,216
            
            
            -
            
            
            2,568,216Cash
                restricted by letter of credit
            
            
            500,000
            
            
            -
            
            
            -Purchase
                of Marwich II, Ltd., net of losses
            
            
            -
            
            
            -
            
            
            (662,406
            )Exchange
                rate gain
            
            
            -
            
            
            (46,820
            )
            
            (193,399
            )Additions
                to other assets and intangibles
            
            
            -
            
            
            -
            
            
            (1,073,872
            )Refund
                of property expenditures
            
            
            -
            
            
            -
            
            
            2,775,000Return
                of assets from dissolution of joint venture
            
            
            -
            
            
            -
            
            
            8,206,446Sale
                of Wahoo facility
            
            
            -
            
            
            2,000,000
            
            
            2,000,000**Net
                cash used in investing activities**
            
            
            (1,087,648
            )
            
            (3,983,032
            )
            
            (19,836,274
            )**Financing
                activities:**Proceeds
                from short term borrowings
            
            
            5,044,732
            
            
            -
            
            
            5,044,732Payments
                of short term borrowings
            
            
            
            
            
            (175,000
            )Proceeds
                from long-term debt
            
            
            -
            
            
            -
            
            
            250,000Payments
                on long-term debt
            
            
            -
            
            
            (241,071
            )
            
            (250,000
            )Proceeds
                from settlement
            
            
            -
            
            
            -
            
            
            200,000Refund
                of investment
            
            
            -
            
            
            -
            
            
            (90,000
            )Proceeds
                from sale of preferred stock, net of offering costs
            
            
            10
            
            
            8,424,148
            
            
            31,910,522**Net
                cash provided by financing activities**
            
            
            5,044,742
            
            
            8,008,077
            
            
            37,065,254Effect
                of exchange rate fluctuations on cash and cash equivalents
            
            
            (21,532
            )
            
            -
            
            
            (6,883
            )**Net
                  (decrease) increase in cash and cash equivalents for
                  period**
            
            
            (83,748
            )
            
            424,289
            
            
            636,654**Cash
                and cash equivalents, beginning of period**
            
            
            720,402
            
            
            1,213,134
            
            
            -**Cash
                and cash equivalents, end of period**
            
            $
            636,654
            
            $
            1,637,423
            
            $
            636,654




*The
      accompanying notes are an integral part of the financial
      statements*




4


**AE
      BIOFUELS, INC.**


**(**A
      Development Stage Company**)**





**NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS**


(Unaudited)




**Net
        (decrease) increase in cash and cash equivalents for
        period**
 
 *Nature
        of Activities* .
        These
        consolidated financial statements include the accounts of AE Biofuels, Inc.,
        a
        Nevada corporation, and its wholly-owned subsidiaries, American Ethanol,
        Inc.
        (“American”), a Nevada corporation; Sutton Ethanol, LLC (“Sutton”), a Nebraska
        limited liability company; Illinois Valley Ethanol, LLC (“Illinois Valley”), an
        Illinois limited liability company; Biofuels Marketing, Inc., a Delaware
        corporation; International Biodiesel, Inc., a Nevada corporation and its
        subsidiaries International Biofuels, Ltd, a Mauritius corporation and its
        subsidiary Universal Biofuels Private Ltd., an India company; Danville Ethanol,
        Inc., an Illinois corporation; AE Biofuels Americas, Inc., a Delaware
        corporation; and Energy Enzymes Inc., a Delaware corporation, collectively,
        (“AE
        Biofuels” or “the Company”).
  The
        Company’s purpose is to develop, acquire, construct, operate and sell fuel grade
        ethanol and biodiesel from advanced technology ethanol and biodiesel production
        facilities. The Company is a development stage company and as such, does
        not
        expect to generate significant revenue until its plants are constructed and
        operational, or operational plants have been acquired. Since inception, the
        Company has engaged in (i) fund raising through the sale of stock, (ii)
        purchased land or acquired options to purchase land for development of ethanol
        plants in the United States, (iii) sold an ethanol plant site in Wahoo,
        Nebraska, (iv) applied for and received permits for ethanol plant sites in
        Nebraska and Illinois, (v) developed, wrote and submitted three patents on
        cellulosic ethanol production technology, (vi) completed construction of a
        biodiesel manufacturing facility in Kakinada, India through International
        Biodiesel, Inc., its wholly owned subsidiary, and Universal Biofuels Private,
        Ltd., a Mauritius corporation, (vii) started ground work for an ethanol facility
        in Sutton, Nebraska, (viii) began the construction of a glycerin refining
        and
        vegetable oil pretreatment facility at the Kakinada plant and (ix) constructed
        a
        cellulosic ethanol commercial demonstration facility in Butte, Montana.
  AE
        Biofuels was originally formed in California on September 12, 2001 as Great
        Valley Ventures LLC, however, no operating agreement was adopted and no capital
        was contributed until November 29, 2005. Between September 2001 and November
        2005 the Company had no operations and engaged in no activities. From November
        2005 through December 2005, the Company commenced development activities
        with
        the addition of key advisors, management, and additional founding shareholders.
        On January 12, 2006, the Company was renamed American Ethanol, LLC. On February
        23, 2006, American Ethanol, LLC merged into American Ethanol, Inc., a Nevada
        corporation.
  On
        June
        23, 2006, American Ethanol acquired 88.3% of the outstanding common stock
        of
        Marwich II, Ltd. (“Marwich”). Marwich was a shell company with no operations. On
        December 7, 2007, American Ethanol merged with and into Marwich and (i) each
        issued and outstanding share of American Ethanol common stock (including
        common
        stock issued upon conversion of American Ethanol Series A Preferred Stock,
        which
        automatically converted into two common shares for each share of Series A
        Preferred Stock immediately prior to the closing of the Merger) and Series
        B
        Preferred Stock (also convertible into common stock at the holders discretion)
        converted into Series B Preferred Stock, respectively, of Marwich, and (ii)
        each
        issued and outstanding warrant and/or option exercisable for common stock
        of
        American Ethanol was assumed and converted into a warrant and/or option
        exercisable for common stock of Marwich. Marwich then changed its name to
        AE
        Biofuels, Inc.
  *Basis
        of Presentation and Consolidation* .
        The
        consolidated financial statements include the accounts of the Company and
        its
        wholly-owned subsidiaries. All intercompany balances and transactions have
        been
        eliminated in consolidation. The accompanying consolidated balance sheets
        as of
        June 30, 2008, the consolidated statements of operations for the three and
        six
        months ended June 30, 2008 and 2007, and the consolidated statements of cash
        flows for the six months ended June 30, 2008 and 2007 are unaudited. The
        consolidated balance sheet data as of December 31, 2007 was derived from
        the
        2007 audited consolidated financial statements and notes thereto. The
        consolidated financial statements in this report should be read in conjunction
        with the 2007 audited consolidated financial statements and notes thereto
        included in the Company’s annual report on Form 10-K for the year ended December
        31, 2007.


5


**AE
      BIOFUELS, INC.**


**(A
      Development Stage Company)**





**NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS**


(Unaudited)





The
      accompanying unaudited interim consolidated financial statements as of June
      30,
      2008 and for the three and six months ended June 30, 2008 and 2007 have been
      prepared in accordance with accounting principles generally accepted in the
      United States (GAAP) pursuant to the rules and regulations of the Securities
      and
      Exchange Commission. Certain information and footnote disclosures normally
      included in financial statements prepared in accordance with accounting
      principles generally accepted in the United States 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 and six months ended June 30, 2008 and 2007 have been prepared
      on
      the same basis as the audited consolidated statements as of December 31, 2007
      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 and six months ended June 30, 2008 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 accounting principles
      generally accepted in the United States 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 as well as the reported amounts of 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, 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.




*Fair
      Value of Financial Instruments.* The
      carrying amounts of cash equivalents, marketable securities, land options,
      accounts receivable and accounts payable approximate their respective fair
      values due to their short-term maturities. Our fair value instruments that
      require remeasurement, primarily marketable securities, are valued by the
      institution that holds the instruments. Due to the nature of these instruments,
      which are essentially time deposits, there is little risk of variances between
      the reported basis by the holding institution and the fair value.




*Reclassifications.* ****** Certain
      prior year amounts were reclassified to conform to the current year
      presentation. These reclassifications had no impact on previously reported
      net
      loss or deficit accumulated during the development stage.




*Revenue
      recognition* .
      The
      Company recognizes revenue when products are shipped and services are rendered,
      the price is fixed or determinable and collection is reasonably assured. To
      date, the Company’s revenues have been negligible.


6


**AE
      BIOFUELS, INC.**


**(A
      Development Stage Company)**





**NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS**


(Unaudited)





*Cash
      and Cash Equivalents* .
      The
      Company considers all highly liquid investments with an original maturity of
      three months or less to be cash equivalents.




*Marketable
      Securities.* The
      Company’s short-term investments consisted primarily of short term time deposits
      in India banks, which represented funds available for plant completion and
      current operations. In accordance with Statement of Financial Accounting
      Standards (“SFAS”) No. 115, *Accounting
      for Certain Investments in Debt and Equity Securities* ,
      these
      short-term investments were classified as available-for-sale and were carried
      at
      fair market value. These securities had stated maturities beyond three months
      but were priced and traded as short-term instruments. Available-for-sale
      securities are marked-to-market based on quoted market values of the securities,
      with the unrealized gains and losses, net of tax, reported as a component of
      accumulated other comprehensive income (loss). Realized gains and losses on
      sales of available-for-sale securities are computed based upon the initial
      cost
      adjusted for any other-than-temporary declines in fair value. The cost of
      investments sold is determined on the specific identification method. The
      Company did not have any marketable securities at June 30, 2008.




*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 expected to be 20 years, once placed
      in
      service. The estimated useful life for office equipment and computers is 3
      years
      and the useful life of machinery and equipment is 7 years. Depreciation is
      provided using the straight line method over the useful life of the
      assets.




*Intangible
      Assets.* Intangible assets are carried at initial fair value less accumulated
      amortization over the estimated useful life. Amortization is computed over
      the
      estimated useful lives of the underlying assets using a method that reflects
      their utilization pattern.




*Stock
      Splits* .
      On
      February 28, 2006 and on May 18, 2006, the Company’s board of directors declared
      a two-for-one stock split. All share amounts have been retroactively adjusted
      to
      reflect the stock splits.




*Research
      and Development.* Research
      and development costs are expensed as incurred.




*Income
      Taxes.*  ****** The
      Company recognizes income taxes in accordance with Statement of Financial
      Accounting Standard No. 109, “Accounting for Income Taxes” (“ SFAS 109”), 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 the Company’s consolidated financial statements or tax returns.
      The measurement of current and deferred taxes is based on provisions of enacted
      tax law.




SFAS
      109
      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, 2007, 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.


7


**AE
      BIOFUELS, INC.**


**(A
      Development Stage Company)**





**NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS**


(Unaudited)





The
      Company is subject to income tax audits by the respective tax authorities in
      all
      of the jurisdictions in which it operates. 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 that the Company make certain estimates and judgments.
      Changes to these estimates or a change in judgment may have a material impact
      on
      the Company’s tax provision in a future period.




Effective
      January 1, 2007, the Company adopted FASB Interpretation No. 48, “Accounting for
      Uncertainty in Income Taxes - an interpretation on FASB Statement No. 109” ("FIN
      48"), which requires a more-likely-than-not threshold for financial statement
      recognition and measurement of tax positions taken or expected to be taken
      in a
      tax return. The Company records a liability for the difference between the
      benefit recognized and measured pursuant to FIN 48 and the tax position taken
      or
      expected to be taken on its tax return. To the extent that the Company’s
      assessment of such tax position changes, the change in estimate is recorded
      in
      the period in which the determination is made. With the adoption of FIN 48,
      the
      Company also began reporting tax-related interest and penalties as a component
      of income tax expense.




*Long
      - Lived Assets.* The
      Company evaluates the recoverability of long-lived assets with finite lives
      in
      accordance with Statement of Financial Accounting Standards No. 144, *"Accounting
      for the Impairment or Disposal of*  *Long-*  *Lived
      Assets"* (“SFAS
      144”), 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.




*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. As the Company incurred net
      losses for the three and six month periods ended June 30, 2008 and 2007 and
      on a
      cumulative basis, potentially dilutive securities have been excluded from the
      diluted net loss per share computations as their effect would be anti-dilutive.
      The weighted-average number of potentially dilutive shares excluded from the
      diluted net loss per share calculation for June 30, 2008 and 2007 and on a
      cumulative basis was 12,490,236, 17,070,476 and 9,019,669,
      respectively.




*Comprehensive Income.* Statement of Financial Accounting Standards No. 130, " *Reporting
      Comprehensive Income"* ("SFAS
      130"), requires that an enterprise report, by major components and as a single
      total, the change in its net assets from non-owner sources. The Company’s other
      comprehensive income consists solely of cumulative currency translation
      adjustments resulting from the translation of the financial statements of its
      foreign subsidiaries. The tax effects on the foreign currency translation
      adjustments have not been significant.




*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.




8




**AE
      BIOFUELS, INC.**


**(A
      Development Stage Company)**





**NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS**


(Unaudited)





*Restricted
      Stock.* The
      Company has granted restricted stock awards, restricted by a service condition,
      with vesting periods of up to 3 years. Restricted stock awards are valued using
      the fair market value of the Company’s common stock as of the date of grant. The
      Company recognizes compensation expense on a straight line basis over the
      requisite service period of the award. The remaining unvested shares are subject
      to forfeitures, repurchase and restrictions on sale, or transfer, up until
      the
      vesting date.




*Stock-Based
      Compensation Expense.* Effective January 1, 2006, we adopted the fair value recognition provisions
      of
      SFAS No. 123 (Revised 2004), “ *Share-Based
      Payment* ”
(“SFAS
      123(R)”), 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 SFAS 123(R) used the
      modified-prospective-transition method where the compensation cost related
      to
      each unvested option as of January 1, 2006, was recalculated and any necessary
      adjustment was recorded in the first quarter of adoption.




We
      made
      the following estimates and assumptions in determining fair value:




·
            *Valuation
                and amortization method*—
                We estimate the fair value of stock options granted using the
                Black-Scholes 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 Securities and Exchange Commission’s
                Staff Accounting Bulletin No. 107 and
                110.




·
            *Expected
                Volatility*—
                The expected volatility is calculated by considering, among other
                things,
                the expected volatilities of public companies engaged in similar
                industries.




·
            *Expected
                Dividend*—
                The Black-Scholes 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.




*Recent
      Accounting Pronouncements*




In
      September 2006, the FASB issued Statement No. 157, “ *Fair
      Value Measurements* ”
(“SFAS
      157”). SFAS 157 defines fair value, establishes a framework and gives guidance
      regarding the methods used in measuring fair value, and expands disclosures
      about fair value measurements. SFAS 157 is applicable whenever another
      accounting pronouncement requires or permits assets and liabilities to be
      measured at fair value. SFAS 157 does not expand or require any new fair value
      measures; however the application of this statement may change current practice.
      On January 1, 2008, the Company adopted SFAS 157 and the adoption of this
      statement had no material effect on the Company’s financial statements. On
      February 12, 2008, the FASB issued FASB Staff Position (FSP) No. 157-2, “Effective
      date of FASB Statement No. 157.”
FSP
      157-2 delays the effective date of adoption for nonfinancial assets and
      liabilities to fiscal years beginning after November 15, 2008. Management is
      currently assessing the impact of the adoption of this
      Statement.


9


**AE
      BIOFUELS, INC.**


**(A
      Development Stage Company)**





**NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS**


(Unaudited)





In
      February 2007, the FASB issued SFAS No. 159, “ *The
      Fair Value Option for Financial Assets and Financial Liabilities-Including
      an
      Amendment of FASB Statement No. 115* ”
("SFAS
      159"). This statement permits entities to choose to measure many financial
      instruments and certain other items at fair value. The fair value option may
      be
      elected on an instrument-by-instrument basis, with few exceptions. SFAS 159
      also
      establishes presentation and disclosure requirements to facilitate comparisons
      between companies that choose different measurement attributes for similar
      assets and liabilities. On January 1, 2008, the Company adopted SFAS 159 and
      the
      adoption of this statement had no material effect on the Company’s financial
      statements.




In
      December 2007, the FASB issued SFAS No. 141(R), “ *Business
      Combinations* ”
(“SFAS
      141R”). This statement 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. Also in December 2007, the FASB
      issued SFAS No. 160, “ *Non-controlling
      Interests in Consolidated Financial Statements-an amendment of ARB No.
      51* ”
(“SFAS
      160”). This statement will change the accounting and reporting for minority
      interests, which will be re-characterized as non controlling interests,
      classified as a component of equity and accounted for at fair value. SFAS 141(R)
      and SFAS 160 are effective for the Company’s 2009 financial statements. Early
      adoption is prohibited. The effect the adoption of SFAS 141(R) and SFAS 160
      will
      have on the Company’s financial statements will depend on the nature and size of
      acquisitions we complete after we adopt SFAS 141(R) and SFAS 160.




In
      May
      2008, the FASB issued SFAS No. 162, “ *The
      Hierarchy of Generally Accepted Accounting Principles”* (“SFAS
      No. 162”). The current GAAP hierarchy was established by the American Institute
      of Certified Public Accountants, and faced criticism because it was directed
      to
      auditors rather than entities. The issuance of this statement corrects this
      and
      makes some other hierarchy changes. This statement is effective 60 days
      following the Securities and Exchange Commission’s approval of the Public
      Company Accounting Oversight Board amendments to AU Section 411, “ *The
      Meaning of Present Fairly in Conformity with Generally Accepted Accounting
      Principles.”* The FASB
      does not expect that this statement will result in a change to current
      practice.




In
      May 2008, the FASB issued Staff Position No. APB 14-1, “ *Accounting
      for Convertible Debt Instruments That May be Settled in Cash upon Conversion
      (Including Partial Cash Settlement)”* (“FSP
      APB 14-1”). FSP APB 14-1 states that convertible debt instruments that may be
      settled in cash upon conversion (including partial cash settlement) are not
      addressed by paragraph 12 of Accounting Principles Board Opinion No. 14 and
      that issuers of such instruments should account separately for the liability
      and
      equity components of the instruments in a manner that will reflect the entity’s
      nonconvertible debt borrowing rate when interest cost is recognized in
      subsequent periods. FSP APB 14-1 is effective for financial statements issued
      for fiscal years beginning after December 15, 2008, and must be applied
      retrospectively to all periods presented. The Company is currently evaluating
      the impact that FSP APB 14-1 will have on its consolidated financial statements.


10


**AE
      BIOFUELS, INC.**


**(A
      Development Stage Company)**





**NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS**


(Unaudited)





**2.**  **Ability
      to Continue as a Going Concern.**




The
      accompanying financial statements have been prepared on a going concern basis,
      which contemplates the realization of assets and satisfaction of liabilities
      in
      the normal course of business. The Company has experienced losses and negative
      cash flow since inception and currently has an accumulated deficit. These
      factors raise substantial doubt about its ability to continue as a going
      concern. The Company’s ability to continue as a going concern is dependent on
      several factors.




The
      Company has had minimal revenues and has incurred losses due to start up costs
      from inception through June 30, 2008. The Company has raised approximately
      $31.8
      million dollars to date through the sale of preferred stock (net of placement
      fees). An additional $8 million of cash was generated through the
      dissolution of the Sutton Ethanol joint venture. The Company 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. The Company had no ethanol
      or
      biodiesel plants in operation as of June 30, 2008. Management plans to begin
      operations of its biodiesel facility in India.




Management
      plans to raise additional capital through equity offerings and debt financings.
      The Company’s goal is to raise additional funds needed to construct and operate
      ethanol and biodiesel facilities through stock offerings and debt
      financings.




**3.**  **Property,
      Plant and Equipment.**




Property,
      plant and equipment consist of the following:


**June
                  30,**
                **2008**
              
              **December
                  31,**
                **2007**Land
              
              $
              3,745,285
              
              $
              3,734,623Furniture
                  and fixtures
              
              
              52,890
              
              
              52,747Construction
                  in progress
              
              
              18,567,920
              
              
              15,800,752Total
                  gross property, plant and equipment
              
              
              22,366,095
              
              
              19,588,122Less
                  accumulated depreciation
              
              
              (11,826
              )
              
              (3,035
              )Total
                  net property, plant and equipment
              
              $
              22,354,249
              
              $
              19,585,087




**4.**  **Other
      Assets.**




Other
      assets consists of payments for land options for possible future ethanol plants,
      Web domain names purchased by the Company, purchased customer lists, prepaid
      expenses, deposits and contract lease prepayments.


11


**AE
      BIOFUELS, INC.**


**(A
      Development Stage Company)**





**NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS**


(Unaudited)


**June
                  30,**
                **2008**
              
              **December
                  31,**
                **2007**CurrentLetter
                  of credit securing material purchases
              
              $
              -
              
              $
              500,000Short
                  term deposits
              
              
              1,050,000
              
              
              -Purchased
                  commodity
              
              
              110,231
              
              
              -Land
                  options
              
              
              40,000
              
              
              164,536Other
              
              
              35,606
              
              
              9,699$
              1,235,837
              
              $
              674,235Long
                  TermDomain
                  names
              
              
              46,098
              
              
              46,098Deposits
              
              
              437,095
              
              
              22,390$
              483,193
              
              $
              68,488




Deposits
      include $1,050,000 with Desmet Ballestra India Pvt. Ltd. guaranteeing payment
      of
      obligations by our subsidiary, Universal Biofuels Pvt. Ltd.




**5.**  **Intangible
      Assets.**




Intangible
      assets consist of purchased customer lists (acquired in 2007 in connection
      with
      the Biofuels Marketing acquisition discussed in Note 11) which are being
      amortized over an estimated useful life of 18 months. Intangible assets had
      a
      net carrying amount of $133,334 and $233,334 as of June 30, 2008 and December
      31, 2007, respectively.




**6.**  **Debt.**




On
      May
      16, 2008, Third Eye Capital ABL Opportunities Fund (“Purchaser”) purchased a
      total of $5 million of our 10% Senior Secured Notes along with warrants
      exercisable for 250,000 shares of common stock at an exercise price of $3.00
      per
      share. Senior Secured Notes are secured by first-lien deeds of trust on real
      property located in Nebraska and Illinois, and by a first priority security
      interest in the equipment located in Montana, as well as a $1m guarantee by
      McAfee Capital LLC (owned by Eric McAfee and his wife). Interest on the Senior
      Secured Notes accrues on the unpaid principal balance and is payable on the
      first business day of each quarter beginning on June 1, 2008. We may prepay
      all
      or any portion of the outstanding principal amount of the Senior Secured Notes
      at any time. The Notes mature on May 15, 2009, and at that time the outstanding
      principal amount of the Senior Secured Notes together with all accrued and
      unpaid interest thereon will become due. At June 30, 2008, the Company
      was not in compliance with the current ratio covenant under the loan
      agreement and is working with the lender to obtain a waiver or modification
      of
      the loan agreement related to this covenant.




A
      discount to the Notes was recorded based on the relative fair value of the
      250,000 warrants issued with the notes. For purposes of the relative fair value
      allocation the Warrants were valued using a Black-Scholes valuation and the
      following inputs: five year term, volatility of 57.8%, no dividends and a risk
      free interest rate of 3.66% and the fair value of the Note was estimated using
      a
      discounted cash flow analysis. The resulting discount of $822,500 combined
      with
      a discount of $500,000 related to cash issuance costs will be amortized over
      the
      term of the Notes, which is one year. Discount amortization recorded for the
      three months ended June 30, 2008 was $165,312.


12


**AE
      BIOFUELS, INC.**


**(A
      Development Stage Company)**





**NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS**


(Unaudited)





D  uring
      the
      six month period ended June 30, 2008, Laird Cagan, a director and related party,
      provided project financing to the Energy Enzymes subsidiary in the amount of
      $600,000 at 10% interest per annum due and payable on December 31, 2008.




**7.**  **Operating
      Leases.**




The
      Company, through its subsidiaries, has non-cancelable operating leases for
      office space and a cellulosic demonstration facility in Butte, Montana. These
      leases expire at various dates through October 14, 2009. The operating lease
      for
      the Butte, Montana facility grants the Company the right to purchase the land
      and building underlying the lease at the end of each lease year.




Future
      minimum operating lease payments as of June 30, 2008 are:




**Rental**
              **Payments**2008
                (remainder of 2008)
            
            $
            124,4902009
            
            
            188,536$
            313,026




**8.**  **Stockholders
      Equity.**




The
      Company is authorized to issue up to 400,000,000 shares of common stock, $0.001
      par value per share and 65,000,000 shares of preferred stock, $0.001 par value
      per share.




*Convertible
      Preferred Stock*




Our
      Articles of Incorporation authorize our board to issue up to 65,000,000 shares
      of preferred stock, $0.001 par value per share, in one or more classes or series
      within a class upon authority of the board without further stockholder approval.
      There were 6,149,821 and 6,487,491 shares of Series B preferred stock issued
      and
      outstanding as of June 30, 2008 and December 31, 2007,
      respectively.




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 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. In addition, without
      obtaining the approval of the holders of a majority of the outstanding preferred
      stock, the Company cannot:




·
            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;


13


**AE
      BIOFUELS, INC.**


**(A
      Development Stage Company)**





**NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS**


(Unaudited)





·
            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 prior to 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 Company’s 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
      the Company’s 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, the Company’s 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 a 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 their shares of Series B preferred stock into common stock at the then
      effective conversion rate, initially and currently at a one for one rate. The
      conversion rate 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 a registration statement covering the resale of the shares of
      common stock issuable upon conversion of the Series B preferred stock has been
      declared effective by the Securities and Exchange Commission ("SEC"), all
      outstanding Series B preferred stock shall be automatically converted into
      common stock at the then effective conversion rate.


14


**AE
      BIOFUELS, INC.**


**(A
      Development Stage Company)**





**NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS**


(Unaudited)





*Registration
      Rights Payment*




Certain
      holders of shares of our common stock (including holders of warrants exercisable
      for common stock) and holders of shares of our Series B preferred stock
      (including holders of warrants exercisable for Series B preferred stock) are
      entitled to have their shares of common stock (including common stock issuable
      upon conversion of Series B preferred stock and exercise of warrants) registered
      under the Securities Act. Registration of these shares under the Securities
      Act
      would result in these shares becoming freely tradable without restriction under
      the Securities Act.




The
      registration rights granted by the Company require the Company to pay to the
      holders of these rights an amount equal to 0.5% of the aggregate dollar amount
      of securities purchased by such investors for each month or portion thereof
      after January 6, 2007 if the Company fails to file a registration statement
      with
      the SEC. The payments are treated as liquidated damages and not as a penalty
      and
      are full compensation to the investors, and shall constitute the investor's
      exclusive remedy for such events. At the Company’s option, the amounts payable
      as liquidated damages may be paid in cash or in shares of the Company's common
      stock.




The
      securities with registration rights described above may be sold under Rule
      144,
      beginning December 12, 2008, at which time the payment obligation shall cease.
      The Company has elected to pay the Registration Rights Payment in shares of
      its
      common stock. The Company expects to issue shares of its common stock for the
      12
      month period ending December 12, 2008 with an aggregate value of $2,274,402,
      which were expensed as a Registration Rights Payment and reflected as a
      component of Other income/expense in the Statement of Operations for the three
      months ended June 30, 2008.




**9.****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
      the
      Company’s common stock issuable upon exercise of the warrants must be included
      in any registration statement filed by the Company with the SEC. Further,
      subject to certain conditions, the Company has 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 agent warrants for 2008 and 2007 is as
      follows:




**Number
                of**
              **Warrants**
            
            **Weighted-**
              **Average**
              **Exercise**
              **Price**
            
            **Warrants**
              **Exercisable**
            
            **Remaining**
              **Term**
              **(years)**Outstanding,
                December 31, 2007
            
            
            1,548,074
            
            $
            2.22
            
            
            1,548,074
            
            
            6.1Exercised
            
            
            (29,166
            )
            
            3.00
            
            
            (29,166
            )Outstanding,
                June 30, 2008
            
            
            1,518,908
            
            
            2.21
            
            
            1,518,908
            
            
            5.6


15


**AE
      BIOFUELS, INC.**


**(A
      Development Stage Company)**





**NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS**


(Unaudited)





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.




One
      member of AE Biofuels’ board of directors and a significant shareholder of the
      Company is a registered representative of the placement agent. He received
      a
      portion of the compensation paid to the placement agent and received 976,721
      of
      the warrants issued pursuant to the Series A and B financings (discussed in
      Note
      14).




*Warrants*




In
      July
      2007, we issued 1,200,000 revocable warrants to Thames Advisory, Ltd. and paid
      $200,000 in consulting fees with respect to a proposed $200 million debt
      facility. The warrants would have been earned if the facility was secured before
      June 30, 2008. To date no warrants have been earned.




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.




*Common
      Stock Reserved for Issuance*




AE
      Biofuels authorized the issuance of 4,000,000 shares under its 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 prior to 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**
            
            **Options
                Outstanding****Available**
            
            **Number**
            
            **Weighted-Average****For
                Grant**
            
            **Of
                Shares**
            
            **Exercise Price**Balance
                as of December 31, 2007
            
            
            2,016,000
            
            
            1,984,000
            
            $
            3.00Authorized
            
            
            -Granted
            
            
            (1,105,000
            )
            
            1,105,000
            
            
            3.70Exercised
            
            
            -
            
            
            -
            
            
            -Cancelled
            
            
            8,250
            
            
            (8,250
            )
            
            3.00Balance
                as of June 30, 2008
            
            
            919,250
            
            
            3,080,750
            
            $
            3.25


16


**AE
      BIOFUELS, INC.**


**(A
      Development Stage Company)**





**NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS**


(Unaudited)





The
      weighted average remaining contractual term is 4.88 years at June 30, 2008.
      The aggregate intrinsic value of the shares outstanding at June 30, 2008 is
      $17,711,000. The aggregate intrinsic value represents the total pretax intrinsic
      value, based on the excess of the Company’s closing stock price of $9.00 as of
      June 30, 2008 over the option 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 fair value of these awards is
      $3.07.




Included
      in the table above are 467,000 options issued to consultants in November 2007
      and June 2008. These options had an exercise price of $3.00 and $3.70 and
      generally vest over three years. At June 30, 2008 the weighted average remaining
      contractual term was 4.47 years. The Company recorded expense of $224,117 and
      $468,878 for the three and six months ended June 30, 2008, respectively, and
      $8,541 for the three and six months ended June 30, 2007 which reflects the
      fair
      value valuation and periodic fair value remeasurement of outstanding consultant
      options under 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,” (“EITF 96-18”). The valuation
      using the Black-Scholes 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). The Company records the expense
      related to consultant options using the accelerated expense pattern prescribed
      in EITF 96-18.




Options
      vested and exercisable at June 30, 2008 and December 31, 2007 were 1,222,250
      and
      817,000, with weighted average exercise prices of $2.56 and $2.85,
      respectively.




*Non-Plan
      Stock Options*




In
      2006,
      the Company issued 290,000 stock options to employees outside of any stock
      option plan, of which 60,000 and 50,000 were forfeited during the six month
      period ended June 30, 2008 and fiscal 2007, respectively. For the remaining
      180,000 options outstanding as of June 30, 2008, the weighted average remaining
      contractual term is 0.25 years. The grant date fair value of this award is
      $0.25.




**10.
      Stock- Based Compensation.**




The
      Company incurred stock compensation expense of $1,196,580 and $1,536,043 in
      the
      three and six months ended June 30, 2008, respectively and $15,000 and $60,409
      in the three and six months ended June 30, 2007, respectively for options
      granted to our general and administrative employees and consultants. Included
      in
      stock compensation is $800,000 of expenses related to modification of a stock
      agreement with one of our executives. Therefore, all stock option expense was
      classified as general and administrative expense.




In
      June
      an employee was terminated who was a party to a Restricted Stock Purchase
      Agreement. Upon his termination, the Company was unable under the agreement
      to exercise its repurchase right for 200,000 shares. The inablility of
      the Company to repurchase the shares is considered an acceleration of
      vesting terms, and as such is treated as if it was a new award. Upon
      termination the shares were revalued at the market value of the stock on the
      day
      of termination times the number shares of for which vesting was
      accelerated. In total, the Company expensed $800,000 as stock-compensation
      in
      the three-month period ended June 30, 2008.


17


**AE
      BIOFUELS, INC.**


**(A
      Development Stage Company)**





**NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS**


(Unaudited)





*Valuation
      and Expense Information under SFAS 123(R)*




As
      of
      June 30, 2008 and December 31, 2007, there was $3,836,796 and $2,585,196,
      respectively, of total unrecognized compensation expense under SFAS 123R, net
      of
      estimated forfeitures, related to stock options that the Company will amortize
      over the next four fiscal years.




**11.****Acquisitions,
      Divestitures and Joint Ventures.**




*E85
      Joint Venture* .
      On
      January 17, 2007, American Ethanol, Inc. received a $5 million advance from
      E85,
      Inc., a Delaware corporation pursuant to a signed Memorandum of Understanding
      between the parties. E85, Inc. is an entity primarily owned by Mr. C.
      Sivasankaran, the founder and Chairman of Siva Limited, Sterling Infotech,
      and
      other businesses.




Subsequently,
      on March 1, 2007, American Ethanol entered into various agreements, including
      a
      Joint Development Agreement, with E85, Inc. The transactions caused no dilution
      to American Ethanol shareholders, and no shares or warrants were issued. Terms
      of the agreement included binding terms related to funding the expected $200
      million construction of American Ethanol’s Sutton, Nebraska ethanol plant, as
      well as non-binding terms related to funding three additional ethanol
      plants.




The
      American Ethanol agreements with E85 included the following terms:




·
            American
                Ethanol agreed to sell all of its interest in and to its wholly-owned
                subsidiary, Wahoo Ethanol, LLC, to E85 for the purchase price of
                $2
                million, resulting in a gain on sale to American Ethanol of
                $854,000;




·
            American
                Ethanol, through its wholly owned subsidiary Sutton Ethanol, LLC,
                was
                developing an ethanol production facility to be located near Sutton,
                Nebraska, which had a permitted production capacity of approximately
                115
                million gallons per year (the "Sutton Project"). E85 agreed to acquire
                a
                50% membership interest in Sutton Ethanol, LLC for a total equity
                contribution of $58 million, of which $24 million was funded on March
                26,
                2007 and American Ethanol agreed to make an additional equity contribution
                to Sutton Ethanol, LLC of $34 million. American Ethanol would retain
                a 50%
                membership interest in Sutton Ethanol,
                LLC;




·
            In
                addition, American Ethanol would have the lead responsibility to
                negotiate, on behalf of Sutton Ethanol, LLC, the terms and conditions
                of a
                turnkey, engineering, procurement and construction contract ("EPC
                Contract") with a suitable qualified construction contractor
                ("Contractor"), which EPC Contract would have terms and conditions
                sufficient to allow the Sutton Project to obtain, on commercially
                reasonable terms, non-recourse construction and term loan financing
                in an
                amount of approximately $100,000,000 (the "Financing"), including,
                without
                limitation, a completion guarantee from the Contractor that would
                be
                backed by a performance bond. E85 would assist American Ethanol in
                such
                negotiations as reasonably requested by American Ethanol. In addition,
                American Ethanol would have the lead responsibility to negotiate,
                on
                behalf of Sutton Ethanol, LLC, the terms and conditions of the Financing.
                E85 would assist American Ethanol in such negotiations as reasonably
                requested by American Ethanol;


18


**AE
      BIOFUELS, INC.**


**(A
      Development Stage Company)**





**NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS**


(Unaudited)





·
            E85
                and American Ethanol agreed that American Ethanol would enter into
                a
                management agreement with Sutton Ethanol, LLC to manage the operation
                of
                the Sutton ethanol facility on such terms and conditions as are consistent
                with an arms-length management agreement for ethanol facilities of
                a
                similar type and size;




·
            E85
                and American Ethanol agreed that American Ethanol or its biofuels
                marketing subsidiary would enter into an exclusive marketing agreement
                with Sutton Ethanol, LLC to market ethanol and any other products
                from the
                Sutton ethanol facility for a fee to American Ethanol of one percent
                (1.0%) of gross sales, and on such terms and conditions as are consistent
                with arms-length marketing agreements for ethanol facilities of a
                similar
                type and size; and




·
            The
                parties recited their intent to pursue the development and construction
                of
                three additional ethanol facilities on terms and conditions substantially
                similar to those for the Sutton
                Project.




In
      addition, American Ethanol entered into the following credit facilities with
      Siva Limited, a Bermuda corporation, an affiliated entity of E85,
      Inc:




·
            Siva
                Limited agreed to loan American Ethanol up to $4.5 million for the
                purpose
                of investing in American Ethanol’s International Biofuels subsidiary for
                the continued construction of a 50 million gallon biodiesel facility.
                If
                the note was repaid prior to thirty days from the date of the advance,
                no
                interest would be due. If the note was not fully paid in that time
                period,
                interest would accrue at the rate of 2.5% per month and the note
                would
                mature 12 months from the date of closing. Interest was payable quarterly.
                The loan was secured by a pledge by American Ethanol of 6% of the
                membership units of Sutton Ethanol, LLC;
                and




·
            Siva
                Limited agreed to loan American Ethanol $32 million for the purpose
                of
                funding American Ethanol’s remaining equity contribution to Sutton
                Ethanol, LLC. If the funds were borrowed, the loan would bear interest
                at
                the rate of 15% per annum, and would be due and payable on December
                30,
                2007. Interest was payable quarterly. The loan was secured by a pledge
                by
                American Ethanol of 35% of the membership units of Sutton Ethanol,
                LLC.
                American Ethanol was not obligated to borrow under this
                facility.




In
      connection with the agreements with E85 and Siva Limited described above, an
      affiliate of Siva Limited purchased from Janikiram Ajjarapu all 8,100,000 shares
      of common stock of American Ethanol held by Mr. Ajjarapu, a former officer
      and
      director of American Ethanol.




Prior
      to
      American Ethanol's acquisition of the Sutton and Wahoo membership interests,
      Geneva Capital was engaged to perform certain consulting services in exchange
      for cash and stock in the company. In June, 2006, Geneva Capital brought action
      against Sutton and Wahoo claiming breach of contract under these agreements.
      Janikiram Ajjarapu and American Ethanol agreed to settle this litigation with
      Geneva Capital, releasing American Ethanol from any liability related to this
      litigation. In addition, American Ethanol received a reimbursement of legal
      expenses in the amount of $200,000 which was recorded as additional paid in
      capital. The settlement and stock sale transaction closed in March
      2007.


19


**AE
      BIOFUELS, INC.**


**(A
      Development Stage Company)**





**NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS**


(Unaudited)





On
      August
      14, 2007 by mutual agreement of the parties, American Ethanol and E85 dissolved
      their joint venture. American Ethanol purchased E85’s 50% interest in the Sutton
      Joint Venture for $16 million in cash which they borrowed on a short term basis
      from the Joint Venture. As part of this repurchase, American Ethanol terminated
      its design contract with Delta T and wrote off approximately $5.2 million in
      design work previously performed by Delta T and its contractors. This $5.2
      million is included as an expense of the Company as of December 31, 2007.
      American Ethanol retained the remaining $8 million invested in the JV by E85.
      This $8 million gain has been included in the Statement of Operations as gain
      from sale of subsidiary. All previous agreements between American Ethanol and
      E85, including the loan facilities with Siva Limited, were terminated as of
      the
      date of the repurchase of the interest in Sutton.




*Public
      Company Acquisition* .
      On June
      23, 2006, American Ethanol acquired approximately 88.3% of the outstanding
      common stock of Marwich II, Ltd. from three principal shareholders and directors
      of Marwich for $675,000. The purchase price, net of current year expenses
      ($662,406), was accounted for as a reduction of additional paid-in capital
      as a
      step in a reverse merger transaction. In connection with this transaction,
      the
      three directors of American Ethanol's management, were named as directors of
      Marwich. Also on June 23, 2006, American Ethanol entered into an Agreement
      and
      Plan of Merger (subsequently amended and restated on July 19, 2007) with Marwich
      pursuant to which American Ethanol would merge with and into Marwich and (i)
      each issued and outstanding share of American Ethanol common stock (including
      common stock issued upon conversion of American Ethanol Series A preferred
      stock, which automatically converted into common stock immediately prior to
      the
      closing of the Merger) and Series B preferred stock was converted into Series
      B
      preferred stock which is convertible into common stock at the holder’s
      discretion on a one for one basis, respectively, of Marwich, and (ii) each
      issued and outstanding option and warrant exercisable for common stock of
      American Ethanol was assumed and converted into an option or warrant exercisable
      for common stock of Marwich. Upon the effectiveness of the Merger, Marwich
      changed its name to AE Biofuels, Inc. The 3,343,200 shares of Marwich purchased
      by American Ethanol were retired upon the completion of the Merger.




On
      December 7, 2007, the Merger was completed and the former shareholders of
      American Ethanol were issued 84,114,998 shares of AE Biofuels, Inc. common
      stock
      in exchange for all of the outstanding shares of American Ethanol common stock,
      6,487,491 shares of AE Biofuels, Inc. Series B preferred stock in exchange
      for
      all of the issued and outstanding shares of American Ethanol’s Series B
      preferred stock, and AE Biofuels, Inc. assumed options and warrants exercisable
      for 4,229,000 shares of common stock and 748,074 shares of Series B preferred
      stock, respectively. For accounting purposes, the Merger was treated as a
      reverse acquisition with American Ethanol as the acquirer and the Company as
      the
      acquired party.




*Marketing
      Company Acquisition.* On
      September 1, 2007, American Ethanol acquired Biofuels Marketing, Inc., a Nevada
      corporation, in exchange for 200,000 shares of American Ethanol common stock
      valued at $3.00 per share. Of the shares issued, 50% are contingent upon the
      continued employment of the President of Biofuels Marketing,and will be
      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
      is
      being amortized over 18 months.


20


**AE
      BIOFUELS, INC.**


**(A
      Development Stage Company)**





**NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS**


(Unaudited)





*Technology
      Company Formation:* On
      February 28, 2007, in consideration for the agreement to fund cellulosic ethanol
      development efforts, the Company acquired a 51% interest in Energy Enzymes,
      Inc.
      The Company has the right to acquire the remaining 49% for 1,000,000 shares
      of
      the Company's common stock upon the fulfillment of certain performance
      milestones. As of June 30, 2008, the Company had funded approximately $807,023
      under this agreement.




*India
      Company Formation.* On July
      14, 2006, the Company, through a wholly owned subsidiary, International
      Biofuels, Inc. and its wholly-owned subsidiary, International Biodiesel, Ltd.,
      LLC, a Mauritius company, entered into a joint venture biodiesel project
      agreement with Acalmar Oils & Fats Limited, an Indian company. The purpose
      of the joint venture was to build a biodiesel production facility with a
      nameplate capacity of 50 million gallons per year adjacent to the existing
      palm
      oil plant in Kakinada, India with such fuel being exported from India to the
      U.S. for sale. By the terms of the agreement the Company agreed to contribute
      approximately $15.4 million and Acalmar agreed to contribute its edible palm
      oil
      facility in India to the joint venture through a leasing arrangement. On August
      22, 2007, the Company and Acalmar mutually terminated this lease
      agreement.




On
      January 23, 2008, International Biofuels, Ltd agreed to terminate the amended
      shareholder agreement with Acalmar Oils and Fats, Ltd. including termination
      of
      Acalmar’s right to own or receive any ownership interest in the joint venture
      biodiesel project. 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. This joint venture has contributed
      income of $13,373 and $0 to the consolidated income for the six months ended
      June 30, 2008 and 2007, respectively, principally from foreign currency exchange
      gains and interest income. This income is not subject to U.S. federal taxation
      until it is repatriated.




*Argentina
      Project Company* .
      On June
      9, 2008, AE Biofuels Americas, Inc., a subsidiary of AE Biofuels, Inc. entered
      into an agreement to develop a biodiesel plant with a nameplate capacity of
      75
      million gallons per year located in San Lorenzo, Argentina, subject to certain
      closing conditions, and signed a preliminary engineering agreement. To date,
      $113,223 has been funded and expensed under the preliminary engineering
      agreement.


21


**AE
      BIOFUELS, INC.**


**(A
      Development Stage Company)**





**NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS**


(Unaudited)





**12.**  **Land
      options and purchases.**




The
      Company and its subsidiary, American Ethanol, Inc., have acquired options to
      purchase land in various locations in Nebraska and Illinois. The terms of these
      options are typically from one to two years and provide that the Company has
      the
      right to acquire the land for a set price per acre subject to the satisfaction,
      in the Company's sole discretion, of its due diligence.




The
      aggregate purchase price of all land currently under option, if all options
      are
      exercised, is $934,000. Currently, the Company is evaluating each site as to
      the
      adequacy of utilities, zoning, subsurface structures and the like and the
      exercise of any option will be dependent upon the result of the Company's
      analysis of these and other factors. The remaining options expire on or before
      January 2010.




**13.**  **Commitments.**




The
      Company contracted with Desmet Ballestra India Pvt. Ltd. to build a glycerin
      refinery and pretreatment plant at our existing biodiesel plant in Kakinada,
      India. At June 30, 2008 and December 31, 2007, construction contracts were
      outstanding for approximately $1,230,000 and $1,850,000, respectively that
      will
      be funded with cash currently held in our India subsidiary and through a term
      loan obtained in July 2008 from the State Bank of India (see note
      17).




**14.**  **Related
      party transactions.**




A
      director and significant shareholder of the Company loaned Energy
      Enzymes $500,000 under a credit facility. During the three months ended
      June 30, 2008, draws of $875,000 were made and offset by repayments of
      $1,987,508, including interest. The loan had $600,000 outstanding at June 30,
      2008. The loan is a short term note with a term of nine months from the date
      of
      issue and carries a 10% per annum interest rate. The monies were used by the
      Company to pay operating expenses and to meet payments related to obligations
      of
      our operation in India.




Chadbourn
      Securities acted as one of the Company’s placement agents with respect to the
      Company’s Series B preferred stock offering in 2007. One of the Company’s
      directors and shareholders is an agent of Chadbourn and received payments from
      Chadbourn related to the sale of stock along with other non-related parties.




The
      Company and Eric A. McAfee, the Company's Chief Executive Officer and Chairman
      of the Board, are parties to an agreement pursuant to which the Company pays
      Mr.
      McAfee a monthly fee of $10,000 per month for services rendered to the Company
      as a director and officer. For the three and six months ended June 30, 2008
      and
      2007, the Company paid Mr. McAfee $30,000 and $60,000, respectively pursuant
      to
      this agreement.




The
      Company and CM Consulting are parties to an agreement pursuant to which the
      Company reimburses CM Consulting for a minimum of 20 hours per month of time
      on
      an aircraft owned by CM Consulting until February 2008. The Company paid an
      upfront fee of $360,000 starting February 2006 for 24 months of usage. The
      contract expired in February 2008 and has neither been extended nor renewed.
      For
      the six months ended June 30, 2008, the Company expensed $15,000, for the six
      months ended June 30, 2007, the Company expensed $90,000 of this rental fee,
      respectively. CM Consulting is 50% owned by Eric McAfee, a director, officer
      and
      significant shareholder of the Company.


22


**AE
      BIOFUELS, INC.**


**(A
      Development Stage Company)**





**NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS**


(Unaudited)





Cagan
      McAfee Capital Partners is owned by two directors of the Company and provides
      office services and advisory services under an advisory agreement with the
      Company. For the six months ended June 30, 2008 and 2007, the Company paid
      Cagan
      McAfee Capital Partners $89,327 and $123,856 for advisory services, office
      services and travel expenses. The Company engaged Cagan McAfee Capital Partners
      in January 2006 for administrative, paralegal and staff support for $15,000
      a
      month for three years.




The
      Industrial Company (TIC) and Delta-T are companies involved in the design and
      construction of ethanol plants in the United States. In 2006 the Company paid
      TIC and Delta-T approximately $7.5 million for services related to the design
      and initial construction work on the Company’s Sutton Ethanol, LLC ethanol plant
      facility. In August 2007 the Company and TIC terminated their relationship,
      and
      the company wrote off approximately $5.2 million in design work and construction
      in progress.




During
      October and December 2007, the Company sold $6,127,727 of commodities
      to Acalmar Oils and Fats, Ltd. Amounts due from Acalmar Oils and Fats, Ltd.
      have been presented on the balance sheet as Accounts receivable - related party.
      These sales were made at prevailing market rates.




**15.**  **Income
      Tax.**




The
      Company files a consolidated federal income tax return. This return includes
      all
      corporate companies 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. State tax returns are filed on a consolidated,
      combined or separate basis depending on the applicable laws relating to the
      Company and its subsidiaries.




We
      do not
      provide for U.S. income taxes on the undistributed earnings of our foreign
      subsidiaries, as we consider these to be permanently reinvested in the
      operations of such subsidiaries. At December 31, 2007, these undistributed
      earnings totaled approximately $598,000. If some of these earnings were
      distributed, some countries may impose withholding taxes. In addition, as
      foreign taxes have previously been paid on these earnings, we would expect
      to be
      entitled to a U.S. foreign tax credit that would reduce the U.S. taxes owed
      on
      such distribution. As such, it is not practicable to determine the net amount
      of
      the related unrecognized U.S. deferred tax liability.




We
      adopted the provisions of FASB Interpretation No. 48, “Accounting for
      Uncertainty in Income Taxes - an interpretation of FASB Statement No. 109” (“FIN
      48”), on January 1, 2007, and there was no impact to our financial statements.
      FIN 48 clarifies the accounting for uncertainty in income tax positions. FIN
      48
      provides that the tax affects from an uncertain tax position can be recognized
      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. Most of our unrecognized tax benefits would
      affect our effective tax rate if recognized. Furthermore, we do not reasonably
      expect the total amounts of unrecognized tax benefits to significantly increase
      or decrease within the next 12 months.


23


**AE
      BIOFUELS, INC.**


**(A
      Development Stage Company)**





**NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS**


(Unaudited)





As
      of
      June 30, 2008 and December 31, 2007, our unrecognized tax benefits were not
      significant.




**16.****Contingent
      Liabilities.**




On
      March
      28, 2008, the Cordillera Fund, L.P. (“Cordillera”) filed a complaint in the
      Clark County District Court of the State of Nevada against American Ethanol,
      Inc. and the Company. The complaint seeks 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 that statute; and a permanent injunction
      compelling the Company to apply the Dissenters’ Rights Statute to Cordillera’s
      shares and reimburse Cordillera for its attorneys fees and
      costs.




On
      April
      29, 2008, we filed a Motion to Transfer Venue, seeking a transfer to the Second
      Judicial District Court of the State of Nevada, located in Washoe County,
      Nevada. The Motion was granted on or about June 2, 2008 and the case is now
      pending in Washoe County.




The
      Company intends to vigorously defend this disputed claim of entitlement under
      the Nevada Dissenters’ Rights Statute. The Company believes based upon their
      interpretation of the facts surrounding this matter and Nevada law that they
      have meritorious defenses against any claims by Cordillera for dissenters’ rights.
      However,
      any ultimate outcome of this matter is highly uncertain and difficult to predict
      at this early stage.




**17.**  **Subsequent
      Events.**




On
      July
      29, 2008, an aggregate additional borrowing in the amount of $400,000 was drawn
      against the project financing loan between Laird Cagan, a director, and Energy
      Enzymes.




On
      July
      17, 2008, Universal Biofuels Private Limited (“UBPL”), a wholly-owned subsidiary
      executed a five year secured term loan with the State Bank of India in the
      amount of approximately $6
      million. The term
      loan
      matures in
      July
      2013, and is secured by UBPL’s assets, consisting of the biodiesel plant
      and land in Kakinada, India and
      the
      personal guarantee ofSuren
      Ajjarapu the
      Company’s President and member of the board of
      directors. The
      Company intends to indemnified Mr. Ajjarapu for cost,
      expenses and liabilities incurred by Mr. Ajjarapu pursuant to the Deed of
      Guarantee.




Borrowings
      generally bear interest at 12.75% and the rate is subject to adjustment after
      two years. We
      borrowed approximately $3,800,000 against the facility in July 2008.




24


**Item
        2. Management's Discussion and Analysis of Financial Condition and Results
        of
        Operations**
  *Forward-Looking
        Statements*
  *This
        Quarterly Report on Form 10-Q (“Report”), including the “Management’s Discussion
        and Analysis of Financial Condition and Results of Operations,” contains
        forward-looking statements regarding future events and the future results
        of the
        Company that are based on current expectations, estimates, forecasts, and
        projections about the industry in which the Company operates and the beliefs
        and
        assumptions of the management of the Company. Words such as “expects,”
“anticipates,” “targets,” “goals,” “projects,” “intends,” “plans,” “believes,”
“seeks,” “estimates,” variations of such words, and similar expressions are
        intended to identify such forward-looking statements. These forward-looking
        statements are only predictions and are subject to risks, uncertainties and
        assumptions that are difficult to predict. Therefore, actual results may
        differ
        materially and adversely from those expressed in any forward-looking statements.
        Factors that might cause or contribute to such differences include, but are
        not
        limited to, those discussed in this Report under the section entitled “Risk
        Factors” in Item 1A of Part II and elsewhere, and in other reports the Company
        files with the Securities and Exchange Commission (“SEC”), specifically the most
        recent Annual Report on Form 10-K. The Company undertakes no obligation to
        revise or update publicly any forward-looking statements for any reason.*
  *The
        following discussion is based upon our unaudited Consolidated Financial
        Statements included elsewhere in this report, which have been prepared in
        accordance with U.S. generally accepted accounting principles. The preparation
        of these financial statements requires us to make estimates and judgments
        that
        affect the reported amounts of assets, liabilities, revenues and expenses,
        and
        related disclosure of contingencies. Actual results may differ from these
        estimates under different assumptions or conditions.*
  **Company
        Overview**
  We
        design, develop, build, own and plan to operate biodiesel and next-generation
        ethanol production facilities in the U.S. and abroad. As of June 30, 2008,
        we own a biodiesel facility in Kakinada, State of Andra Pradesh,
        India, with a nameplate capacity of 50 million gallons per year. In addition,
        on
        June 12, 2008, we announced that our wholly-owned subsidiary, AE Biofuels
        Americas, Inc. acquired a 90% ownership interest in a permitted 75 million
        gallon biodiesel site in San Lorenzo, Argentina, through a Joint Development
        Agreement with DS Development SA, a subsidiary of DS Group, a Belgian holding
        company globally active in the agro-industrial sector for the development,
        construction, ownership and operation of a new biodiesel plant. We expect
        that
        our production facilities in India will produce biodiesel primarily for export
        to the U.S. and Europe and the Argentina production facility will produce
        biodiesel primarily for export to Europe. We continue to evaluate sites for
        additional production facilities in India and South America.
  During
        the quarter, we continued the construction of our glycerin refinery and
        pretreatment facility at our Kakinada plant which will enable us to produce
        industrial and pharmaceutical-grade glycerin for sale to the Indian market.
        Refined glycerin is extensively used in personal care products, pharmaceuticals,
        food and beverages, tobacco, alkyd resins, and other technical applications.
        Refined glycerin typically commands a significantly higher price than crude
        glycerin.
  Finally,
        in the second quarter of 2008, we also substantially completed construction
        of
        our cellulosic ethanol demonstration facility in Butte, Montana, and continued
        to fund the optimization of our cellulosic ethanol technology for large-scale
        commercial implementation. This facility was officially opened on August
        11,
        2008.


25


**Company
      Organization**




AE
      Biofuels, Inc., through its wholly-owned subsidiary American Ethanol, Inc.,
      owns
      operating subsidiaries. Through our subsidiary International Biodiesel, Inc.,
      we
      own International Biofuels, Ltd, a Mauritius corporation and its subsidiary
      Universal Biofuels Private Ltd, an India company. Universal Biofuels Private
      Ltd. holds as its primary asset a biodiesel plant with the nameplate capacity
      of
      50 million gallons annually in Kakinada, India. Two other subsidiaries of
      American Ethanol, Sutton Ethanol, LLC and Danville Ethanol, Inc, hold future
      plant development assets including approximately 375 acres of land. Biofuels
      Marketing, Inc., a Delaware corporation was acquired by us on September 1,
      2007,
      as a marketing organization whose purpose is to acquire feedstock and sell
      the
      commodities related to our ethanol and biodiesel plants. Energy Enzymes, Inc.
      is
      held as a 51% owned joint venture for the development of next-generation
      cellulosic ethanol. The other 49% interest in Energy Enzymes is held by
      Renewable Technology Corporation. Under the joint venture agreement,
      the Company acquires the remaining 49% ownership in Energy Enzymes for
      consideration of one million shares upon the completion of certain project
      milestones.




**Six
      Months Ended June 30, 2008 Compared To Six Months Ended June 30, 2007**




**Revenues**




We
      had no
      revenues in either the six months ended, June 30, 2008 or June
      30, 2007.




**Expenses**




*Expenses* .
      For the
      period from November 29, 2005 (inception) through June 30, 2008, the Company
      was
      considered a development stage enterprise under Statement of Financial
      Accounting Standards (“SFAS”) No. 7 *Development
      Stage Enterprises* .
      We have
      been devoting substantially all of our efforts to establishing biodiesel and
      ethanol plants and securing feedstock to operate those plants. We will remain
      a
      development stage company until planned principal operations have commenced
      and
      significant revenues have been generated from those operations.




*Research
      and Development Expenses*




During
      2007, we formed a joint venture with Renewable Technology Corporation for the
      purpose of developing next-generation ethanol production processes. Under this
      joint venture agreement in 2007, we acquired 51% of Energy Enzymes, Inc. and
      have subsequently funded the operating expenses of Energy Enzymes and
      its team to optimize cellulosic ethanol technology for large-scale
      commercial implementation. For the six months ended June 30, 2008, we funded
      operating expenses of $512,056 consisting of consulting services of $120,000
      and
      the balance in lab supplies, lab equipment and travel expenses. For the six
      months ended June 30, 2007, we funded operating expenses of $120,030 principally
      for the services of the key scientists.




*General
      and Administrative Expenses*




Principal
      areas of spending for general and administrative expenses are in the areas
      of
      employee compensation and professional services. We summarize our spending
      into
      eight components as follows:


Six
                  Months
                Ended
              
              Six
                  Months
                EndedJune
                  30, 2008
              
              June
                  30, 2007%
              
              %Salaries,
                  wages and compensation
              
              
              40
              %
              
              43
              %Supplies
                  and services
              
              
              6
              %
              
              7
              %Repair
                  and maintenance
              
              
              0
              %
              
              0
              %Taxes,
                  insurance, rent and utilities
              
              
              6
              %
              
              2
              %Professional
                  services
              
              
              41
              %
              
              35
              %Depreciation
                  and amortization
              
              
              2
              %
              
              0
              %Travel
                  and entertainment
              
              
              5
              %
              
              12
              %Miscellaneous
                  expense
              
              
              0
              %
              
              1
              %Total
              
              
              100
              %
              
              100
              %


26


The
      largest component of general and administrative expense is professional
      services, which include legal, accounting, financial advisory, board
      compensation, security filings, and transfer agent fees and financing fees
      along
      with associated non-cash stock compensation expense. For the six months ended
      June 30, 2008, we spent approximately $2,344,365 on professional services
      including a non-cash stock compensation charge of approximately $493,878 for
      stock and option grants to key consultants and advisors. The major components
      of
      this spending were legal fees of $438,169, accounting fees of $313,552,
      professional fees of $294,900, and financial advisory fees of $192,441 and
      independent board member fees of $141,750. The balance of these fees relate
      principally to fees paid with respect to securities filings and marketing
      services. For the six months ended June 30, 2007, we spent approximately
      $1,130,714 on professional services of which $8,541 was for stock based
      compensation. On an inception-to-date basis, we spent $8,052,953 on professional
      services, including $773,490 of compensation for stock and options issued to
      consultants.




The
      second largest component of general and administrative expense is employee
      compensation, including related stock compensation. The number of employees
      grew
      as a result of hiring in India. Compensation expense grew from approximately
      $582,305 for the six months ended June 30, 2007 to approximately $2,297,392
      for
      the six months ended June 30, 2008. The increase was principally driven by
      the
      non-cash, stock compensation of approximately $1,067,165 for the six months
      ended June 30, 2008 compared to the stock compensation of $60,408 for the six
      months ended June 30, 2007. The increase in stock compensation expense is due
      to
      the modification of an option plan for a departing executive. On an
      inception-to-date basis, we spent $6,217,680 on employee compensation, including
      approximately $2,220,860 of stock compensation.




**Other
      Income (Expense)**




During
      the six months ended June 30, 2008, we purchased and resold glycerin. These
      sales resulted in profits of $26,534 on sales of $205,270. At June 30, 2008,
      we
      held $110,231 of glycerin as a purchased commodity in other current assets,
      which we plan to resell.




Pursuant
      to the terms of its Amended and Restated Registration Rights Agreement,
      beginning in January 2008 the Company was obligated to file a registration
      statement to register shares of common stock issued or issuable upon conversion
      of the Company's for Series A and B preferred stock or pay in cash or shares
      of
      stock to these investors an amount equal to 0.5% per month of their investment
      amount. The expense related to this payment from the period from January through
      December 2008 of $2,274,402 is reflected in our Statement of Operations as
      a
      registration rights payment.




On
      January 23, 2008, International Biofuels, Ltd agreed to terminate the amended
      shareholder agreement with Acalmar Oils and Fats, Ltd. including termination
      of
      Acalmar’s right to own or receive any ownership interest in the joint venture
      biodiesel project. The total cancellation price payable by IBL of $900,000
      is
      reflected in our Statement of Operations as a shareholder agreement cancellation
      payment.


27


**Three
      Months Ended June 30, 2008 Compared to Three Months Ended June 30, 2007**




**Revenues**




We
      had no
      revenues for the three months ended, June 30, 2008 or June 30,
      2007.




**Expenses**




*Research
      and Development Expenses*




For
      the
      three months ended June 30, 2008, we funded the operating expenses of Energy
      Enzymes, Inc. in the amount of $387,708, consisting of consulting
      services of $60,000 and the balance in various components of building a
      commercial demonstration plant.




*General
      and Administrative Expenses*




Principal
      areas of spending for general and administrative expenses are in the areas
      of
      employee compensation and professional services. We summarize our spending
      into
      eight components as follows:


ThreeMonths
                Ended
              
              Three
                  Months
                EndedJune
                  30, 2008
              
              June
                  30, 2007%
              
              %Salaries,
                  wages and compensation
              
              
              44
              %
              
              44
              %Supplies
                  and services
              
              
              8
              %
              
              7
              %Repair
                  and maintenance
              
              
              0
              %
              
              0
              %Taxes,
                  insurance, rent and utilities
              
              
              6
              %
              
              2
              %Professional
                  services
              
              
              37
              %
              
              35
              %Depreciation
                  and amortization
              
              
              1
              %
              
              0
              %Travel
                  and entertainment
              
              
              4
              %
              
              12
              %Miscellaneous
                  expense
              
              
              0
              %
              
              0
              %Total
              
              
              100
              %
              
              100
              %




The
      largest component of general and administrative expense is employee
      compensation, including related stock compensation. Compensation expense grew
      from approximately $824,922 for the three months ended June 30, 2007 to
      $1,646,122 for the three months ended June 30, 2008. The increase was
      principally driven by non-cash, stock compensation of $947,463 for the three
      months ended June 30, 2008 compared to stock compensation of $15,000 for the
      three months ended June 30, 2007. This increase was due to the acceleration
      of
      vesting of restricted Stock in connection with the termination of one of the
      Company's executives.




The
      second largest component of 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 June 30, 2008,
      we spent $1,275,944 on professional services including a non-cash stock
      compensation charge of $249,117 for stock and option grants to key consultants
      and advisors. For the three months ended June 30, 2007, we spent $652,778 on
      professional services of which none was for stock based compensation.


28


**Liquidity**




Through
      June 30, 2008 we have raised approximately $32,000,000 (net of expenses) through
      the sale of equity; $4,500,000 from the sale of 10% Senior Secured Notes; and
      $8,206,000 pursuant to the repurchase of our interest in Sutton Ethanol, LLC.
      The Company has established a credit facility with a director and
      significant shareholder which allows the Company to borrow money on a short
      term basis. Through June 30, 2008, the Company borrowed an aggregate of
      $2,675,000 under this credit facility of which $600,000 was outstanding as
      of
      June 30, 2008.  At June 30, 2008 we had approximately $423,000 in cash
      and cash equivalents held in our domestic entities. The funds that we have
      raised to date have been used for the development of our biodiesel facility
      in
      India (approximately $15,900,000), a land acquisition in Illinois for
      development of an ethanol facility (approximately $2,300,000), and a land
      acquisition and improvements in Nebraska for development of an ethanol facility
      (approximately $11,000,000), four land options in Illinois and Nebraska for
      possible future development of ethanol facilities (approximately $610,000),
      and
      operating expenses.




We
      will
      need significantly more cash to implement our plan to build our next-generation
      ethanol plants, to continue to develop biodiesel facilities in India and to
      develop biodiesel facilities in Argentina. We intend to raise these funds
      through the sale of additional equity either in AE Biofuels or one of our
      subsidiaries, joint ventures, construction loans, long-term debt financings
      and
      operating cash flows. We estimate that the cost to develop a biodiesel facility
      in India or Argentina is approximately $30 to $50 million with an additional
      $6
      to $10 million required for working capital.




The
      Company contracted with Desmet Ballestra India Pvt. Ltd. to build a glycerin
      refinery in Kakinada, India. At June 30, 2008 and December 31, 2007,
      construction contracts were outstanding for approximately $1,230,000 and
      $1,850,000, respectively that we will fund with cash currently held in our
      India
      subsidiary and through a term loan facility from the State Bank of
      India.




Due
      to
      the risk factors discussed in our annual report on form 10-K, there can be
      no
      assurance that we will be successful in raising the additional funds necessary
      to carry out management’s plans for the future. Management estimates that it
      will need to obtain additional debt or equity funds for each ethanol and
      biodiesel facility it builds, plus cash to continue its development efforts.
      The
      Company today is spending approximately $550,000 per month to cover its general
      and administrative costs. Funds available at June 30, 2008 are only sufficient
      to cover less than one month of our domestic operating costs. During the three
      months ended June 30, 2008, we borrowed $500,000 under the credit facility
      established with a director and related party, in order to meet our funding
      obligations with respect to our Energy Enzymes subsidiary and meet current
      obligations. Subsequent to June 30, 2008, we borrowed an additional $400,000
      under this credit facility.




**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.


29


*Impairment
      of Intangible and Long-Lived Assets*  ****




Our
      intangible asset was derived from the acquisition of Biofuels Marketing on
      September 1, 2007. In accordance with SFAS No. 141, “ *Business
      Combinations* ,”
we
      allocated the purchase price to the tangible assets, liabilities and intangible
      asset acquired based upon their estimated fair values. The principal asset
      was
      an intangible asset consisting of a customer list. All of the capitalizable
      costs of this acquisition were allocated to this customer list as the value
      of
      the remaining tangible and intangible assets were negligible. This customer
      list
      is being amortized over 18 months, its estimated useful life.




Our
      long-lived assets are primarily associated with our plant in Kakinada, India.
      This production facility was constructed with our former partner, Acalmar Oils
      and Fats, during 2007. The first phase of the plant is currently operational
      and
      we are evaluating various feedstock agreements in order to fully utilize the
      facility. We are constructing a glycerin refinery and pretreatment plant at
      our
      Kakinada facility, which is expected to be fully operational by the fourth
      quarter of 2008. Costs for building the plant remained in
      construction-in-progress at June 30, 2008, and will be reclassified once the
      plant is fully operational and placed in service.




We
      evaluate impairment of long-lived assets in accordance with 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. For the year ended December
      31, 2007 we recognized an impairment of approximately $5,114,000 due to
      non-recoverable engineering costs associated with the development efforts at
      our
      Sutton site.




*Stock-Based
      Compensation*




Effective
      January 1, 2006, we adopted the fair value recognition provisions of SFAS No.123
      (Revised 2004), “ *Share-Based
      Payment* ”
(“SFAS
      123(R)”), where the fair value of each option is adjusted to reflect only those
      shares that are expected to vest. Our implementation of SFAS 123(R) used the
      modified-prospective-transition method where the compensation cost related
      to
      each unvested option as of January 1, 2006 was recalculated and any necessary
      adjustment was reported in the first quarter of adoption.




We
      made
      the following estimates and assumptions in determining fair value:




·
            Valuation
                and amortization method — We estimate the fair value of stock options
                granted using the Black-Scholes 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 Securities and Exchange Commission’s
                Staff Accounting Bulletin No. 107.




·
            Expected
                Volatility — The Company’s expected volatilities are based on historical
                volatility of comparable companies’
stock.


30


·
            Expected
                Dividend — The Black-Scholes 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.




Given
      the
      absence of an active market for our common stock as a private company prior
      to
      the Merger with American Ethanol, our board of directors, the members of which
      we believe have extensive business, finance or venture capital experience,
      were
      required to estimate the fair value of our common stock for purposes of
      determining exercise prices for the options it granted. Our board of directors
      determined the estimated fair value of our common stock, based in part on an
      analysis of relevant metrics, including the following:




·
            the
                prices for our convertible preferred stock sold to outside investors
                in
                arm’s-length transactions;




·
            the
                rights, preferences and privileges of that convertible preferred
                stock
                relative to those of our common
                stock;




·
            our
                operating and financial
                performance;




·
            the
                hiring of key personnel;




·
            the
                introduction of new products;




·
            our
                stage of development and revenue
                growth;




·
            the
                fact that the option grants involved illiquid securities in a private
                company;




·
            the
                risks inherent in the development and expansion of our operations;
                and




·
            the
                likelihood of achieving a liquidity event, such as an initial public
                offering or a sale of the Company, for the shares of common stock
                underlying the options given prevailing market
                conditions.




**Recently
      Issued Accounting Pronouncements**




*Recent
      Accounting Pronouncements*




In
      September 2006, the FASB issued Statement No. 157, “ *Fair
      Value Measurements* ”
(“SFAS
      157”). SFAS 157 defines fair value, establishes a framework and gives guidance
      regarding the methods used in measuring fair value, and expands disclosures
      about fair value measurements. SFAS 157 is applicable whenever another
      accounting pronouncement requires or permits assets and liabilities to be
      measured at fair value. SFAS 157 does not expand or require any new fair value
      measures, however, the application of this statement may change current
      practice. On January 1, 2008, the Company adopted SFAS 157 and the adoption
      of
      this statement had no material effect on the Company’s financial statements. On
      February 12, 2008, the FASB issued FASB Staff Position (FSP) No. 157-2,
“Effective Date of FASB Statement No. 157.” FSP 157-2 delays the effective date
      of adoption for nonfinancial assets and liabilities to fiscal years beginning
      after November 15, 2008. Management is currently assessing the impact of the
      adoption of this Statement.




In
      February 2007, the FASB issued SFAS No. 159, “ *The
      Fair Value Option for Financial Assets and Financial Liabilities-Including
      an
      Amendment of FASB Statement No. 115* ”
("SFAS
      159") . This statement permits entities to choose to measure many financial
      instruments and certain other items at fair value. The fair value option may
      be
      elected on an instrument-by-instrument basis, with few exceptions. SFAS 159
      also
      establishes presentation and disclosure requirements to facilitate comparisons
      between companies that choose different measurement attributes for similar
      assets and liabilities. On January 1, 2008, the Company adopted SFAS 159 and
      the
      adoption of this statement had no material effect on the Company’s financial
      statements.


31


In
      December 2007, the FASB issued SFAS No. 141(R), “ *Business
      Combinations* ”
(“SFAS
      141R”). This statement 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. Also in December 2007, the FASB
      issued SFAS No. 160, “ *Noncontrolling
      Interests in Consolidated Financial Statements-an amendment of ARB No.
      51* ”
(“SFAS
      160”). This statement will change the accounting and reporting for minority
      interests, which will be recharacterized as noncontrolling interests, classified
      as a component of equity and accounted for at fair value. SFAS 141(R) and SFAS
      160 are effective for the Company’s 2009 financial statements. Early adoption is
      prohibited. The effect the adoption of SFAS 141(R) and SFAS 160 will have
      on the Company’s financial statements will depend on the nature and size of
      acquisitions we complete after we adopt SFAS 141(R) and SFAS 160.




In
      May
      2008, the FASB issued SFAS No. 162, “ *The
      Hierarchy of Generally Accepted Accounting Principles”* (“SFAS
      No. 162”). The current GAAP hierarchy was established by the American Institute
      of Certified Public Accountants, and faced criticism because it was directed
      to
      auditors rather than entities. The issuance of this statement corrects this
      and
      makes some other hierarchy changes. This statement is effective 60 days
      following the Securities and Exchange Commission’s approval of the Public
      Company Accounting Oversight Board amendments to AU Section 411, “ *The
      Meaning of Present Fairly in Conformity with Generally Accepted Accounting
      Principles.”* The FASB
      does not expect that this statement will result in a change to current
      practice.




In
      May 2008, the FASB issued Staff Position No. APB 14-1, “ *Accounting
      for Convertible Debt Instruments That May be Settled in Cash upon Conversion
      (Including Partial Cash Settlement)”* (“FSP
      APB 14-1”). FSP APB 14-1 states that convertible debt instruments that may be
      settled in cash upon conversion (including partial cash settlement) are not
      addressed by paragraph 12 of Accounting Principles Board Opinion No. 14 and
      that issuers of such instruments should account separately for the liability
      and
      equity components of the instruments in a manner that will reflect the entity’s
      nonconvertible debt borrowing rate when interest cost is recognized in
      subsequent periods. FSP APB 14-1 is effective for financial statements issued
      for fiscal years beginning after December 15, 2008, and must be applied
      retrospectively to all periods presented. The Company is currently evaluating
      the impact that FSP APB 14-1
      will have on its consolidated financial statements.




**Item
      3. Quantitative And Qualitative Disclosures About Market
      Risk**




*Interest
      Rate Sensitivity*




We
      had
      cash, cash equivalents and marketable securities totaling $636,654 and $720,402
      at June 30, 2008 and December 31, 2007, respectively. These amounts were
      invested primarily in money market funds and short term time deposits. The
      unrestricted cash and cash equivalents and marketable securities are held for
      working capital purposes. We do not enter into investments for trading or
      speculative purposes. We believe that we do not have any material exposure
      to
      changes in the fair value as a result of changes in interest rates. Declines
      in
      interest rates, however, will reduce future investment income.




At
      June
      30, 2008 and March 31, 2008, we had $5,600,000 and $1,712,508 of fixed- rate,
      short-term debt outstanding, respectively.


32


**Item
        4T. Controls And Procedures**
  **Evaluation
        of Disclosure Controls and Procedures**
  The
        Company's management is responsible for establishing and maintaining a system
        of
        disclosure controls and procedures (as defined in Rule 13a-15(e) and 15d-15(e)
        under the Exchange Act of 1934, as amended) that is designed to ensure that
        information required to be disclosed by the Company in the reports that the
        Company files or submits under the Exchange Act is recorded, processed,
        summarized and reported, within the time periods specified in the Commission's
        rules and forms. Based upon their evaluation, our Chief Executive Officer
        and
        Chief Financial Officer have concluded that as of June 30, 2008 our disclosure
        controls and procedures were not effective. Disclosure controls and procedures
        include, without limitation, controls and procedures designed to ensure that
        information required to be disclosed by an issuer in the reports that it
        files
        or submits under the Exchange Act is accumulated and communicated to the
        issuer's management, including its principal executive officer or officers
        and
        principal financial officer or officers, or persons performing similar
        functions, as appropriate to allow timely decisions regarding required
        disclosure.
  **Changes
        in Internal Control over Financial Reporting**
  There
        were no changes in our internal control over financial reporting, during
        our
        most recent fiscal quarter that have materially affected, or are reasonably
        likely to materially affect, our internal control over financial reporting,
        except those discussed below with respect to our remediation efforts.
  **Remediation
        Efforts to Address Material Weakness in Internal Control over Financial
        Reporting**
  Throughout
        the three and six months ended June 30, 2008, we began the implementation
        of a
        remediation plan to address the material weaknesses identified during the
        audit
        of our fiscal year ended December 31, 2007. The control deficiencies that
        gave
        rise to the material weaknesses related to the fact that our accounting
        resources did not include enough people with the detailed knowledge, experience
        and training in the selection and application of certain accounting principles
        generally accepted in the United States of America (GAAP) to meet our financial
        reporting needs. These control deficiencies contributed to material weaknesses
        in internal control with respect to segregation of duties, controls over
        financial reporting at the India subsidiary, stockholders equity and share-based
        compensation, acquisitions as well as financial statement presentation and
        disclosures. We have hired two employees with the necessary accounting
        knowledge, experience and training to meet the needs of our organization.
        We
        will continue to implement process changes and hire employees or consultants
        to
        address the material weaknesses noted in the internal controls over financial
        reporting for fiscal 2007. Once placed in operation for a sufficient period
        of
        time, we will evaluate the overall effectiveness of these new process changes
        to
        determine if they are operating effectively.
  **Inherent
        Limitations of Internal Controls**
  Our
        management, including our CEO and CFO, does not expect that our disclosure
        controls and procedures or our internal controls will prevent all error and
        all
        fraud. A control system, no matter how well conceived and operated, can provide
        only reasonable, not absolute, assurance that the objectives of the control
        system are met. Because of the inherent limitations in all control systems,
        no
        evaluation of controls can provide absolute assurance 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 a simple error or mistake.
        Additionally, controls can be circumvented by the individual acts of some
        persons, by collusion of two or more people, or by management override of
        the
        control. The design of any system of controls also is based in part upon
        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. Over time, controls may become inadequate because of changes
        in conditions, or the degree of compliance with the policies or procedures
        may
        deteriorate. Because of the inherent limitations in a cost-effective control
        system, misstatements due to error or fraud may occur and not be
        detected.
 33


**PART
      II— OTHER INFORMATION**




**Item
      1. Legal Proceedings**




On
      March
      28, 2008, the Cordillera Fund, L.P. ("Cordillera") filed a
      complaint in the Clark County District Court of the State of Nevada against
      American Ethanol, Inc. and the Company. The complaint seeks 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
      April
      29, 2008, we filed a Motion to Transfer Venue, seeking a transfer to the Second
      Judicial Court of the State of Nevada, located in Washoe County, Nevada. The
      Motion was granted on or about June 2, 2008 and the case is now pending in
      Washoe County.




The
      Company intends to vigorously defend this disputed claim of entitlement under
      the Nevada Dissenters' Rights Statute.




**Item
      1A. Risk Factors**




There
      has
      been no material change in the Company's risk factors as previously disclosed
      in
      the Company’s Annual Report on Form 10-K filed with the SEC on April 1,
      2008.




**Item
      2. Unregistered Sales Of Equity Securities And Use Of
      Proceeds**




None




**Item
      3. Defaults Upon Senior Securities**




None




**Item
      4. Submission Of Matters To A Vote Of Security Holders**




The
      following matters were presented for stockholder vote at the Company's annual
      meeting of stockholders held on May 8, 2008: (1) election of 6 members to our
      board of directors, each to serve until our annual meeting in 2009, and until
      their respective successors are qualified and elected or earlier resignation
      or
      removal; (2) ratification of the appointment of the Company’s independent
      registered public accounting firm for the fiscal year ended on December 31,
      2008; and (3) the approval of the Company’s Amended and Restated 2007 Stock
      Plan. The respective votes of each matter were indicated as
      follows:




1.  Election
      of 6 members to our board of directors:




Name
                of Director
            For
            Withhold
                AuthorityEric
                A. McAfee
            57,153,189
            1,150Surendra
                Ajjarapu
            57,153,189
            1,150Harold
                Sorgenti
            57,153,289
            1,050Michael
                DeLong
            57,153,289
            1,050Laird
                Cagan
            57,153,189
            1,150Michael
                Peterson
            57,153,289
            1,050


34


2.  Ratification
      of the appointment of BDO Seidman, LLP as our independent auditors for the
      fiscal year ended December 31, 2008:




For
            Against
            Abstain57,153,504
            635
            200




3.  Approval
      of the Company’s Amended and Restated 2007 Stock Plan:




For
            Against
            Abstain56,741,770
            69,575
            300




There
      were no broker non-votes.




**Item
      5. Other Information**




On
        July
        17, 2008, Universal Biofuels Private Limited, a wholly-owned subsidiary of
        the
        Company entered into a five-year secured term loan with the State Bank of
        India
        in the amount of approximately $6 million. The term loan matures in July
        2013
        and is secured by all of the assets of Universal Biofuels, including a biodiesel
        plant and land in Kakinada, India. Borrowings generally bear interest at
        12.75%
        per annum, which interest rate is subject to adjustment after two years.
        On July
        18, 2008, Universal Biofuels borrowed $3.8 million under this facility.
  In
        connection with the term loan, Surendra Ajjarapu, the Company’s president and
        member of its board of directors, entered into a Deed of Guarantee for Overall
        Limit with the State Bank of India pursuant to which Mr. Ajjarapu personally
        guaranteed Universal Biofuels’ obligations under the term loan. The Company
        intends to indemnify Mr. Ajjarapu for any costs, expenses and liabilities
        incurred by Mr. Ajjarapu pursuant to the Deed of Guarantee.
  **Item
        6. Exhibits**




10.12
            Agreement
                of Loan for Overall Limit10.13
            Deed
                of Guarantee for Overall Limit31.1
            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.


35


**SIGNATURES**




In
      accordance with the requirements of the Exchange Act, the registrant caused
      this
      Report on Form 10-Q to be signed on its behalf by the undersigned, thereunto
      duly authorized.




Date:
      August 13, 2008




**AE
                Biofuels, Inc.**By:
            /s/
                Eric A. McAfeeEric
                A. McAfeeChief
                Executive Officer
              (Principal
                Executive Officer)





36