UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549





FORM 10-K/A

Amendment No. 1







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



For the fiscal year ended December 31, 2008

Commission file number: 000-51354



AE BIOFUELS, INC.

(Exact name of registrant as specified in its charter)



|                                                               |                                        
|-------------------------------------------------------------- | ---------------------------------------
|Nevada                                                         | 26-1407544                             
|(State or other jurisdiction of
incorporation or organization) | (I.R.S. Employer
Identification Number)



20400 Stevens Creek Blvd., Suite 700

Cupertino, California 95014

Address of principal executive offices



Registrants telephone number (including area code): (408) 213-0940



Securities registered under Section 12(g) of the Exchange Act:



Common Stock, Par Value $.001

(Title of class)



Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes o No þ

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes o No þ

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or Section 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 þ No o

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrants knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. þ

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 þ        
|Non-accelerated filer   | o(Do not check if a smaller reporting company) | Smaller reporting company o

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

The aggregate market value of the voting and non-voting common equity held by non-affiliates of the registrant was approximately $441,981,180 as of June 30, 2008, the registrants most recently completed second fiscal quarter, based on the average bid and asked price on the Over-The-Counter Bulletin Board reported for such date. This calculation does not reflect a determination that certain persons are affiliates of the registrant for any other purpose.

The number of shares outstanding of the registrants Common Stock on May 12, 2009 was 86,171,532 shares.

DOCUMENTS INCORPORATED BY REFERENCE

None









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Explanatory Note

AE Biofuels, Inc. is filing this Amendment No. 1 on Form 10-K/A to its Annual Report on Form 10-K for the fiscal year ended December 31, 2008 to file Exhibits 10.10, 10.11 and 14 and to correct certain formatting errors on Pages 69 and 70 in the financial statements. Except as discussed above, we have not modified or updated disclosures presented in the original annual report on Form 10-K. Accordingly, this Form 10-K/A does not reflect events occurring after the filing of our original Form 10-K or modify or update those disclosures affected by subsequent events, except as specifically referenced therein. References to this Annual Report on Form 10-K herein shall refer to the Annual Report on Form 10-K originally filed on May 15, 2009, as amended by this Amendment No. 1.

Item 15.

Exhibits and Financial Statement Schedules.

Index to Exhibits

|        |  |                                                                                                                                                                                                                                                                       
|------- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit |  | Description                                                                                                                                                                                                                                                           
|2.1     |  | Amended and Restated Agreement and Plan of Merger By and Among Marwich II, Ltd., a Colorado corporation, Marwich II Ltd., a Nevada corporation, AE Biofuels, Inc., a Nevada corporation and American Ethanol, Inc., a Nevada corporation dated as of July 19, 2007 (1)
|2.2     |  | Agreement and Plan of Merger by and between Marwich II, Ltd., a Colorado corporation, and Marwich II, Ltd., a Nevada corporation dated July 19, 2007 (1)                                                                                                              
|3.1     |  | Articles of Incorporation (2)                                                                                                                                                                                                                                         
|3.2     |  | Bylaws (3)                                                                                                                                                                                                                                                            
|3.3     |  | Certificate of Designation of Series B Preferred Stock (3)                                                                                                                                                                                                            
|3.4     |  | Certificate of Amendment to Articles of Incorporation (2)                                                                                                                                                                                                             
|4.1     |  | Specimen Common Stock Certificate (3)                                                                                                                                                                                                                                 
|4.2     |  | Specimen Series B Preferred Stock Certificate (3)                                                                                                                                                                                                                     
|4.3     |  | Form of Common Stock Warrant (3)                                                                                                                                                                                                                                      
|4.4     |  | Form of Series B Preferred Stock Warrant (3)                                                                                                                                                                                                                          
|10.1    |  | Amended and Restated 2007 Stock Plan (4)                                                                                                                                                                                                                              
|10.2    |  | Amended and Restated 2007 Stock Plan form of Stock Option Award Agreement (4)                                                                                                                                                                                         
|10.3    |  | Amended and Restated Registration Rights Agreement, dated February 28, 2007 (3)                                                                                                                                                                                       
|10.4    |  | Executive Chairman Agreement, dated January 30, 2006 with Eric A. McAfee (3)                                                                                                                                                                                          
|10.7    |  | Executive Employment Agreement, dated May 22, 2007 with Andrew Foster (3)                                                                                                                                                                                             
|10.8    |  | Sublease, dated August 20, 2007, by and between Navio Systems, Inc. and American Ethanol, Inc. (3)                                                                                                                                                                    
|10.9    |  | First Addendum to Sublease, dated September 6, 2007 by and between Navio Systems, Inc. and American Ethanol, Inc. (3)                                                                                                                                                 
|10.10   |  | Executive Employment Agreement, dated June 17, 2008 with Scott A. Janssen                                                                                                                                                                                             
|10.11   |  | Executive Employment Agreement, dated September 1, 2007 with Sanjeev Gupta                                                                                                                                                                                            
|10.12   |  | Agreement of Loan for Overall Limit(5)                                                                                                                                                                                                                                
|10.13   |  | Deed of Guarantee for Overall Limit(5)                                                                                                                                                                                                                                
|10.14   |  | $5 million Note and Warrant Purchase Agreement dated May 16, 2008 among Third Eye Capital Corporation, as Agent; the Purchasers; and AE Biofuels, Inc., including the form of Note(6)                                                                                 
|10.15   |  | Agreement with TIC  The Industrial Company (2)                                                                                                                                                                                                                       
|14      |  | Code of Ethics                                                                                                                                                                                                                                                        
|21.1    |  | Subsidiaries of the Registrant(7)                                                                                                                                                                                                                                     
|24      |  | Power of Attorney (see signature page)                                                                                                                                                                                                                                
|31.1    |  | Rule 13a-14(a)/15d-14(a) Certification by the Chief Executive Officer                                                                                                                                                                                                 
|31.2    |  | Rule 13a-14(a)/15d-14(a) Certification by the Chief Financial Officer Certification by the Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002                                           
|32.1    |  | Certification by the Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.                                                                                                                
|32.2    |  | Rule 13a-14(a)/15d-14(a) Certification by the Chief Financial Officer Certification by the Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002                                           



1.

Filed as an exhibit to the Companys Current Report on Form 8-K, as filed with the Securities and Exchange Commission on July 20, 2007.

2.

Filed as an exhibit to the Companys Quarterly Report on Form 10-Q, as filed with the Securities and Exchange Commission on November 14, 2008.

3.

Filed as an exhibit to the Companys Current Report on Form 8-K, as filed with the Securities and Exchange Commission on December 13, 2007.

4.

Filed as an exhibit to the Companys Definitive Proxy Statement on Schedule 14A, filed with the Securities and Exchange Commission on April 15, 2008.



1



---

5.

Filed as an exhibit to the Companys quarterly Report on Form 10-Q, as filed with the Securities and Exchange Commission on August 14, 2008.

6.

Filed as an exhibit to the Companys Current Report on Form 8-K, as filed with the Securities and Exchange Commission on May 20, 2008.

7.

Filed as an exhibit to the Companys Annual Report on Form 10-K, as filed with the Securities and Exchange Commission on May 15, 2009.





2



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AE BIOFUELS, INC.

Consolidated Financial Statements



|                                                             |  |            
|------------------------------------------------------------ |  | -----------
|Index To Financial Statements                                |  | Page
Number
|                                                             |  |            
|Report of Independent Registered Public Accounting Firm      |  | 62         
|                                                             |  |            
|Consolidated Financial Statements                            |  |            
|                                                             |  |            
|Consolidated Balance Sheets                                  |  | 63         
|                                                             |  |            
|Consolidated Statements of Operations and Comprehensive Loss |  | 64         
|                                                             |  |            
|Consolidated Statements of Cash Flows                        |  | 65         
|                                                             |  |            
|Consolidated Statements of Stockholders' Equity              |  | 66         
|                                                             |  |            
|Notes to Consolidated Financial Statements                   |  | 67         





3



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Report of Independent Registered Public Accounting Firm

Board of Directors and Stockholders

AE Biofuels, Inc.

Cupertino, CA

We have audited the accompanying consolidated balance sheets of AE Biofuels, Inc. as of December 31, 2008 and 2007 and the related consolidated statements of operations and comprehensive loss, stockholders equity, and cash flows for each of the three years in the period ended December 31, 2008. These financial statements are the responsibility of the Companys management. Our responsibility is to express an opinion on these financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of AE Biofuels, Inc. at December 31, 2008 and 2007, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2008, in conformity with accounting principles generally accepted in the United States of America.

The accompanying financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note 2 to the financial statements, the Company has suffered recurring losses and negative cash flows from operations since inception. These conditions raise substantial doubt about the Companys ability to continue as a going concern. Managements plans in regard to these matters are also described in Note 2. The financial statements do not include any adjustments that might result from the outcome of this uncertainty.

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), AE Biofuels, Inc.'s internal control over financial reporting as of December 31, 2008, based on criteria established in Internal Control  Integrated Frameworkissued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) and our report dated May 15, 2009 expressed an adverse opinion on the effectiveness of the Companys internal control over financial reporting due to the existence of a material weakness.

/s/ BDO Seidman, LLP

San Jose, California

May 15, 2009





62



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AE BIOFUELS, INC.

CONSOLIDATED BALANCE SHEETS

FOR THE YEARS ENDED DECEMBER 31, 2008 AND 2007



|                                                                                                                                                                                                                       |  |      |             |   |      |   |             |  
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ---- | ----------- | - | ---- | - | ----------- | -
|                                                                                                                                                                                                                       |  |      |             |   |      |  
|                                                                                                                                                                                                                       |  | 2008 |             |   | 2007 |  
|Assets                                                                                                                                                                                                                 |  |      |             |   |      |  
|Current assets:                                                                                                                                                                                                        |  |      |             |   |      |  
|Cash and cash equivalents                                                                                                                                                                                              |  | $    | 377,905     |   |      | $ | 720,402     |  
|Time deposits                                                                                                                                                                                                          |  |      |            |   |      |   | 2,635,892   |  
|Accounts receivable                                                                                                                                                                                                    |  |      |            |   |      |   | 3,447,039   |  
|Accounts receivable - related party                                                                                                                                                                                    |  |      |            |   |      |   | 6,127,727   |  
|Inventories                                                                                                                                                                                                            |  |      | 1,049,583   |   |      |   |            |  
|Prepaid expenses                                                                                                                                                                                                       |  |      | 110,581     |   |      |   | 58,872      |  
|Other current assets                                                                                                                                                                                                   |  |      | 438,703     |   |      |   | 674,235     |  
|Total current assets                                                                                                                                                                                                   |  |      | 1,976,772   |   |      |   | 13,664,167  |  
|                                                                                                                                                                                                                       |  |      |             |   |      |   |             |  
|Property, plant and equipment, net                                                                                                                                                                                     |  |      | 21,236,604  |   |      |   | 19,585,087  |  
|Intangible assets                                                                                                                                                                                                      |  |      | 33,333      |   |      |   | 233,334     |  
|Other assets                                                                                                                                                                                                           |  |      | 289,990     |   |      |   | 68,488      |  
|Total assets                                                                                                                                                                                                           |  | $    | 23,536,699  |   |      | $ | 33,551,076  |  
|                                                                                                                                                                                                                       |  |      |             |   |      |   |             |  
|Liabilities and stockholders' equity                                                                                                                                                                                   |  |      |             |   |      |   |             |  
|Current liabilities:                                                                                                                                                                                                   |  |      |             |   |      |   |             |  
|                                                                                                                                                                                                                       |  |      |             |   |      |   |             |  
|Accounts payable                                                                                                                                                                                                       |  | $    | 2,829,117   |   |      | $ | 9,985,639   |  
|Income taxes payable                                                                                                                                                                                                   |  |      |            |   |      | $ | 36,750      |  
|Short term borrowings, net of discount                                                                                                                                                                                 |  |      | 4,504,062   |   |      |   |            |  
|Registration rights liability                                                                                                                                                                                          |  |      | 1,807,748   |   |      |   |            |  
|Mandatorily redeemable Series B preferred stock                                                                                                                                                                        |  |      | 1,750,002   |   |      |   |            |  
|Other current liabilities                                                                                                                                                                                              |  |      | 1,616,259   |   |      |   |            |  
|Current portion of long term debt                                                                                                                                                                                      |  |      | 816,738     |   |      |   |            |  
|Total current liabilities                                                                                                                                                                                              |  |      | 13,323,926  |   |      |   | 10,022,389  |  
|                                                                                                                                                                                                                       |  |      |             |   |      |   |             |  
|Long term debt, net of discount                                                                                                                                                                                        |  |      | 3,174,275   |   |      |   |            |  
|Long term debt (related party)                                                                                                                                                                                         |  |      | 2,044,691   |   |      |   |            |  
|                                                                                                                                                                                                                       |  |      |             |   |      |   |             |  
|Commitments and contingencies (Notes 2,7,8,9,13,16, 18, 19 and 20)                                                                                                                                                     |  |      |             |   |      |   |             |  
|Stockholders' equity:                                                                                                                                                                                                  |  |      |             |   |      |   |             |  
|Series B preferred stock - $.001 par value - 7,235,565 authorized; 3,451,892 and 6,487,491 shares issued and outstanding, respectively (aggregate liquidation preference of $10,355,676 and $19,462,473, respectively) |  |      | 3,452       |   |      |   | 6,487       |  
|Common stock - $.001 par value 400,000,000 authorized;85,643,709 and 84,557,462 shares issued and outstanding, respectively                                                                                            |  |      | 85,643      |   |      |   | 84,557      |  
|Additional paid-in capital                                                                                                                                                                                             |  |      | 34,238,925  |   |      |   | 33,707,953  |  
|Accumulated deficit                                                                                                                                                                                                    |  |      | (27,831,340 | ) |      |   | (11,995,395 | )
|Accumulated other comprehensive income                                                                                                                                                                                 |  |      | (1,502,873  | ) |      |   | 1,725,085   |  
|Total stockholders' equity                                                                                                                                                                                             |  |      | 4,993,807   |   |      |   | 23,528,687  |  
|                                                                                                                                                                                                                       |  |      |             |   |      |   |             |  
|Total liabilities and stockholders' equity                                                                                                                                                                             |  | $    | 23,536,699  |   |      | $ | 33,551,076  |  



The accompanying notes are an integral part of the financial statements



63



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AE BIOFUELS, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS

FOR THE YEARS ENDED DECEMBER 31, 2008, 2007 AND 2006



|                                             |  |      |             |   |      |   |             |      |  |   |            |  
|-------------------------------------------- |  | ---- | ----------- | - | ---- | - | ----------- | ---- |  | - | ---------- | -
|                                             |  | 2008 |             |   | 2007 |   |             | 2006 | 
|Sales                                        |  | $    | 815,655     |   |      | $ |            |      |  | $ | 744,450    |  
|                                             |  |      |             |   |      |   |             |      |  |   |            |  
|Cost of goods sold                           |  |      | 2,214,364   |   |      |   |            |      |  |   | 735,000    |  
|                                             |  |      |             |   |      |   |             |      |  |   |            |  
|Gross profit                                 |  |      | (1,398,709  | ) |      |   |            |      |  |   | 9,450      |  
|                                             |  |      |             |   |      |   |             |      |  |   |            |  
|Research and development                     |  |      | 1,036,948   |   |      |   | 257,761     |      |  |   |           |  
|Selling, general and administrative expenses |  |      | 9,730,022   |   |      |   | 14,650,742  |      |  |   | 6,163,724  |  
|Loss on forward purchase commitments         |  |      | 532,500     |   |      |   |            |      |  |   |           |  
|                                             |  |      |             |   |      |   |             |      |  |   |            |  
|Operating loss                               |  |      | (12,698,179 | ) |      |   | (14,908,503 | )    |  |   | (6,154,274 | )
|                                             |  |      |             |   |      |   |             |      |  |   |            |  
|Other income / (expense)                     |  |      |             |   |      |   |             |      |  |   |            |  
|Interest income                              |  |      | 50,691      |   |      |   | 171,331     |      |  |   |           |  
|Interest expense                             |  |      | (614,426    | ) |      |   | (73,582     | )    |  |   |           |  
|Other income, net of expenses                |  |      | 148,793     |   |      |   | 188,316     |      |  |   |           |  
|Gain from sale of subsidiaries               |  |      |            |   |      |   | 9,061,141   |      |  |   |           |  
|Gain (loss) on foreign currency exchange     |  |      |            |   |      |   | 544,774     |      |  |   | (46,820    | )
|Share agreement cancellation payment         |  |      | (900,000    | ) |      |   |             |      |  |   |           |  
|Registration rights payment                  |  |      | (1,807,748  | ) |      |   |             |      |  |   |           |  
|Income related to 50/50 joint venture        |  |      |            |   |      |   | 50,910      |      |  |   | 132,013    |  
|                                             |  |      |             |   |      |   |             |      |  |   |            |  
|Loss before income taxes                     |  |      | (15,820,869 | ) |      |   | (4,965,613  | )    |  |   | (6,069,081 | )
|                                             |  |      |             |   |      |   |             |      |  |   |            |  
|Income taxes                                 |  |      | (15,076     | ) |      |   | (78,584     | )    |  |   |           |  
|                                             |  |      |             |   |      |   |             |      |  |   |            |  
|Net loss                                     |  | $    | (15,835,945 | ) |      | $ | (5,044,197  | )    |  | $ | (6,069,081 | )
|                                             |  |      |             |   |      |   |             |      |  |   |            |  
|Other comprehensive loss, net of tax         |  |      |             |   |      |   |             |      |  |   |            |  
|Foreign currency translation adjustment      |  |      | (3,227,958  | ) |      |   | 1,531,686   |      |  |   | 193,399    |  
|Comprehensive loss, net of tax               |  | $    | (19,063,903 | ) |      | $ | (3,512,511  | )    |  | $ | (5,875,682 | )
|                                             |  |      |             |   |      |   |             |      |  |   |            |  
|Loss per common share                        |  |      |             |   |      |   |             |      |  |   |            |  
|Basic and diluted                            |  | $    | (0.19       | ) |      | $ | (0.07       | )    |  | $ | (0.09      | )
|Weighted average shares outstanding          |  |      |             |   |      |   |             |      |  |   |            |  
|Basic and diluted                            |  |      | 84,641,642  |   |      |   | 74,006,368  |      |  | $ | 71,261,428 |  



The accompanying notes are an integral part of the financial statements



64



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AE BIOFUELS, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

FOR THE YEARS ENDED DECEMBER 31, 2008, 2007 AND 2006



|                                                                             |  |      |             |   |      |   |             |      |  |   |             |  
|---------------------------------------------------------------------------- |  | ---- | ----------- | - | ---- | - | ----------- | ---- |  | - | ----------- | -
|                                                                             |  | 2008 |             |   | 2007 |   |             | 2006 | 
|Operating activities:                                                        |  |      |             |   |      |   |             |      | 
|Net loss                                                                     |  | $    | (15,835,945 | ) |      | $ | (5,044,197  | )    |  |   | (6,069,081  | )
|Adjustments to reconcile net loss to net cash used in operating activities:  |  |      |             |   |      |   |             |      |  |   |             |  
|Stock based compensation                                                     |  |      | 1,981,524   |   |      |   | 1,274,500   |      |  |   | 363,460     |  
|Expired land options                                                         |  |      | 124,536     |   |      |   | 445,124     |      |  |   |            |  
|Amortization and depreciation                                                |  |      | 425,033     |   |      |   | 69,775      |      |  |   |            |  
|Inventory provision                                                          |  |      | 1,365,682   |   |      |   |             |      |  |   |             |  
|Loss (gain) on forward purchase contracts                                    |  |      | 532,500     |   |      |   | (482,974    | )    |  |   | 46,820      |  
|Amortization of debt discount                                                |  |      | 826,562     |   |      |   |            |      |  |   |            |  
|Registration rights payment                                                  |  |      | 1,807,748   |   |      |   |            |      |  |   |            |  
|Gain on sale of subsidiary                                                   |  |      |            |   |      |   | (854,695    | )    |  |   |            |  
|Loss on impairment of assets                                                 |  |      |            |   |      |   | 5,114,236   |      |  |   |            |  
|Gain on dissolution of joint venture                                         |  |      |            |   |      |   | (8,206,446  | )    |  |   |            |  
|Changes in assets and liabilities:                                           |  |      |             |   |      |   |             |      |  |   |             |  
|Accounts receivable                                                          |  |      | 8,621,006   |   |      |   | (8,933,275  | )    |  |   |            |  
|Inventories                                                                  |  |      | (2,537,088  | ) |      |   |            |      |  |   |            |  
|Prepaid expenses                                                             |  |      | (54,996     | ) |      |   | 288,072     |      |  |   | (348,869    | )
|Other assets                                                                 |  |      | (652,809    | ) |      |   | 416,767     |      |  |   |            |  
|Accounts payable                                                             |  |      | (6,480,203  | ) |      |   | 8,846,132   |      |  |   | 528,800     |  
|Other liabilities                                                            |  |      | 1,230,257   |   |      |   | (55,245     | )    |  |   |            |  
|Income taxes payable                                                         |  |      | (34,092     | ) |      |   | 34,963      |      |  |   |            |  
|Net cash used in operating activities                                        |  |      | (8,680,285  | ) |      |   | (7,087,263  | )    |  |   | (5,478,870  | )
|Investing activities:                                                        |  |      |             |   |      |   |             |      |  |   |             |  
|Purchase of property, plant and equipment                                    |  |      | (5,192,124  | ) |      |   | (12,117,355 | )    |  |   | (14,727,918 | )
|Purchases of time deposits                                                   |  |      |            |   |      |   | (2,459,292  | )    |  |   |            |  
|Redemption of time deposits                                                  |  |      | 2,373,326   |   |      |   |            |      |  |   |            |  
|Cash payments to settle forward contracts                                    |  |      | (200,115    | ) |      |   |            |      |  |   |            |  
|Cash restricted by letter of credit                                          |  |      | 500,000     |   |      |   | (500,000    | )    |  |   |            |  
|Purchase of Marwich II, Ltd., net of losses                                  |  |      |            |   |      |   |            |      |  |   | (662,406    | )
|Exchange rate contract settlements                                           |  |      |            |   |      |   |            |      |  |   | (193,399    | )
|Additions to other assets and intangibles                                    |  |      |            |   |      |   |            |      |  |   | (1,073,872  | )
|Refund of property expenditures                                              |  |      |            |   |      |   | 2,775,000   |      |  |   |            |  
|Return of cash from dissolution of joint venture                             |  |      |            |   |      |   | 8,206,446   |      |  |   |            |  
|                                                                             |  |      |            |   |      |   | 2,000,000   |      |  |   |            |  
|Net cash used in investing activities                                        |  |      | (2,518,913  | ) |      |   | (2,095,201  | )    |  |   | (16,657,595 | )
|Financing activities:                                                        |  |      |             |   |      |   |             |      |  |   |             |  
|Proceeds from short term borrowings (net of cash issuance costs of $500,000) |  |      | 4,500,000   |   |      |   |            |      |  |   | 1,250,000   |  
|Payments of short term borrowings                                            |  |      |            |   |      |   | (1,250,000  | )    |  |   |            |  
|Proceeds from long-term debt (net of cash issuance costs of $54,434)         |  |      | 8,374,313   |   |      |   |            |      |  |   | 250,000     |  
|Payments of long-term debt                                                   |  |      | (1,967,693  | ) |      |   | (241,071    | )    |  |   | (8,929      | )
|Proceeds from settlement                                                     |  |      |            |   |      |   | 200,000     |      |  |   |            |  
|Refund of investment                                                         |  |      |            |   |      |   | (90,000     | )    |  |   |            |  
|Proceeds from sale of preferred stock, net of offering costs                 |  |      |            |   |      |   | 10,056,154  |      |  |   | 21,854,358  |  
|Net cash provided by financing activities                                    |  |      | 10,906,620  |   |      |   | 8,675,083   |      |  |   | 23,345,429  |  
|Effect of exchange rate changes on cash and cash equivalents                 |  |      | (49,919     | ) |      |   | 14,649      |      |  |   |            |  
|Net cash increase (decrease) for period                                      |  |      | (342,497    | ) |      |   | (492,732    | )    |  |   | 1,208,964   |  
|Cash and cash equivalents at beginning of period                             |  |      | 720,402     |   |      |   | 1,213,134   |      |  |   | 4,170       |  
|Cash and cash equivalents at end of period                                   |  | $    | 377,905     |   |      | $ | 720,402     |      |  | $ | 1,213,134   |  



|                                                                                              |   |         |         |  |   |        |        |  |   |   |   |  |  |  |  |  |  |  | 
|--------------------------------------------------------------------------------------------- | - | ------- | ------- |  | - | ------ | ------ |  | - | - | - |  |  |  |  |  |  |  | 
|Supplemental disclosures of cash flow information, cash paid during the year for:             |   |         |         |  |   |        |        | 
|                                                                                              |   |         |         |  |   |        |        |  |  
|Interest paid                                                                                 | $ | 534,729 |         |  | $ | 73,583 |        |  | $ |  |  
|Income taxes, net of refunds                                                                  |   | $       | 51,829  |  |   | $      | 41,834 |  |   | $ |  | 
|                                                                                              |   |         |         |  |   |        |        |  |   |   |   | 
|Supplemental disclosures of cash flow information, non-cash transactions during the year for: |   |         |         |  |   |        |        |  |  
|Issuance of warrants in connection with debt facility                                         |   | $       | 822,500 |  |   |        |        |  |   |  

The accompanying notes are an integral part of the financial statements



65



---





AE BIOFUELS, INC.

CONSOLIDATED STATEMENTS OF STOCKHOLDERS EQUITY

FOR THE YEARS ENDED DECEMBER 31, 2008, 2007 AND 2006



|                                                                               |  |                  |             |   |                          |   |        |                          |  |  |              |   |  |           |        |   |             |  |            |               |  |   |         |   |  |                 |            |   |         |   |        |              |  |   |            |   |  |       |             |   |  |   |            |   |  |   |             |  
|------------------------------------------------------------------------------ |  | ---------------- | ----------- | - | ------------------------ | - | ------ | ------------------------ |  |  | ------------ | - |  | --------- | ------ | - | ----------- |  | ---------- | ------------- |  | - | ------- | - |  | --------------- | ---------- | - | ------- | - | ------ | ------------ |  | - | ---------- | - |  | ----- | ----------- | - |  | - | ---------- | - |  | - | ----------- | -
|                                                                               |  |                  |             |   |                          |   |        |                          |  |  |              |   |  |           |        |   |             |  |            |               |  |   |         |   |  | Paid-in Capital |            |   |         |   |        | Accum. Other |  |   |            |  
|                                                                               |  | Membership Units |             |   | Series B Preferred Stock |   |        | Series A Preferred Stock |  |  | Common Stock |   |  | in excess |        |   | Accumulated |  |            | Comprehensive |  |   | Total   |  
|                                                                               |  | Units            |             |   | Dollars                  |   |        | Shares                   |  |  | Dollars      |   |  | Shares    |        |   | Dollars     |  |            | Shares        |  |   | Dollars |   |  | of Par          |            |   | Deficit |   |        | Income       |  |   | Dollars    |  
|Balance, December 31, 2005                                                     |  |                  | 53,320,000  |   |                          |   | 4,170  |                          |  |  |              |   |  |           |        |   |             |  |            |               |  |   |         |   |  |                 |            |   |         |   |        |              |  |   |            |   |  | 4,170 |            
|                                                                               |  |                  |             |   |                          |   |        |                          |  |  |              |   |  |           |        |   |             |  |            |               |  |   |         |   |  |                 |            |   |         |   |        |              |  |   |            |   |  |       |            
|Conversion of units to common shares                                           |  |                  | (53,320,000 | ) |                          |   | (4,170 | )                        |  |  |             |   |  |           |       |   |             |  |           |               |  |   |        |   |  |                 | 53,320,000 |   |         |   | 53,320 |              |  |   | (49,150    | ) |  |       |            |   |  |   |           |   |  |   |            |  
|Sale and grant of founders shares to advisors and strategic partners         |  |                  |             |   |                          |   |        |                          |  |  |             |   |  |           |       |   |             |  |           |               |  |   |        |   |  |                 | 12,692,000 |   |         |   | 12,692 |              |  |   | 26,038     |   |  |       |            |   |  |   |           |   |  |   | 38,730      |  
|                                                                               |  |                  |             |   |                          |   |        |                          |  |  |              |   |  |           |        |   |             |  |            |               |  |   |         |   |  |                 |            |   |         |   |        |              |  |   |            |   |  |       |             |   |  |   |            |   |  |   |             |  
|Sale of founders shares to executives                                         |  |                  |             |   |                          |   |        |                          |  |  |             |   |  |           |       |   |             |  |           |               |  |   |        |   |  |                 | 4,400,000  |   |         |   | 4,400  |              |  |   | 6,600      |   |  |       |            |   |  |   |           |   |  |   | 11,000      |  
|Shares issued for acquisitions                                                 |  |                  |             |   |                          |   |        |                          |  |  |             |   |  |           |       |   |             |  |           |               |  |   |        |   |  |                 | 3,752,000  |   |         |   | 3,752  |              |  |   | 484,248    |   |  |       |            |   |  |   |           |   |  |   | 488,000     |  
|Shares issued to an outside director                                           |  |                  |             |   |                          |   |        |                          |  |  |             |   |  |           |       |   |             |  |           |               |  |   |        |   |  |                 | 200,000    |   |         |   | 200    |              |  |   | 25,800     |   |  |       |            |   |  |   |           |   |  |   | 26,000      |  
|Shares issued to an employee                                                   |  |                  |             |   |                          |   |        |                          |  |  |             |   |  |           |       |   |             |  |           |               |  |   |        |   |  |                 | 160,000    |   |         |   | 160    |              |  |   | 20,640     |   |  |       |            |   |  |   |           |   |  |   | 20,800      |  
|Sale of Preferred Series A convertible stock net of issuance expenses          |  |                  |             |   |                          |   |        |                          |  |  |             |   |  |           |       |   |             |  | 4,999,999  |               |  |   | 5,000   |   |  |                 |           |   |         |   |       |              |  |   | 14,110,719 |   |  |       |            |   |  |   |           |   |  |   | 14,115,719  |  
|Loss on purchase of subsidiaries                                               |  |                  |             |   |                          |   |        |                          |  |  |             |   |  |           |       |   |             |  |           |               |  |   |        |   |  |                 |           |   |         |   |       |              |  |   |           |   |  |       | (882,117    | ) |  |   |           |   |  |   | (882,117    | )
|Shares issued to a director and advisors                                       |  |                  |             |   |                          |   |        |                          |  |  |             |   |  |           |       |   |             |  |           |               |  |   |        |   |  |                 | 186,000    |   |         |   | 186    |              |  |   | 278,814    |   |  |       |            |   |  |   |           |   |  |   | 279,000     |  
|Sale of Preferred Series B convertible stock net of issuance expenses          |  |                  |             |   |                          |   |        |                          |  |  | 2,828,996    |   |  |           | 2,828  |   |             |  |           |               |  |   |        |   |  |                 |           |   |         |   |       |              |  |   | 7,693,401  |   |  |       |            |   |  |   |           |   |  |   | 7,696,229   |  
|Compensation expense related to options issued to employees                    |  |                  |             |   |                          |   |        |                          |  |  |             |   |  |           |       |   |             |  |           |               |  |   |        |   |  |                 |           |   |         |   |       |              |  |   | 37,659     |   |  |       |            |   |  |   |           |   |  |   | 37,659      |  
|                                                                               |  |                  |             |   |                          |   |        |                          |  |  |              |   |  |           |        |   |             |  |            |               |  |   |         |   |  |                 |            |   |         |   |        |              |  |   |            |   |  |       |             |   |  |   |            |   |  |   |             |  
|Purchase of shares in Marwich II, Ltd. net of acquired losses for current year |  |                  |             |   |                          |   |        |                          |  |  |             |   |  |           |       |   |             |  |           |               |  |   |        |   |  |                 |           |   |         |   |       |              |  |   | (662,406   | ) |  |       |            |   |  |   |           |   |  |   | (662,406    | )
|Net loss from start up operations                                              |  |                  |             |   |                          |   |        |                          |  |  |             |   |  |           |       |   |             |  |           |               |  |   |        |   |  |                 |           |   |         |   |       |              |  |   |           |   |  |       | (6,069,081  | ) |  |   |           |   |  |   | (6,069,081  | )
|Accumulated other comprehensive income                                         |  |                  |             |   |                          |   |        |                          |  |  |             |   |  |           |       |   |             |  |           |               |  |   |        |   |  |                 |           |   |         |   |       |              |  |   |           |   |  |       |            |   |  |   | 193,399    |   |  |   | 193,399     |  
|                                                                               |  |                  |             |   |                          |   |        |                          |  |  |             |   |  |           |        |   |             |  |            |               |  |   |         |   |  |                 |            |   |         |   |        |              |  |   |            |   |  |       |             |   |  |   |            |   |  |   |             |  
|                                                                               |  |                  |             |   |                          |   |        |                          |  |  |              |   |  |           |        |   |             |  |            |               |  |   |         |   |  |                 |            |   |         |   |        |              |  |   |            |   |  |       |             |   |  |   |            |   |  |   |             |  
|Balance at December 31, 2006                                                   |  |                  |            |   |                          | $ |       |                          |  |  | 2,828,996    |   |  | $         | 2,828  |   |             |  | 4,999,999  |               |  | $ | 5,000   |   |  |                 | 74,710,000 |   |         | $ | 74,710 |              |  | $ | 21,972,363 |   |  | $     | (6,951,198  | ) |  | $ | 193,399    |   |  | $ | 15,297,102  |  
|                                                                               |  |                  |             |   |                          |   |        |                          |  |  |              |   |  |           |        |   |             |  |            |               |  |   |         |   |  |                 |            |   |         |   |        |              |  |   |            |   |  |       |             |   |  |   |            |   |  |   |             |  
|Sale of Series B preferred, net of offering costs of $1,009,331                |  |                  |             |   |                          |   |        |                          |  |  | 3,688,495    |   |  |           | 3,689  |   |             |  |            |               |  |   |         |   |  |                 |            |   |         |   |        |              |  |   | 10,052,465 |   |  |       |             |   |  |   |            |   |  |   | 10,056,154  |  
|Forfeited shares of former employee                                            |  |                  |             |   |                          |   |        |                          |  |  |              |   |  |           |        |   |             |  |            |               |  |   |         |   |  |                 | (800,000   | ) |         |   | (800   | )            |  |   | 800        |   |  |       |             |   |  |   |            |   |  |   |            |  
|Addition Paid in Capital from settlement                                       |  |                  |             |   |                          |   |        |                          |  |  |              |   |  |           |        |   |             |  |            |               |  |   |         |   |  |                 |            |   |         |   |        |              |  |   | 200,000    |   |  |       |             |   |  |   |            |   |  |   | 200,000     |  
|Shares issued to employee as compensation                                      |  |                  |             |   |                          |   |        |                          |  |  |              |   |  |           |        |   |             |  |            |               |  |   |         |   |  |                 | 5,000      |   |         |   | 5      |              |  |   | 14,995     |   |  |       |             |   |  |   |            |   |  |   | 15,000      |  
|Stock based employee compensation                                              |  |                  |             |   |                          |   |        |                          |  |  |              |   |  |           |        |   |             |  |            |               |  |   |         |   |  |                 |            |   |         |   |        |              |  |   | 1,259,500  |   |  |       |             |   |  |   |            |   |  |   | 1,259,500   |  
|Refund of Investment                                                           |  |                  |             |   |                          |   |        |                          |  |  | (30,000      | ) |  |           | (30    | ) |             |  |            |               |  |   |         |   |  |                 |            |   |         |   |        |              |  |   | (89,970    | ) |  |       |             |   |  |   |            |   |  |   | (90,000     | )
|Shares issued in connection with business combination                          |  |                  |             |   |                          |   |        |                          |  |  |              |   |  |           |        |   |             |  |            |               |  |   |         |   |  |                 | 200,000    |   |         |   | 200    |              |  |   | 299,800    |   |  |       |             |   |  |   |            |   |  |   | 300,000     |  
|Foreign currency translation adjustment                                        |  |                  |             |   |                          |   |        |                          |  |  |              |   |  |           |        |   |             |  |            |               |  |   |         |   |  |                 |            |   |         |   |        |              |  |   |            |   |  |       |             |   |  |   | 1,531,686  |   |  |   | 1,531,686   |  
|Net loss                                                                       |  |                  |             |   |                          |   |        |                          |  |  |              |   |  |           |        |   |             |  |            |               |  |   |         |   |  |                 |            |   |         |   |        |              |  |   |            |   |  |       | (5,044,197  | ) |  |   |            |   |  |   | (5,044,197  | )
|Conversion of Series A Shareholders                                            |  |                  |             |   |                          |   |        |                          |  |  |              |   |  |           |        |   |             |  | (4,999,999 | )             |  |   | (5,000  | ) |  |                 | 9,999,998  |   |         |   | 10,000 |              |  |   | (5,000     | ) |  |       |             |   |  |   |            |   |  |   |            |  
|Merger of shares formerly Marwich II                                           |  |                  |             |   |                          |   |        |                          |  |  |              |   |  |           |        |   |             |  |            |               |  |   |         |   |  |                 | 442,464    |   |         |   | 442    |              |  |   | 3,000      |   |  |       |             |   |  |   |            |   |  |   | 3,442       |  
|                                                                               |  |                  |             |   |                          |   |        |                          |  |  |              |   |  |           |        |   |             |  |            |               |  |   |         |   |  |                 |            |   |         |   |        |              |  |   |            |   |  |       |             |   |  |   |            |   |  |   |             |  
|Balance at December 31, 2007                                                   |  |                  |             |   |                          |   |        |                          |  |  | 6,487,491    |   |  | $         | 6,487  |   |             |  |           |               |  | $ |        |   |  |                 | 84,557,462 |   |         | $ | 84,557 |              |  | $ | 33,707,953 |   |  | $     | (11,995,395 | ) |  | $ | 1,725,085  |   |  | $ | 23,528,687  |  
|                                                                               |  |                  |             |   |                          |   |        |                          |  |  |              |   |  |           |        |   |             |  |            |               |  |   |         |   |  |                 |            |   |         |   |        |              |  |   |            |   |  |       |             |   |  |   |            |   |  |   |             |  
|Stock based employee compensation                                              |  |                  |             |   |                          |   |        |                          |  |  |              |   |  |           |        |   |             |  |            |               |  |   |         |   |  |                 |            |   |         |   |        |              |  |   | 1,956,524  |   |  |       |             |   |  |   |            |   |  |   | 1,956,524   |  
|Series B to Common conversion                                                  |  |                  |             |   |                          |   |        |                          |  |  | (2,461,695   | ) |  |           | (2,461 | ) |             |  |            |               |  |   |         |   |  |                 | 2,461,695  |   |         |   | 2,461  |              |  |   |            |   |  |       |             |   |  |   |            |   |  |   |            |  
|Warrant exercise                                                               |  |                  |             |   |                          |   |        |                          |  |  | 9,430        |   |  |           | 9      |   |             |  |            |               |  |   |         |   |  |                 | 504,552    |   |         |   | 505    |              |  |   | (514       | ) |  |       |             |   |  |   |            |   |  |   |            |  
|Foreign currency translation adjustment                                        |  |                  |             |   |                          |   |        |                          |  |  |              |   |  |           |        |   |             |  |            |               |  |   |         |   |  |                 |            |   |         |   |        |              |  |   |            |   |  |       |             |   |  |   | (3,227,958 | ) |  |   | (3,227,958  | )
|Debt issuance discount                                                         |  |                  |             |   |                          |   |        |                          |  |  |              |   |  |           |        |   |             |  |            |               |  |   |         |   |  |                 |            |   |         |   |        |              |  |   | 822,500    |   |  |       |             |   |  |   |            |   |  |   | 822,500     |  
|Repurchase of common stock                                                     |  |                  |             |   |                          |   |        |                          |  |  |              |   |  |           |        |   |             |  |            |               |  |   |         |   |  |                 | (1,880,000 | ) |         |   | (1,880 | )            |  |   | (498,119   | ) |  |       |             |   |  |   |            |   |  |   | (499,999    | )
|Reclassification of Series B preferred stock to a liability                    |  |                  |             |   |                          |   |        |                          |  |  | (583,334     | ) |  |           | (583   | ) |             |  |            |               |  |   |         |   |  |                 |            |   |         |   |        |              |  |   | (1,749,419 | ) |  |       |             |   |  |   |            |   |  |   | (1,750,002  | )
|Net loss                                                                       |  |                  |             |   |                          |   |        |                          |  |  |              |   |  |           |        |   |             |  |            |               |  |   |         |   |  |                 |            |   |         |   |        |              |  |   |            |   |  |       | (15,835,945 | ) |  |   |            |   |  |   | (15,835,945 | )
|                                                                               |  |                  |             |   |                          |   |        |                          |  |  |              |   |  |           |        |   |             |  |            |               |  |   |         |   |  |                 |            |   |         |   |        |              |  |   |            |   |  |       |             |   |  |   |            |   |  |   |             |  
|Balance at December 31, 2008                                                   |  |                  |             |   |                          |   |        |                          |  |  | 3,451,892    |   |  | $         | 3,452  |   |             |  |           |               |  | $ |        |   |  |                 | 85,643,709 |   |         | $ | 85,643 |              |  | $ | 34,238,925 |   |  | $     | (27,831,340 | ) |  | $ | (1,502,873 | ) |  | $ | 4,993,807   |  

The accompanying notes are an integral part of the financial statements



66





---





AE BIOFUELS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

1. Nature of Activities and Summary of Significant Accounting Policies.

Nature of Activities. These consolidated financial statements include the accounts of AE Biofuels, Inc., a Nevada corporation, and its wholly owned subsidiaries: (i) American Ethanol, Inc. (American), a Nevada corporation and its subsidiaries; Sutton Ethanol, LLC (Sutton), a Nebraska limited liability company, Illinois Valley Ethanol, LLC (Illinois Valley), an Illinois limited liability company; Danville Ethanol Inc, an Illinois corporation; and Energy Enzymes LLC, a Delaware limited liability company; (ii) Biofuels Marketing, a Delaware corporation; (iii) International Biodiesel, Inc., a Nevada corporation and its subsidiary International Biofuels, Ltd, a Mauritius corporation and its subsidiary Universal Biofuels Private Ltd, an India company; and (iv) AE Biofuels Americas, a Delaware corporation collectively, (AE Biofuels or the Company).

The Company is an international biofuels company focused on the development, acquisition, construction and operation of next-generation fuel grade ethanol and biodiesel facilities, and the distribution, storage, and marketing of biofuels. The Company began selling fuel grade biodiesel from its production facility in Kakinada in November 2008 and opened and began operating a cellulosic ethanol commercial demonstration facility in Butte, Montana in August 2008.

On December 7, 2007, American Ethanol merged with and into a wholly-owned subsidiary of 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 shares of common stock for each share of Series A preferred stock immediately before the closing of the Merger) and Series B preferred stock (also convertible into common stock at the holders discretion) converted into common stock or Series B preferred stock, respectively, of Marwich, and (ii) each issued and outstanding warrant and/or option exercisable for common stock or Series B preferred stock of American Ethanol was assumed and converted into a warrant and/or option exercisable for common stock or Series B preferred stock of Marwich, respectively. Marwich then changed its name to AE Biofuels, Inc.

Development Stage Enterprise. The Company prepared its statements in accordance with the Development Stage Enterprise guidance as specified in SFAS No. 7 Accounting and Reporting by Development Stage Enterprises (SFAS 7) until October 1, 2008, when planned principal operations commenced.

Principles of Consolidation. The consolidated financial statements include the accounts of the Company and its subsidiaries. All material inter-company accounts and transactions are eliminated in consolidation.

Use of Estimates. The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and revenues and expenses during the reporting period. Significant estimates, assumptions and judgments made by management include the determination of impairment of long-lived assets, the valuation of equity instruments such as options and warrants, the recognition and measurement of current taxes payable and deferred tax assets or liabilities, and the accrual for the payments under the Companys registration rights agreement with certain of its shareholders and managements judgment about contingent liabilities. Management believes that the estimates and judgments upon which they rely are reasonable based upon information available to them at the time that these estimates and judgments are made. To the extent there are material differences between these estimates and actual results, the Companys consolidated financial statements will be affected.

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

Revenue recognition. The Company recognizes revenue when products are shipped, the price is fixed or determinable and collection is reasonably assured.

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

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



67



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AE BIOFUELS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Accounts Receivable. Accounts receivable consist of commodities purchased and resold either secured by letters of credit or made to large credit worthy customers. Peripheral or incidental purchases and subsequent sales of commodities are recorded as net other income.

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

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

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, unless they have alternative future uses to the Company.

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, 2008, 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.

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 positions 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.



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AE BIOFUELS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Basic and Diluted Net Loss per Share.Basic loss per share is computed by dividing loss attributable to common shareholders by the weighted average number of common shares outstanding for the period, net of shares subject to repurchase. Diluted loss per share reflects the dilution of common stock equivalents such as options, convertible preferred stock and warrants to the extent the impact is dilutive. Basic loss per share includes the vested portion of restricted stock grants. The unvested restricted stock grants are included only in the fully diluted net loss per share calculation. As the Company incurred net losses for the years ended December 31, 2008, 2007 and 2006, potentially dilutive securities have been excluded from the diluted net loss per share computations as their effect would be anti-dilutive.

The following table shows the weighted-average number of potentially dilutive shares excluded from the diluted net loss per share calculation for the year ended December 31, 2008, 2007 and 2006:

|                                                                                                                      |  |                                |            |  |      |  |           |      |  |  |            | 
|--------------------------------------------------------------------------------------------------------------------- |  | ------------------------------ | ---------- |  | ---- |  | --------- | ---- |  |  | ---------- | 
|                                                                                                                      |  |                                |            |  |      |  |           |      | 
|                                                                                                                      |  | For the year ended December 31 |           
|                                                                                                                      |  | 2008                           |            |  | 2007 |  |           | 2006 | 
|Series A preferred stock                                                                                              |  |                                |           |  |      |  |          |      |  |  | 6,876,711  | 
|Series B preferred stock                                                                                              |  |                                | 5,876,301  |  |      |  | 5,059,201 |      |  |  | 876,632    | 
|Series B warrants                                                                                                     |  |                                | 702,990    |  |      |  | 556,525   |      |  |  | 68,299     | 
|Common stock options and warrants                                                                                     |  |                                | 4,291,853  |  |      |  | 2,075,866 |      |  |  | 240,685    | 
|Unvested restricted stock                                                                                             |  |                                | 375,068    |  |      |  | 1,253,151 |      |  |  | 2,764,110  | 
|Total weighted average number of potentially dilutive shares excluded from the diluted net loss per share calculation |  |                                | 11,246,212 |  |      |  | 8,944,743 |      |  |  | 10,826,437 | 



Series A preferred stock was converted to common stock on a 2:1 basis effective December 7, 2007.

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 investment in this subsidiary is considered indefinitely invested overseas, and as a result, deferred income taxes are not recorded related to the currency translation adjustments.

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.

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 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 and restrictions on sale, or transfer, up until the vesting date.

Fair Value of Financial Instruments.The Companys financial instruments include cash and cash equivalents, mandatorily redeemable Series B preferred stock, short and long-term debt and long-term debt (related party). Cash and cash equivalents are carried at fair value as discussed in Note 19. The Company is unable to estimate the fair value of the mandatorily redeemable Series B preferred stock due to the contingent nature of the ultimate settlement of this liability. The carrying value of the Companys short-term debt approximates fair value due to the short-term maturity of this instrument, which absent an amendment to the existing loan agreement, matures in May 2009. The Companys long-term debt carrying value approximates fair value based upon the borrowing rates currently available to the Company for bank loans in India with similar terms and maturities. The Company is also unable to estimate the fair value of the long-term debt (related party) due to the unsecured nature of this loan and the lack of comparable available credit facilities.

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.



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AE BIOFUELS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

We made the following estimates and assumptions in determining fair value of stock options as prescribed by SFAS 123(R):

·

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

·

Expected Term  The expected term represents the weighted-average period that our stock-based awards are expected to be outstanding. We applied the Simplified Method as defined in the Securities and Exchange Commissions Staff Accounting Bulletin No. 107 and 110.

·

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

·

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

·

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

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 measurements 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. As such, the Company will adopt the provisions of SFAS 157 with respect to non-recurring fair value measurements for non-financial assets and liabilities as of January 1, 2009.

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) 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). The adoption of SFAS 160 will result in reclassification of the 49% noncontrolling interest in our Energy Enzymes, Inc. subsidiary to equity. Under SAS 160, the 49% noncontrolling interest is expected to show a deficit balance.



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AE BIOFUELS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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, if any, that FSP APB 14-1 will have on its consolidated financial statements.

In April 2008, the FASB issued FASB Staff Position Financial Accounting Standard 142-3 (FSP FAS 142-3), Determination of the Useful Life of Intangible Assets. FSP FAS 142-3 amends the factors that should be considered in developing renewal or extension assumptions used to determine the useful life of a recognized intangible asset under SFAS No. 142 (SFAS 142), Goodwill and Other Intangible Assets. The intent of the FSP is to improve the consistency between the useful life of a recognized intangible asset under SFAS 142 and the period of expected cash flows used to measure the fair value of the asset under SFAS No. 141, Business Combinations. We are required to adopt FSP FAS 142-3 in the first quarter of 2009 and will apply it prospectively to intangible assets acquired after the effective date. We do not currently believe that adopting FSP FAS 142-3 will have a material impact on our Consolidated Financial Statements.

In June 2008, the FASB ratified EITF Issue 07-5, Determining Whether an Instrument (or Embedded Feature) Is Indexed to an Entitys Own Stock (EITF 07-5). Paragraph 11(a) of Statement of Financial Accounting Standard No 133 Accounting for Derivatives and Hedging Activities (SFAS 133) specifies that a contract that would otherwise meet the definition of a derivative but is both (a) indexed to the Companys own stock and (b) classified in stockholders equity in the statement of financial position would not be considered a derivative financial instrument. EITF 07-5 provides a new two-step model to be applied in determining whether a financial instrument or an embedded feature is indexed to an issuers own stock and thus able to qualify for the SFAS 133 paragraph 11(a) scope exception. EITF 07-5 will be effective for the first annual reporting period beginning after December 15, 2008, and early adoption is prohibited. The Company is evaluating the impact this standard will have on its consolidated financial statements.

2. Ability to Continue as a Going Concern.

The accompanying financial statements have been prepared on the going concern basis, which contemplates the realization of assets and satisfaction of liabilities in the normal course of business. 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, including the ability to raise a significant amount of capital for operating expenses and capital expenditures.

The Company has minimal revenues, has less than one month of cash, and has incurred losses from inception through December 31, 2008. The Company has raised approximately $31.8 million dollars to date through the sale of preferred stock. An additional $2 million of cash has been generated through the sale of its subsidiary, Wahoo Ethanol, LLC, with an additional $8 million through the dissolution of the Sutton Ethanol Joint venture. 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 one biodiesel production facility in operation that only began selling biodiesel into the domestic Indian in November 2008. Although the biodiesel plant provides some cash flow to the Company it will likely be insufficient to allow for the completion of our business plan.

Management believes that it will be able to raise additional capital through equity offerings and debt financings. Should the Company not be able to raise enough equity or debt financings it may be forced to sell all or a portion of its existing biodiesel facility or other assets to generate cash to continue the Companys business plan or possibly discontinue operations. The Companys goal is to raise additional funds needed to construct and operate next generation ethanol and biodiesel facilities through public stock offerings and debt financings.



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AE BIOFUELS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

3. Inventory.

Inventory consists of the following:

|                 |  |              |           |  |      |   |   | 
|---------------- |  | ------------ | --------- |  | ---- | - | - | 
|                 |  | December 31, |          
|                 |  | 2008         |           |  | 2007 |  
|Raw materials    |  | $            | 674,069   |  |      | $ |  | 
|Work-in-progress |  |              | 53,251    |  |      |   |  | 
|Finished goods   |  |              | 322,263   |  |      |   |  | 
|Total inventory  |  | $            | 1,049,583 |  |      | $ |  | 

For the year ended December 31, 2008, the Company expensed $1,365,682 in connection with the write-down of inventory to reflect market value below cost.

4. Property, Plant and Equipment.

Property, plant and equipment consist of the following:

|                                        |  |                   |            |   |                   |   |            |  
|--------------------------------------- |  | ----------------- | ---------- | - | ----------------- | - | ---------- | -
|                                        |  | December 31,
2008 |            |   | December 31,
2007 |  
|Land                                    |  | $                 | 3,656,676  |   |                   | $ | 3,734,623  |  
|Buildings                               |  |                   | 12,445,883 |   |                   |   |           |  
|Furniture and fixtures                  |  |                   | 73,983     |   |                   |   | 52,747     |  
|Machinery and equipment                 |  |                   | 618,487    |   |                   |   |           |  
|Construction in progress                |  |                   | 4,648,149  |   |                   |   | 15,800,752 |  
|Total gross property, plant & equipment |  |                   | 21,443,178 |   |                   |   | 19,588,122 |  
|Less accumulated depreciation           |  |                   | (206,574   | ) |                   |   | (3,035     | )
|Total net property, plant & equipment   |  | $                 | 21,236,604 |   |                   | $ | 19,585,087 |  

For the years ended December 31, 2008, 2007 and 2006, the Company recorded $219,571, $3,035 and zero, respectively, in depreciation. The Company determined that certain construction in progress costs associated with the repurchase of assets from the Sutton Joint Venture were impaired and an amount of $5,114,236 was recognized as a loss on impairment, during 2007. Interest in the amount of $929,058 was capitalized during 2008. No interest was capitalized in 2007.

In January and February 2007 the Company canceled orders for equipment and services included in property, plant and equipment at December 31, 2006 and received a refund of previously advanced funds of $2,775,000, which was credited to such account.

Components of construction in progress include $2,594,200 related to our India biodiesel pretreatment and glycerin facility (expected to be placed in service during 2009) and $2,053,949 related to the development of our Sutton property (held for future development of a next generation cellulosic ethanol facility). Estimated costs to complete construction of the pretreatment and glycerin facility is $1,000,000, and estimated costs to complete the development of the Sutton property are estimated to be approximately $240 million. In addition, we hold land in Danville, Illinois which is being held for future development.

5. 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.

|                                             |  |                   |         |  |                   |   |         | 
|-------------------------------------------- |  | ----------------- | ------- |  | ----------------- | - | ------- | 
|                                             |  | December 31,
2008 |         |  | December 31,
2007 |  
|Current                                      |  |                   |         |  |                   |  
|Letter of Credit securing material purchases |  | $                 |        |  |                   | $ | 500,000 | 
|Short term deposits                          |  |                   | 235,119 |  |                   |   |        | 
|Foreign input credits                        |  |                   | 112,925 |  |                   |   |        | 
|Land options                                 |  |                   | 40,000  |  |                   |   | 164,536 | 
|Other                                        |  |                   | 50,659  |  |                   |   | 9,699   | 
|                                             |  | $                 | 438,703 |  |                   | $ | 674,235 | 
|Long Term                                    |  |                   |         |  |                   |   |         | 
|Restricted cash                              |  | $                 | 267,600 |  |                   | $ |        | 
|Domain names                                 |  |                   |        |  |                   |   | 46,098  | 
|Deposits                                     |  |                   | 22,390  |  |                   |   | 22,390  | 
|                                             |  | $                 | 289,990 |  |                   | $ | 68,488  | 



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AE BIOFUELS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

The Company acquired options to purchase land in various locations in Nebraska and Illinois. These options gave the Company the right to buy specific property for a set price per acre and typically ended in one to two years.

As of December 31, 2008, the Company had one option to purchase land in Illinois for $934,000. This option expires in May 2009. For the years ended December 31, 2008 and 2007, the Company expensed options that ended or were released in the amount of $124,536 and $445,125, respectively.

6. Intangible Assets.

Intangible assets consist of purchased customer lists (acquired in 2007 in connection with the acquisition of Biofuels Marketing, Inc. discussed in Note 12 below), which have been amortized over an estimated useful life of 18 months. The intangible assets have a cost basis of $300,000 and a net carrying amount of $33,334 and $233,334 at December 31, 2008 and 2007, respectively. For the years ended December 31, 2008 and 2007, the Company recorded $200,000 and $66,666, respectively, in amortization.

7. Debt.

Debt consists of the following:

|                                                          |  |              |            |   |      |   |   | 
|--------------------------------------------------------- |  | ------------ | ---------- | - | ---- | - | - | 
|                                                          |  | December 31, |           
|                                                          |  | 2008         |            |   | 2007 |  
|Revolving line of credit (related party)                  |  | $            | 2,044,691  |   |      |   |  | 
|Secured term loan, net of unamortized discount of $43,200 |  |              | 3,991,013  |   |      |   |  | 
|Less: current portion                                     |  |              | (816,738   | ) |      |   |  | 
|Total long term debt                                      |  |              | 5,218,966  |   |      |   |  | 
|Senior secured note                                       |  |              | 4,504,062  |   |      |   |  | 
|Current portion of long term debt                         |  |              | 816,738    |   |      |   |  | 
|Total current debt                                        |  |              | 5,320,800  |   |      |   |   | 
|Total debt                                                |  | $            | 10,539,766 |   |      | $ |  | 

Scheduled debt repayments as of December 31, 2008, are:

|      |  |                 |            | 
|----- |  | --------------- | ---------- | 
|      |  | Debt
Repayments |           
|2009  |  | $               | 5,771,923  | 
|2010  |  |                 | 1,029,230  | 
|2011  |  |                 | 2,979,230  | 
|2012  |  |                 | 1,029,230  | 
|2013  |  |                 | 174,599    | 
|Total |  | $               | 10,984,212 | 



Senior secured note. On May 16, 2008, Third Eye Capital ABL Opportunities Fund (Purchaser) purchased a 10% senior secured note in the amount of $5 million along with 5 year warrants exercisable for 250,000 shares of common stock at an exercise price of $3.00 per share. The note is secured by first-lien deeds of trust on real property located in Nebraska and Illinois, by a first priority security interest in equipment located in Montana, and a guarantee of $1 million by McAfee Capital LLC (owned by Eric McAfee and his wife). Interest on the note accrues on the unpaid principal balance and is payable on the first business day of each quarter beginning on July 1, 2008. The Company may prepay all or any portion of the outstanding principal amount of the note at any time. The note matures on May 15, 2009, and at that time the outstanding principal amount of the note together with all accrued and unpaid interest thereon will become due.



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AE BIOFUELS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

The Company has two financial covenants, a stock market capitalization covenant and a current ratio covenant. The stock market capitalization covenant requires the Company to maintain an aggregate dollar market value of at least $100,000,000 as of the end of each month. This calculation is performed by multiplying the stock price at the end of each month by the aggregate shares outstanding. The current ratio covenant requires the company to maintain a ratio of at least 1.10:1 exclusive of the indebtedness under the note and the registration rights liability. This calculation is performed by first adjusting the current liabilities by the amount of the note and the registration rights liability, then by applying this denominator to the current assets numerator. The calculations as of December 31, 2008 are as follows:

|                                            |  |                   |             |  
|------------------------------------------- |  | ----------------- | ----------- | -
|                                            |  | December 31,
2008 |            
|Aggregate shares outstanding                |  |                   | 89,095,601  |  
|Share price at December 31, 2008            |  | $                 | .38         |  
|Market Capitalization                       |  | $                 | 33,856,328  |  
|Covenant Requirement                        |  | $                 | 100,000,000 |  
|                                            |  |                   |             |  
|                                            |  | December 31
2008  |            
|Total Current Assets                        |  | $                 | 1,976,772   |  
|                                            |  |                   |             |  
|Total Current Liabilities                   |  |                   | 13,323,926  |  
|Less: Registration Rights Liability         |  |                   | (1,807,748  | )
|Less: 10% Senior Secured Notes              |  |                   | (4,504,062  | )
|Total Current Liabilities for Current Ratio |  | $                 | 7,012,116   |  
|Current Ratio                               |  |                   | 0.28        |  
|Covenant Requirement                        |  |                   | 1.10        |  



The Company was not in compliance with the current ratio covenants for October, November and December 2008 or the stock market capitalization covenant for December under the loan agreement. On May 6, 2009, the Company entered into an amendment and limited waiver (the Amendment) with Third Eye Capital Corporation (Agent) dated March 31, 2009. The Amendment shall be effective upon and subject to satisfaction of certain conditions. The Company acknowledges and agrees that the failure to perform the conditions will constitute an Event of Default under the Agreement and the Agent shall have the right to demand the immediate repayment in full in cash of all outstanding indebtedness owing to Agent under the Agreement. Once the Amendment becomes effective, the Amendment provides for the extension of the maturity date of the $5 Million Promissory Note (the Note) issued to Agent pursuant to that certain Note and Warrant Purchase Agreement dated May 16, 2008, as amended, to December 31, 2009 and it provides for a waiver of certain covenant defaults for a fee. The Company has also agreed to provide Agent additional collateral as security for the Note and has agreed to amend the exercise price of the warrants issued to a price equal to the volume weighted average trading price of a share of Common Stock of the Company for the twenty trading days immediately preceding the date of this Amendment.

While we expect to obtain waivers for the covenant defaults, in the event we are unable to do so, the interest rate under this facility increases by 8% during the period of default and, at the option of the lender, the indebtedness may become immediately due and payable. The Company has no cross default provisions in this or any other debt agreement. As a result, our inability to obtain a waiver will have no adverse impact on our other debt obligations. Nevertheless, the failure to obtain a waiver or the acceleration of this debt obligation as a result of this breach may have an adverse impact on our ability to obtain additional borrowings. There is no assurance that the Company will be able to obtain alternative funding in the event this debt obligation is accelerated. Immediate acceleration would have a significant adverse impact on the Companys near term liquidity.

A discount to the note was recorded based on the relative fair value of the 250,000 warrants issued with the note. For purposes of the relative fair value allocation, the warrants were valued using a Black-Scholes valuation with the following assumptions: five year term, volatility of 58.7%, no dividends and a risk free interest rate of 3.66%. The fair value of the note was estimated using a discounted cash flow analysis. The resulting relative fair value of the warrants of $822,500, combined with a discount of $500,000 related to cash issuance costs, will be amortized over one year, the term of the note.



74



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Amortization of this discount for the year ended December 31, 2008 was $826,562.

AE BIOFUELS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Secured term loan. On July 17, 2008, Universal Biofuels Private Limited (UBPL), a wholly-owned subsidiary, 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 UBPLs assets, consisting of the biodiesel plant and land in Kakinada. Repayments begin June 2009 with quarterly payments in the amount of approximately $275,000. In addition, Suren Ajjarapu, a former officer and member of the Companys board of directors, entered into a Deed of Overall Guarantee on October 16, 2008. The Company has agreed to indemnify Mr. Ajjarapu for any damages incurred by him pursuant to this Deed of Overall Guarantee. The interest rate under this facility is subject to adjustment, based on 0.25% above the Reserve Bank of India advance rate and is currently 13.25%. This loan facility contains certain annual financial covenants. If the Company does not meet the annual covenants, the Company will be charged an additional 1% per annum interest on the outstanding balance.

Revolving line of credit  related party. On November 16, 2006, the Company entered into a short-term loan agreement with a former member of the Companys board of directors. In 2008 this short-term loan agreement was amended to convert the facility into a revolving line of credit with a credit limit of $2,500,000. In addition, the maturity date of the credit facility was extended to January 31, 2011. At December 31, 2008, a total of $2,044,690 was outstanding under this credit facility which accrues interest at 10% interest per annum. All outstanding principal and accrued interest is due and payable on January 31, 2011.

8. Operating Leases

The Company, through its subsidiaries, has non-cancelable operating leases for office space in various worldwide locations and the property housing our cellulosic demonstration facility in Butte. These leases expire at various dates through April 26, 2010. The operating lease for the cellulosic demonstration facility grants the Company the right to purchase the underlying land and building at the end of each lease year. The Company records rent expense on a straight line basis.

Future minimum operating lease payments as of December 31, 2008, are:

|      |  |                 |         | 
|----- |  | --------------- | ------- | 
|      |  | Rental
Payments |        
|2009  |  | $               | 209,975 | 
|2010  |  |                 | 4,348   | 
|Total |  | $               | 214,323 | 



For the year ended December 31, 2008 and 2007, the Company paid rent under operating leases of $276,442 and $101,331, respectively.

9. Stockholders Equity.

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

Convertible Preferred Stock

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

|                         |  |            |            |  |                                            |  |           |      |  |  |           | 
|------------------------ |  | ---------- | ---------- |  | ------------------------------------------ |  | --------- | ---- |  |  | --------- | 
|                         |  | Authorized |            |  | Shares Issued and
Outstanding
December 31, | 
|                         |  | Shares     |            |  | 2008                                       |  |           | 2007 | 
|Series B preferred stock |  |            | 7,235,565  |  |                                            |  | 3,451,892 |      |  |  | 6,487,491 | 
|Undesignated             |  |            | 57,764,435 |  |                                            |  |          |      |  |  |          | 
|                         |  |            | 65,000,000 |  |                                            |  | 3,451,892 |      |  |  | 6,487,491 | 

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



75



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AE BIOFUELS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Significant terms of the designated preferred stock are as follows:

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

·

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

·

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

·

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

·

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

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

Liquidation Preference. In the event of any voluntary or involuntary liquidation, dissolution or winding up of the Company, the holders of the Series B preferred stock are entitled to receive, prior and in preference to any payment to the holders of the common stock, $3.00 per share plus all declared but unpaid dividends (if any) on the Series B preferred stock. If the 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 party (including, without limitation, any stock acquisition, reorganization, merger or consolidation but excluding any sale of stock for capital raising purposes) that results in the voting securities of the Company outstanding immediately prior thereto failing to represent immediately after such transaction or series of transactions (either by remaining outstanding or by being converted into voting securities of the surviving entity or the entity that controls such surviving entity) a majority of the total voting power represented by the outstanding voting securities of the Company, such surviving entity or the entity that controls such surviving entity, or (b) a sale, lease or other conveyance of all or substantially all of the assets of the Company.

Conversion. Holders of Series B preferred stock have the right, at their option at any time, to convert any shares into common stock. Each share of preferred stock will convert into one share of common stock, at the current conversion rate. The conversion ratio is subject to adjustment from time to time in the event of certain dilutive issuances and events, such as stock splits, stock dividends, stock combinations, reclassifications, exchanges and the like. In addition, at such time as the Registration Statement covering the resale of the shares of common stock is issuable, then all outstanding Series B preferred stock shall be automatically converted into common stock at the then effective conversion rate. For the year ended December 31, 2008, holders of 2,461,695 shares of Series B preferred stock elected to convert their shares of Series B preferred stock into 2,461,695 shares of common stock.



76



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AE BIOFUELS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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

The Company is required to make pro rata payments to each eligible stock investor as liquidated damages and not as a penalty, in the amount equal to 0.5% of the aggregate purchase price paid by such investor for the preferred stock for each thirty (30) day period or pro rata for any portion thereof following the date by which or on which such Registration Statement should have been filed or effective, as the case may be. Payments shall be in full compensation to the investors, and shall constitute the investor's exclusive remedy for such events. The amounts payable as liquidated damages shall be paid in cash or shares of common stock at the Companys election. In lieu of registering the securities, the Company elected to issue shares of its common stock to eligible stockholders in full compensation to such stockholders. The liquidated damages ceased accruing in December 2008 when the shares became available for trading in compliance with Rule 144. The Company elected to pay these liquidated damages through the issuance of 406,656 shares of common stock to the holders of shares of our Series B preferred stock. The accrual of the liquidated damages resulted in an expense of $1,807,746, classified in other income/expense, and a corresponding liability classified in the balance sheet as registration rights liability for the year ended December 31, 2008. The Company issued the 406,656 shares of its common stock to eligible stockholders on or about February 12, 2009.

Mandatorily Redeemable Series B preferred stock.In connection with the election of dissenters rights by the Cordillera Fund, L.P., at December 31, 2008 the Company reclassified 583,334 shares with an original purchase price of $1,750,002 out of shareholders equity to a liability called mandatorily redeemable Series B preferred stock and accordingly reduced stockholders equity by the same amount to reflect the Companys estimate of its obligations with respect to this matter. See Note 18  Contingent Liabilities.

Series A Conversion

In December 2007, in connection with the Reverse Merger, American Ethanol converted all Series A preferred stock into common stock of AE Biofuels, Inc. at a two-for-one ratio.

Common Stock

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

During 2007, the Company reacquired 800,000 shares from its former CEO (under the terms of a repurchase agreement) upon his voluntary termination.

The Company issued 200,000 shares in fiscal 2007, for the purchase of Biofuels Marketing, Inc. As discussed in Note 11  Stock-Based Compensation, 100,000 of these shares are subject to vesting based on the continued employment of one key employee.

10. Private Placement of Preferred Stock and Warrants

In connection with the sale of our Series A and B preferred stock, we issued to our placement agent warrants to purchase a number of shares of our Common Stock representing up to 8% of the shares of Series A and Series B preferred stock sold. The warrants are exercisable for a period of seven years from the date of issuance, have a net exercise provision and are transferable. The shares of the Companys common stock issuable upon exercise of the warrants must be included in any Registration Statement filed by the Company with the Securities and Exchange Commission. 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.



77



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AE BIOFUELS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS



A summary of warrant activity for placement warrants for 2008 and 2007 is as follows:



|                               |  |                    |           |   |                                  |   |      |                      |  |  |                        |   |  |  |      | 
|------------------------------ |  | ------------------ | --------- | - | -------------------------------- | - | ---- | -------------------- |  |  | ---------------------- | - |  |  | ---- | 
|                               |  |                    |           |   |                                  |   |      |                      |  |  |                        |  
|                               |  | Number of
Warrants |           |   | Weighted-
Average
Exercise
Price |   |      | Warrants
Exercisable |  |  | Remaining
Term
(years) |  
|Outstanding, December 31, 2006 |  |                    | 1,020,653 |   |                                  |   | 1.82 |                      |  |  | 1,020,653              |   |  |  | 6.7  | 
|Granted                        |  |                    | 527,421   |   |                                  |   | 3.00 |                      |  |  | 527,421                |   |  |  |      | 
|Exercised                      |  |                    |          |   |                                  |   |     |                      |  |  |                        |   |  |  |      | 
|Outstanding, December 31, 2007 |  |                    | 1,548,074 |   |                                  | $ | 3.00 |                      |  |  | 1,548,074              |   |  |  | 6.1  | 
|Granted                        |  |                    |          |   |                                  |   |     |                      |  |  |                        |   |  |  |      | 
|Exercised                      |  |                    | (881,487  | ) |                                  |   | 3.00 |                      |  |  | (881,487               | ) |  |  |      | 
|Outstanding, December 31, 2008 |  |                    | 666,587   |   |                                  |   | 3.00 |                      |  |  | 666,587                |   |  |  | 3.45 | 

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 former member of the Companys 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 from the Series A and B financing. During 2008, he net exercised the warrant for 881,487 shares of common stock resulting in the issuance of 504,552 shares of common stock and transferred 175,000 warrants to another individual.

Warrants

In May 2008, we issued 250,000 common stock warrants to Third Eye Capital in connection with our sale of a 10% senior secured note. These warrants are immediately exercisable at $3.00 per share.

In July 2007, we issued 1,200,000 revocable warrants to Thames Advisory, Ltd. and paid $200,000 in consulting fees in exchange for potentially raising a $200 million debt facility. The warrants are earned on the percentage of the offering that is successfully raised before June 30, 2008. To date no warrants have been earned and none are exercisable since no fundraising has occurred.

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

11. Stock-Based Compensation

Common Stock Reserved for Issuance

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

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

|                                 |  |                            |            |   |                  |  |           |                                 |  |   |      | 
|-------------------------------- |  | -------------------------- | ---------- | - | ---------------- |  | --------- | ------------------------------- |  | - | ---- | 
|                                 |  | Shares
Available For
Grant |            |   | Number of
Shares |  |           | Weighted-Average
Exercise Price | 
|Balance as of December 31, 2006  |  |                            |           |   |                  |  |          |                                 |  |   |     | 
|Authorized (2007 plan inception) |  |                            | 4,000,000  |   |                  |  |           |                                 |  |   |      | 
|Granted                          |  |                            | (1,984,000 | ) |                  |  | 1,984,000 |                                 |  | $ | 3.00 | 
|Exercised                        |  |                            |           |   |                  |  |          |                                 |  |   |     | 
|Forfeited                        |  |                            |           |   |                  |  |          |                                 |  |   |     | 
|Balance as of December 31, 2007  |  |                            | 2,016,000  |   |                  |  | 1,984,000 |                                 |  | $ | 3.00 | 
|Granted                          |  |                            | (1,222,000 | ) |                  |  | 1,222,000 |                                 |  | $ | 3.85 | 
|Exercised                        |  |                            |           |   |                  |  |          |                                 |  |   |     | 
|Forfeited                        |  |                            | 696,500    |   |                  |  | (696,500  | )                               |  |   |     | 
|Balance as of December 31, 2008  |  |                            | 1,490,500  |   |                  |  | 2,509,500 |                                 |  | $ | 3.24 | 



78



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AE BIOFUELS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

The weighted average remaining contractual term at December 31, 2008 and 2007 is 5.09 and 9.78 years, respectively. The aggregate intrinsic value of the shares outstanding at December 31, 2008 and 2007 is $0 and $18,848,000, respectively. The aggregate intrinsic value represents the total pretax intrinsic value, based on the excess of the Companys closing stock price at December 31, 2008 and 2007 of $0.38 and $12.50, respectively, over the options holders strike price, which would have been received by the option holders had all option holders exercised their options as of that date. The weighted average grant date fair value of these awards issued during the year ended December 31, 2008 and 2007 is $1.59 and $0.85, respectively.

Included in the table above are 549,000 options issued to consultants in November 2007 and June 2008. These options had an exercise price of $3.00 and $3.70, respectively, and generally vest over 3 years. At December 31, 2007 the weighted average remaining contractual term was 3.97 years. The Company recorded an expense for the years ended December 31, 2008 and 2007 in the amount of $219,669 and $296,071, respectively, which reflects 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 outstanding that have vested or are unvested of December 31, 2008 are as follows:

|         |  |                  |           |  |                                 |   |      |                                       |  |  |                            |  |  |   |   | 
|-------- |  | ---------------- | --------- |  | ------------------------------- | - | ---- | ------------------------------------- |  |  | -------------------------- |  |  | - | - | 
|         |  | Number of
Shares |           |  | Weighted
Average
Exercise
Price |   |      | Remaining
Contractual
Term
(In Years) |  |  | Aggregate
Intrinsic
Value1 | 
|Vested   |  |                  | 1,511,751 |  |                                 | $ | 3.12 |                                       |  |  | 5.72                       |  |  | $ |  | 
|Unvested |  |                  | 997,749   |  |                                 | $ | 3.44 |                                       |  |  | 4.54                       |  |  |   |  | 
|Total    |  |                  | 2,509,500 |  |                                 | $ | 3.24 |                                       |  |  | 5.09                       |  |  | $ |  | 



(1)

None of the options were in-the-money based on the $0.38 closing price of AE Biofuels stock on December 31, 2008, as reported on the Over the Counter Bulletin Board. As a result, these options had no intrinsic value.

Non-Plan Stock Options

In 2006, the Company issued 290,000 stock options to employees outside of any stock option plan. None of the options were exercised and all have been forfeited as of December 31, 2008.

Valuation and Expense Information under SFAS 123(R)

The weighted-average fair value calculations for options granted within the period are based on the following weighted average assumptions:

|                                                      |  |                                |       |   |      |              |      |  
|----------------------------------------------------- |  | ------------------------------ | ----- | - | ---- | ------------ | ---- | -
|                                                      |  | Fiscal Year Ended
December 31, |      
|                                                      |  | 2008                           |       |   | 2007 |             
|Risk-free interest rate                               |  |                                | 3.66  | % |      | 3.01 to 5.00 | %   
|Expected volatility                                   |  |                                | 57.77 | % |      |              | 61.9 | %
|Expected life (years)                                 |  |                                | 3.96  |   |      |              | 3.31 |  
|Weighted average fair value per share of common stock |  | $                              | 1.77  |   |      | $            | 0.47 |  

The Company incurred non-cash stock compensation expense of $1,956,524, $1,274,500 and $363,460 in fiscal 2008, 2007 and 2006, respectively, for options granted to our general & administrative employee and consultants. Of the non-cash stock compensation expense for the year ended December 31, 2008, $800,000 was incurred as a result of the accelerated vesting of restricted stock in connection with the termination of one of our officers, which is treated for accounting purposes as a new award and revalued at the market value of the stock on the day of termination, and $150,000 was attributable to stock granted to an officer pursuant to the acquisition of Biofuels Marketing, Inc. discussed in Note 12  Acquisitions, Divestitures and Joint Ventures below. Therefore all stock option expense was classified as general and administrative expense.



79



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AE BIOFUELS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

As of December 31, 2008, 2007 and 2006, there was $1,814,128, $696,048 and $60,058, respectively, of total unrecognized compensation expenses under FAS 123R, net of estimated forfeitures, related to stock options that the Company will amortize over the next four fiscal years.

In January 2006, the Company issued certain employees 4,400,000 shares of common stock at $0.0025 per share in the form of restricted stock awards in connection with employment agreements under restricted unit purchase agreements. These shares were issued as an incentive to retain key employees and officers and will vest over 3 years.

The following table summarizes the Companys repurchase rights under these agreements:

|                                             |  |                  |            |   |                                        |   |         |  
|-------------------------------------------- |  | ---------------- | ---------- | - | -------------------------------------- | - | ------- | -
|                                             |  | Number of
Shares |            |   | Weighted
Average
Grant Date
Fair Value |  
|Repurchasable shares as of January 1, 2006   |  |                  | 4,400,000  |   |                                        | $ | 0.0025  |  
|Vested                                       |  |                  | (1,550,000 | ) |                                        |   | (0.0025 | )
|Forfeited                                    |  |                  |           |   |                                        |   |        |  
|Repurchasable shares as of December 31, 2006 |  |                  | 2,850,000  |   |                                        |   | 0.0025  |  
|Vested                                       |  |                  | (950,000   | ) |                                        |   | (0.0025 | )
|Forfeited                                    |  |                  | (800,000   | ) |                                        |   | (0.0025 | )
|Repurchasable shares as of December 31, 2007 |  |                  | 1,100,000  |   |                                        |   | 0.0025  |  
|Vested                                       |  |                  | (750,000   | ) |                                        |   | (0.0025 | )
|Forfeited                                    |  |                  | (100,000   | ) |                                        |   | (0.0025 | )
|Repurchasable shares as of December 31, 2008 |  |                  | 250,000    |   |                                        | $ | 0.0025  |  

12. 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.

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 ended 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 a selling, general and administrative 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 a gain from sale of subsidiary. All previous agreements between American Ethanol and E85, including the loan facilities with Siva Limited, were ended as of the date of the repurchase of the interest in Sutton.



80



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AE BIOFUELS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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 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, three members 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 effective December 7, 2007, American Ethanol merged with and into a wholly-owned subsidiary of 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 before the closing of the Merger) and Series B preferred stock was converted into common stock and Series B preferred stock, respectively, of Marwich, and (ii) each issued and outstanding option and warrant exercisable for common stock or Series B preferred stock of American Ethanol was assumed and converted into an option or warrant exercisable for common stock or Series B preferred stock of Marwich, respectively. 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 through August 31, 2009, 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.

The acquisitions of Wahoo Ethanol, LLC, Sutton Ethanol, LLC, Illinois Valley Ethanol, LLC, were treated as capital transactions. We accounted for the acquisition of Biofuels Marketing, Inc. using purchase accounting. After the acquisition, the financial results of these entities were consolidated.

Technology Company Formation. On February 28, 2007, 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. The performance milestones had not been met as of December 31, 2008.

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 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 with such fuel being exported from India to the U.S. for sale. Under the terms of the joint venture 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 entity through a leasing arrangement. On August 22, 2007, the Company and Acalmar mutually ended this lease agreement.

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

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, $264,348 has been funded and expensed under the preliminary engineering agreement. On August 10, 2008 the Company and DS Development S.A. mutually agreed to cancel the agreement.



81



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AE BIOFUELS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

13. Commitments.

The Company contracted with Desmet Ballestra India Pvt. Ltd. to build a glycerin refinery and pre-treatment plant at our existing biodiesel plant in Kakinada. At December 31, 2008 and 2007, commitments under construction contracts were outstanding for approximately $57,637 and $1,850,000, respectively. Commitments under purchase orders and other short term construction contracts were $11,079 at December 31, 2008.

14. Segment Information

FASB Statement No. 131, Disclosures about Segments of an Enterprise and Related Information (SFAS 131), establishes standards for reporting information about operating segments. Operating segments are defined as components of an enterprise about which separate financial information is available that is evaluated regularly by the chief operating decision maker (CODM), or decision-making group, in deciding how to allocate resources and in assessing performance. Currently, the CODM is the Chief Financial Officer. In the prior year the Company considered itself to operate within a single operating segment. The commencement of operations in India as well as the opening of the demonstration facility in Butte, MT resulted in the Companys reevaluation of its management structure and reporting around business segments.

AE Biofuels recognized three reportable geographic segments: India, North America and Other.

·

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

·

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

·

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

In addition, the Company determined that it is not necessary to include fiscal year 2006 segment results for the following reasons:

·

It is not practicable to provide such analysis; and

·

It does not add to an understanding of our financial condition, changes in financial condition and results of operations.



82



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AE BIOFUELS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Summarized financial information by reportable segment for the years ended December 31, 2008 and 2007, based on the internal management system, is as follows:

|                             |  |                         |            |   |      |   |   | 
|---------------------------- |  | ----------------------- | ---------- | - | ---- | - | - | 
|                             |  |                         |            |   |      |  
|Statement of Operations Data |  | Year Ended
December 31, |           
|                             |  | 2008                    |            |   | 2007 |  
|Revenues                     |  |                         |            |   |      |  
|India                        |  | $                       | 815,655    |   |      | $ |  | 
|North America                |  |                         |           |   |      |   |  | 
|Other                        |  |                         |           |   |      |   |  | 
|Total revenues               |  | $                       | 815,655    |   |      | $ |  | 
|                             |  |                         |            |   |      |   |   | 
|Cost of goods sold           |  |                         |            |   |      |   |   | 
|India                        |  | $                       | 2,214,364  |   |      |   |  | 
|North America                |  |                         |           |   |      |   |  | 
|Other                        |  |                         |           |   |      |   |  | 
|Total cost of goods sold     |  | $                       | 2,214,364  |   |      | $ |  | 
|                             |  |                         |            |   |      |   |   | 
|Gross profit                 |  |                         |            |   |      |   |   | 
|India                        |  | $                       | (1,398,709 | ) |      | $ |  | 
|North America                |  |                         |           |   |      |   |  | 
|Other                        |  |                         |           |   |      |   |  | 
|Total gross profit           |  | $                       | (1,398,709 | ) |      | $ |  | 

In 2008 all of our revenues were from sales to external customers in our India segment. Because of our limited sales in 2008, three of our customers accounted for approximately 37%, 20%, and 16%, respectively, of our consolidated 2008 revenue. However, as we increase production, we do not expect any single customer to account for more than 10% of our consolidated revenues.

|                              |      |                        |            |      |  |   |            | 
|----------------------------- | ---- | ---------------------- | ---------- | ---- |  | - | ---------- | 
|Balance Sheet Data            |      | Year Ended
December 31 |           
|                              | 2008 |                        |            | 2007 | 
|Total Assets                  |      |                        |            |      |  |  
|India                         |      | $                      | 17,764,708 |      |  | $ | 26,745,283 | 
|North America (United States) |      |                        | 5,416,705  |      |  |   | 5,862,928  | 
|Other                         |      |                        | 355,286    |      |  |   | 942,865    | 
|Total Assets                  |      | $                      | 23,536,699 |      |  | $ | 33,551,076 | 





83



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AE BIOFUELS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

15. Quarterly Financial Data.

The following is a summary of the unaudited quarterly results of operations for the years ended December 31, 2008 and 2007:

|                                                |  |          |        |   |         |   |        |              |  |   |                |   |  |   |        |  
|----------------------------------------------- |  | -------- | ------ | - | ------- | - | ------ | ------------ |  | - | -------------- | - |  | - | ------ | -
|                                                |  |          |        |   |         |   |        |              |  |   |                |  
|2008                                            |  | March 31 |        |   | June 30 |   |        | September 30 |  |   | December 31(1) |  
|(In thousands, except per share amounts)        |  |          |        |   |         |   |        |              |  |   |                |  
|Net sales                                       |  | $        |       |   |         | $ |       |              |  | $ |               |   |  | $ | 816    |  
|Gross profit (loss)                             |  |          |       |   |         |   |       |              |  |   | (952           | ) |  |   | (447   | )
|Operating loss                                  |  |          | (2,086 | ) |         |   | (4,045 | )            |  |   | (3,722         | ) |  |   | (2,845 | )
|Net income (loss)                               |  | $        | (5,233 | ) |         | $ | (4,273 | )            |  | $ | (3,651         | ) |  | $ | (3,146 | )
|Loss per common share, basic and fully diluted: |  | $        | (.06   | ) |         | $ | (.05   | )            |  | $ | (.04           | ) |  | $ | (.04   | )
|2007                                            |  |          |        |   |         |   |        |              |  |   |                |   |  |   |        |  
|(In thousands, except per share amounts)        |  |          |        |   |         |   |        |              |  |   |                |   |  |   |        |  
|Net sales                                       |  | $        |       |   |         | $ |       |              |  | $ |               |   |  | $ |       |  
|Gross profit                                    |  |          |       |   |         |   |       |              |  |   |               |   |  |   |       |  
|Operating loss                                  |  |          | (1,440 | ) |         |   | (1,934 | )            |  |   | (8,612         | ) |  |   | (2,922 | )
|Net income (loss)                               |  | $        | (624   | ) |         | $ | (1,083 | )            |  | $ | 158            |   |  | $ | (3,495 | )
|Loss per common share, basic and fully diluted: |  | $        | (.01   | ) |         | $ | (.01   | )            |  | $ |               |   |  | $ | (.05   | )
|2006                                            |  |          |        |   |         |   |        |              |  |   |                |   |  |   |        |  
|(In thousands, except per share amounts)        |  |          |        |   |         |   |        |              |  |   |                |   |  |   |        |  
|Net sales                                       |  | $        |       |   |         | $ |       |              |  | $ |               |   |  | $ | 744    |  
|Gross profit (loss)                             |  |          |       |   |         |   |       |              |  |   |               |   |  |   | 9      |  
|Operating loss                                  |  |          | (1,065 | ) |         |   | (1,665 | )            |  |   | (1,953         | ) |  |   | (1,471 | )
|Net income (loss)                               |  | $        | (1,040 | ) |         | $ | (1,586 | )            |  | $ | (1,940         | ) |  | $ | (1,503 | )
|Loss per common share, basic and fully diluted: |  | $        | (.02   | ) |         | $ | (.02   | )            |  | $ | (.03           | ) |  | $ | (.02   | )



(1)

The Company made the following adjustments in the fourth quarter of 2008 relating to earlier quarters:

·

The Company reduced the liability for Registration Rights by $466,656 and made an offsetting reduction to the Registration Rights expense to reflect the difference between the original liability recorded in the first quarter of 2008 and the revised calculation of the liability upon issuance of shares in the first quarter of 2009.

·

The Company recorded $240,512 of additional capitalized interest to accurately reflect the interest capitalized related to the construction of our biodiesel facility that was expensed in the second quarter of 2008.

·

The Company adjusted stock based compensation related to options that became fully vested in prior quarters totaling $205,297.

The net impact of all adjustments was a decrease to operating loss of $501,871, an increase to assets of $240,512, a decrease to liabilities of $466,656 and a decrease to additional paid-in capital of $205,297.

16. Related party transactions.

Laird Cagan, a former member of the Companys board of directors and a significant stockholder, provided project financing to the Energy Enzymes subsidiary. At December 31, 2008, a total of $1,950,000 plus accrued interest of $94,690 was outstanding under this credit facility which accrues interest at 10% interest per annum. All outstanding principal and accrued interest is due and payable on January 31, 2011. On September 5, 2008 this credit facility was amended which converted the facility into a revolving line of credit with a credit limit of $2,500,000. In addition, the maturity date of the credit facility was extended to January 31, 2011.

The Company and Eric A. McAfee, the Companys Chief Executive Officer and Chairman of the board of directors, are parties to an agreement pursuant to which the Company pays Mr. McAfee a monthly salary of $10,000 per month for services rendered to the Company as its President and CEO. For each of the years ended December 31, 2008, 2007 and 2006, the Company paid or accrued Mr. McAfee $120,000, $120,000 and $110,000, respectively, pursuant to this agreement. As of December 31, 2008, the Company owed Mr. McAfee $40,000 under the terms of this agreement.



84



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AE BIOFUELS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

The Company and CM Consulting are parties to an agreement pursuant to which the Company reimbursed 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. The Company expensed $30,000, $180,000 and $150,000 of this rental fee for the years ended December 31, 2008, 2007 and 2006 respectively. Eric A. McAfee, a director, officer and significant shareholder of the Company owns 50% of CM Consulting.

The Company and Cagan McAfee Capital Partners are parties to an agreement pursuant to which Cagan McAfee Capital Partners provides administrative and advisory services for a monthly fee of $15,000 plus expense reimbursement to the Company. For the years ended December 31, 2008, 2007 and 2006, the Company paid Cagan McAfee Capital Partners $321,547, $345,046 and $339,479, respectively. Eric A. McAfee, an officer and member of the Companys board of director and Laird Cagan, a former member of the Companys board of directors, together own 100% of Cagan McAfee Capital Partners. As of December 31, 2008, the Company owed CMCP $48,778 under the terms of this agreement.

TIC - 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 plant facility. In August 2007, the Company and TIC ended their relationship, and the company wrote off approximately $5.2 million in design work and construction in progress. On October 6, 2008, the Company and TIC cancelled their Strategic Alliance Agreement and TIC agreed to return 4,000,000 shares of the Companys common stock for a total payment of $500,000 by the Company. Upon cancellation of the agreement, TIC returned 1,880,000 shares and will return the remaining 2,120,000 shares upon the receipt of the final payment. The final payment was not made as required on December 30, 2008 and interest is accruing at the annual rate of 18% until paid in full.

Chadbourn Securities acted as one of the Companys placement agents with respect to the Companys Series B preferred stock offering in 2007. Laird Cagan, a former member of the board of directors and a significant shareholder is an agent of Chadbourn and received payments from Chadbourn related to the sale of stock along with other non-related parties.

During October and December 2007, the Company sold $6,127,727 of crude palm oil 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 and this balance was substantially collected in full. During December 2008, the Company purchased feedstock from Acalmar Oils and Fats, Ltd. in the approximate amount of $470,000. At December 31, 2008, approximately $470,000 remained payable to Acalmar Oils and Fats, Ltd.

In November 2008, we entered into an operating agreement with Secunderabad Oils Limited. Under this agreement Secunderabad agreed to provide us with plant operational expertise on an as-needed basis, and working capital, on an as-needed basis, to fund the purchase of feedstock and other raw materials for our Kakinada biodiesel facility. Working capital advances bear interest at the actual bank borrowing rate of Secunderabad. In return, we agreed to pay Secunderabad an amount equal to 30% of the plants monthly net operating profit. The agreement can be terminated by either party at any time without penalty. Secunderabad began providing us with working capital under this agreement in the first quarter of 2009. Through December 31, 2008, we have not needed any plant operational assistance from Secunderabad.



17. 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. Energy Enzymes, Inc. is 51% owned by the Company, files a separate federal income tax return and is 100% consolidated for financial reporting. State tax returns are filed on a consolidated, combined or separate basis depending on the applicable laws relating to the Company and its subsidiaries.





85



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AE BIOFUELS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Components of tax expense consist of the following:

|                   |  |                         |        |  |      |   |        |      |  |   |   | 
|------------------ |  | ----------------------- | ------ |  | ---- | - | ------ | ---- |  | - | - | 
|                   |  |                         |        |  |      |   |        |      | 
|                   |  | Year Ended December 31, |       
|                   |  | 2008                    |        |  | 2007 |   |        | 2006 | 
|Current:           |  |                         |        |  |      |   |        |      | 
|Federal            |  | $                       | 4,738  |  |      | $ | 33,664 |      |  | $ |  | 
|State and local    |  |                         | 4,008  |  |      |   | 19,421 |      |  |   |  | 
|Foreign            |  |                         | 6,330  |  |      |   | 25,499 |      |  |   |  | 
|                   |  |                         | 15,076 |  |      |   | 78,584 |      |  |   |   | 
|                   |  |                         |        |  |      |   |        |      |  |   |   | 
|Deferred:          |  |                         |       |  |      |   |       |      |  |   |  | 
|Federal            |  |                         |       |  |      |   |       |      |  |   |  | 
|State and local    |  |                         |       |  |      |   |       |      |  |   |  | 
|Foreign            |  |                         |       |  |      |   |       |      |  |   |  | 
|Income tax expense |  | $                       | 15,076 |  |      | $ | 78,584 |      |  | $ |  | 



U.S. loss and foreign income before income taxes are as follows:



|                           |  |                         |             |   |      |   |            |      |  |   |            |  
|-------------------------- |  | ----------------------- | ----------- | - | ---- | - | ---------- | ---- |  | - | ---------- | -
|                           |  | Year Ended December 31, |            
|                           |  | 2008                    |             |   | 2007 |   |            | 2006 | 
|United States              |  | $                       | (12,526,682 | ) |      | $ | (5,585,407 | )    |  | $ | (6,069,081 | )
|Foreign                    |  |                         | (3,294,187  | ) |      |   | 619,794    |      |  |   |           |  
|Income before income taxes |  | $                       | (15,820,869 | ) |      | $ | (4,965,613 | )    |  | $ | (6,069,081 | )



Income tax expense differs from the amounts computed by applying the statutory U.S. federal income tax rate (34%) to income before income taxes as a result of the following:



|                                                 |  |                         |            |    |      |   |            |      |  |   |            |  
|------------------------------------------------ |  | ----------------------- | ---------- | -- | ---- | - | ---------- | ---- |  | - | ---------- | -
|                                                 |  | Year Ended December 31, |           
|                                                 |  | 2008                    |            |    | 2007 |   |            | 2006 | 
|Income tax expense at the federal statutory rate |  | $                       | (5,379,095 | )  |      | $ | (1,688,308 | )    |  | $ | (2,063,488 | )
|Increase (decrease) resulting from:              |  |                         |            |    |      |   |            |      |  |   |            |  
|Net gain on sale of subsidiary                   |  |                         |           |    |      |   | (1,173,803 | )    |  |   |           |  
|State tax                                        |  |                         | (626,506   | )  |      |   | (196,638   | )    |  |   | (443,043   | )
|Stock-based compensation                         |  |                         | 704,066    |    |      |   | 483,800    |      |  |   |           |  
|Foreign loss (income)                            |  |                         | 1,250,473  |    |      |   | (235,274   | )    |  |   | (309,478   | )
|Registration rights                              |  |                         | 686,221    |    |      |   |           |      |  |   |           |  
|Joint venture termination fee                    |  |                         | 341,640    |    |      |   |           |      |  |   |           |  
|Other                                            |  |                         | 57,146     |    |      |   | 24,282     |      |  |   | (46,466    | )
|Valuation allowance                              |  |                         | 2,981,131  |    |      |   | 2,864,526  |      |  |   | 2,862,475  |  
|Income tax expense                               |  | $                       | 15,076     |    |      | $ | 78,584     |      |  | $ |           |  
|                                                 |  |                         |            |    |      |   |            |      |  |   |            |  
|Effective tax rate                               |  |                         | (0.10      | )% |      |   | (1.58      | )%   |  |   | 0          | %





86



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AE BIOFUELS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

The components of the net deferred tax asset or (liability) are as follows:

|                                        |  |              |            |   |      |   |            |  
|--------------------------------------- |  | ------------ | ---------- | - | ---- | - | ---------- | -
|                                        |  |              |            |   |      |  
|                                        |  | December 31, |           
|                                        |  | 2008         |            |   | 2007 |  
|Deferred tax assets (liabilities):      |  |              |            |   |      |  
|Organization and start-up costs         |  | $            | 7,351,996  |   |      | $ | 5,284,869  |  
|Stock-based compensation                |  |              | 738,496    |   |      |   | 206,574    |  
|Property, plant and equipment           |  |              | (933,688   | ) |      |   |           |  
|Net operating loss carryforward         |  |              | 446,101    |   |      |   |           |  
|Other, net                              |  |              | 112,924    |   |      |   | 3,436      |  
|Total deferred tax assets (liabilities) |  |              | 7,715,829  |   |      |   | 5,494,879  |  
|Less valuation allowance                |  | $            | (7,715,829 | ) |      |   | (5,494,879 | )
|Deferred tax assets (liabilities)       |  |              |           |   |      |   |           |  



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



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, 2008 and 2007, these undistributed earnings (losses) totaled approximately ($2,696,187), and $598,000, respectively. If some of these earnings were distributed, some countries may impose withholding taxes. However, due to the Companys overall deficit in foreign cumulative earnings and U.S. loss provision, we do not believe the net unrecognized U.S. deferred tax liability is material.

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 effects 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. Furthermore, we do not reasonably expect the total amount of uncertain tax positions to significantly increase or decrease within the next 12 months. As of December 31, 2008, our uncertain tax positions were not significant.

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

The following describes the open tax years, by major tax jurisdiction, as of December 31, 2008:

|                        |  |                | 
|----------------------- |  | -------------- | 
|United States  Federal |  | 2006 - present | 
|United States  State   |  | 2005 - present | 
|India                   |  | 2006 - present | 
|Mauritius               |  | 2006 - present | 



We file a U.S. federal income tax return and tax returns in nine U.S. states, as well as in two foreign jurisdictions. Currently, our U.S. federal income tax returns dating back to 2006 are open to possible examination. Penalties and interest are classified as general and administrative expenses.



87



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AE BIOFUELS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

As of December 31, 2008, the Company had federal net operating loss carryforwards of $1,175,186 and state net operating loss carryforwards of $1,137,862. The federal net operating loss and other tax credit carryforwards expire on various dates between 2027 and 2028. The state net operating loss carryforwards expire on various dates between 2014 through 2029. Under the current tax law, net operating loss and credit carryforwards available to offset future income in any given year may be limited by statute or upon the occurrence of certain events, including significant changes in ownership interests.

18. 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 the statute; and a permanent injunction compelling the Company to apply the Dissenters Rights Statute to Cordilleras shares and reimburse Cordillera for attorneys fees and costs.

On June 2, 2008 the case was transferred to the Second Judicial Court of the State of Nevada, located in Washoe County, Nevada. On February 17, 2009, a jury trial commenced on the sole issue of whether Cordillera timely delivered its notice of Dissenters Rights to the Company. On February 17, 2009, the jury delivered its verdict in favor of Cordillera. The remaining issue in the lawsuit concerns the fair market value of the shares of stock held by Cordillera and consists of the Court appointing one or more persons as appraisers to receive evidence and recommend a decision on the question of fair value. There is presently no timeline for undertaking this next step in the litigation. Based upon this recent event, the Company reclassified these shares as a liability on its balance sheet. See Note 9  Stockholders Equity.

19. Fair Value of Financial Instruments and Related Measurement

Fair value, as defined in SFAS 157, is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. The fair value of an asset should reflect its highest and best use by market participants, whether using an in-use or an in-exchange valuation premise. The fair value of a liability should reflect the risk of nonperformance, which includes, among other things, the Companys credit risk.

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

Level 1 Inputs

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

Level 2 Inputs

These inputs are other than quoted prices that are observable, for an asset or liability. This includes: quoted prices for similar assets or liabilities in active markets; quoted prices for identical or similar assets or liabilities in markets that are not active; inputs other than quoted prices that are observable for the asset or liability; and inputs that are derived principally from or corroborated by observable market data by correlation or other means.

Level 3 Inputs

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

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



88



---





AE BIOFUELS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS



20. Subsequent Events.

In February, March and April 2009, the Company issued 406,656 shares of common stock to settle liquidated damages under the Registration Rights Agreement. See Note 9  Stockholders Equity above.

In February, March, April and May 2009, the Company borrowed an additional $585,000 under the credit facility provided by Laird Cagan, a former director. See Notes 7 and 16 above.

Our subsidiary Universal Biofuels Pvt. Ltd. applied and is expecting to be granted a license to operate under the Export Promotion Capital Goods taxation program and exit from the Exported Oriented Unit (EOU) taxation holiday. Upon completion, this transition will create an obligation to export approximately $3.8 million of biodiesel over the next eight years. In addition, a payment of tax on the previous purchases of raw material is required. As of December 31, 2008, a tax liability of $31,758 has been recognized for this obligation.

On May 6, 2009, the Company entered into an amendment and limited waiver (the Amendment) with Third Eye Capital Corporation (Agent) on behalf of itself and Third Eye Capital ABL Opportunities Fund (the Purchaser) dated March 31, 2009. Subject to the satisfaction of certain conditions, the Amendment will be effective as of March 31, 2009. The failure to perform the conditions constitutes an Event of Default under the Agreement which gives the Purchaser the right to demand the immediate repayment in full in cash of all outstanding indebtedness owing to Purchaser under the Agreement. Once the Amendment becomes effective, the parties have agreed to extend the maturity date of the $5 Million Promissory Note (the Note) issued to Purchaser pursuant to that certain Note and Warrant Purchase Agreement dated May 16, 2008, as amended, to December 31, 2009 and waive certain covenant defaults. The Company has also agreed to make monthly principal payments on the Note beginning July 31, 2009 in the amount of the greater of (i) $50,000 or (ii) twenty-five percent (25.0%) of the Companys Total Free Cash Flow for the immediately preceding month increasing to the greater of (i) $100,000 or (ii) twenty-five percent (25.0%) of the Companys Total Free Cash Flow for the immediately preceding month commencing October 31, 2009. Total Free Cash Flow means the dollar amount of the Companys and its Subsidiaries (i) total net earnings before interest, taxes, depreciation and amortization, less (ii) interest payments under the Note, less (iii) approved budgeted capital expenditures. Interest payments are due quarterly. In consideration for the waiver of covenant defaults, the Company has agreed to pay Agent a waiver fee of $10,000 per event of default. In consideration for the extension of the Maturity Date, the Company has agreed to pay the Agent an amendment fee of $250,000 and an amendment fee of $100,000 plus all fees, costs and expenses owed to and/or incurred by Agent and its counsel in connection with the Amendment.

The Company has also agreed to provide additional collateral as security for the Note and has agreed to amend the exercise price of the Warrant to a price equal to the volume weighted average trading price of a share of common stock of the Company for the twenty trading days immediately preceding the effective date of the Amendment.



89



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SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.



Date: May 19, 2009

| |                              
| | -----------------------------
| |                              
| | AE Biofuels, Inc.            
| |                              
| | /s/ ERIC A. MCAFEE           
| | Eric A. McAfee               
| | Chief Executive Officer      
| | (Principal Executive Officer)



POWER OF ATTORNEY



KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature appears below constitutes and appoints Eric A. McAfee and Scott A. Janssen, and each of them, his true and lawful attorneys-in-fact, each with full power of substitution, for him in any and all capacities, to sign any amendments to this report on Form 10-K/A and to file the same, with exhibits thereto and other documents in connection therewith, with the Securities and Exchange Commission, hereby ratifying and confirming all that each of said attorneys-in-fact or their substitute or substitutes may do or cause to be done by virtue hereof.



Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated:

|                    |  |                                              |  |             
|------------------- |  | -------------------------------------------- |  | ------------
|                    |  |                                              |  |             
|Signature           |  | Title                                        |  | Date        
|                    |  |                                              |  |             
|/s/ ERIC A. MCAFEE  |  | Chairman/Chief Executive Officer             |  | May 19, 2009
|Eric A. McAfee      |  | (Principal Executive Officer and Director)   |  |             
|                    |  |                                              |  |             
|/s/SCOTT A. JANSSEN |  | Chief Financial Officer                      |  | May 19, 2009
|Scott A. Janssen    |  | (Principal Financial and Accounting Officer) |  |             
|                    |  |                                              |  |             
|**                  |  | Director                                     |  | May 19, 2009
|Michael Peterson    |  |                                              |  |             
|                    |  |                                              |  |             
|**                  |  | Director                                     |  | May 19, 2009
|Harold Sorgenti     |  |                                              |  |             
|                    |  |                                              |  |             
|**                  |  | Director                                     |  | May 19, 2009
|John R. Block       |  |                                              |  |             



|                                    |  |  |  | 
|----------------------------------- |  |  |  | 
|** Power of Attorney                |  |  |  | 
|By: /s/ Eric A. McAfee              |  |  |  | 
|Eric A. McAfee, as attorney in fact |  |  |  | 









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EXHIBIT INDEX

|        |  |                                                                                                                                                                                                                            
|------- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit |  | Description                                                                                                                                                                                                                
|        |  |                                                                                                                                                                                                                            
|10.10   |  | Executive Employment Agreement, dated June 17, 2008 with Scott A. Janssen                                                                                                                                                  
|        |  |                                                                                                                                                                                                                            
|10.11   |  | Executive Employment Agreement, dated September 1, 2007 with Sanjeev Gupta                                                                                                                                                 
|        |  |                                                                                                                                                                                                                            
|14      |  | Code of Ethics                                                                                                                                                                                                             
|        |  |                                                                                                                                                                                                                            
|24      |  | Power of Attorney (see signature page)                                                                                                                                                                                     
|        |  |                                                                                                                                                                                                                            
|31.1    |  | Rule 13a-14(a)/15d-14(a) Certification by the Chief Executive Officer                                                                                                                                                      
|        |  |                                                                                                                                                                                                                            
|31.2    |  | Rule 13a-14(a)/15d-14(a) Certification by the Chief Financial Officer Certification by the Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
|        |  |                                                                                                                                                                                                                            
|32.1    |  | Certification by the Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.                                                                     
|        |  |                                                                                                                                                                                                                            
|32.2    |  | Rule 13a-14(a)/15d-14(a) Certification by the Chief Financial Officer Certification by the Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002