UNITED
STATES SECURITIES AND EXCHANGE COMMISSION
 Washington, D.C. 20549
 
 Form 10-Q
 
 x
              
              QUARTERLY
      REPORT UNDER SECTION 13 OR 15(d)
                OF
      THE SECURITIES EXCHANGE ACT OF 1934FOR
      THE QUARTERLY PERIOD ENDED March 31, 2008ORo
              
              TRANSITION
      REPORT UNDER SECTION 13 OR 15(d)
                OF
      THE SECURITIES EXCHANGE ACT OF 1934
  Commission
File Number 000-50842
  
 Earth
Biofuels, Inc.
 (Exact
name of small business issuer specified in its charter)
 
 Delaware
              
              71-0915825(State
      or other jurisdiction of
                incorporation
      or organization)
              
              (IRS
      Employer
                Identification
      Number)
  3001
Knox Street, Suite 403
 Dallas,
TX 75205
 (Address
of principal executive offices)
  (214) 389-9800
 (Issuer’s
telephone number)
   Indicate
by check mark whether the registrant (1) has filed all reports required to be
filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the
preceding 12 months (or for such shorter period that the registrant was required
to file such reports), and (2) has been subject to such filing requirements for
the past 90 days.xYes   oNo
  
  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.
  Large
accelerated filer 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.
  Large
accelerated filer  oAccelerated
filer o
  Non-accelerated
filer  o
(Do not check if a smaller reporting
company)     Smaller reporting company x
  I       Indicate
by check mark whether the registrant is a shell company (as defined in Rule
12b-2 of the Exchange
Act).                                            Yes
o No
x
  As
of May 16, 2008 there were 324,576,294 shares of common stock of the registrant
outstanding.
  
 
  1
  EARTH BIOFUELS, INC.
  FORM10-Q QUARTERLY REPORT
  PART I
FINANCIAL INFORMATION
  
 Item
      1.
              Financial
      Statements
              2Consolidated Balance Sheets at March 31, 2008 (unaudited), and
      December 31, 2007
              3Consolidated Statements of Operations for the Three Months
      Ended March 31, 2008 and 2007 (unaudited)
              4Consolidated Statement of Stockholders’ Equity for the Three
      Month period ended March 31, 2008 (unaudited)
              5Consolidated Statements of Cash Flows for the Three Months
      Ended March 31, 2008 and 2007 (unaudited)
              6Notes to Consolidated Financial Statements
      (unaudited)
              7Item
      2.
              Management’s Discussion and Analysis of Financial Condition
      and Results of Operations
              23Item
      3.
              Quantitative and Qualitative Disclosures About Market
      Risk
              32Item4.
              Controls and Procedures
              32PART
      II OTHER INFORMATIONItem
      1.
              Legal Proceedings
              34Item
      1A.
              Risk Factors
              35Item
      2.
              Unregistered Sales of Equity Securities and Use of
      Proceeds
              39Item
      3.
              Defaults upon Senior Securities
              44Item
      4.
              Submission of Matters to a Vote of Security
      Holders
              44Item
      5.
              Other Information
              44Item
      6.
              Exhibits
              44Signatures
              
              45Certification
      of Chief Executive OfficerCertification
      of Chief Financial OfficerCertification
      of Chief Executive OfficerCertification
      of Chief Financial Officer
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
  2
 Table of Contents
  Item 1.
 PART I FINANCIAL INFORMATION
 EARTH
BIOFUELS, INC.
 CONSOLIDATED BALANCE SHEETS
 (Unaudited)
 ($ in
thousands except share amounts)
 March 31,
      2008
              
              
              December
      31, 2007Current
      AssetsCash
      and cash equivalents
              
              $
              85
              
              
              $
              42Investments
      in equity securities
              
              
              48
              
              
              
              73Trade
      accounts receivable, net of allowances totaling $31 and
$30
              
              
              2,026
              
              
              
              2,545Inventory
              
              
              147
              
              
              
              159Prepaid
      expenses and other current assets
              
              
              1,526
              
              
              
              2,417Total
      Current Assets
              
              
              3,832
              
              
              
              5,236Property,
      Plant and equipment, net of accumulated depreciation
              
              
              24,405
              
              
              
              25,078Investments
      and advances
              
              
              11,779
              
              
              
              11,740Deferred
      financing fees
              
              
              906
              
              
              
              2,036Goodwill
              
              
              35,533
              
              
              
              35,533Prepaid
      and other long term assets
              
              
              479
              
              
              
              222Total
      Assets
              
              $
              76,934
              
              
              $
              79,845Current
      LiabilitiesAccounts
      payable
              
              $
              15,774
              
              
              $
              12,754Accrued
      interest payable
              
              
              48,151
              
              
              
              48,151Payables
      to related parties
              
              
              50
              
              
              
              253Demand
      Notes
              
              
              976
              
              
              
              679Note
      payable
              
              
              1,376
              
              
              
              1,508Convertible
      promissory notes, net of discount
              
              
              27,354
              
              
              
              24,711Term
      debt facilities
              
              
              28,700
              
              
              
              28,700Accrued
      income taxes
              
              
              17,462
              
              
              
              17,233Total
      Current Liabilities
              
              
              139,843
              
              
              
              133,989Commitments
      and contingencies (Note 14)Redeemable
      preferred stock, $.001 par value, 15,000,000 shares authorized,
      100,000 and 0 shares issued and outstanding at March 31, 2008 and
      December 31, 2007, respectively; liquidation preference of
      $135,000
              
              
              —
              
              
              
              —Redeemable
      preferred stock liability
              
              
              135
              
              
              
              —Stockholders’
      Equity (Deficiency)Common
      stock, $.001 par value, 400,000,000 shares authorized,
      311,576,294 and 308,442,294  shares issued and outstanding, and
      278,389,134 issued and 276,554,134 shares outstanding as of December 31,
      2007
              
              
              311
              
              
              
              278Additional
      paid-in capital
              
              
              155,295
              
              
              
              154,122Accumulated
      deficit
              
              
              (213,952
              )
              
              
              (204,277
              )Notes
      receivable from parent
              
              
              (4,472
              )
              
              
              (4,111
              )Treasury
      stock at cost (3,134,000 shares)
              
              
              (226
              )
              
              
              (156
              )Total
      Stockholders’ Equity (Deficiency)
              
              
              (63,044
              )
              
              
              (54,144
              )Total
      Liabilities and Stockholders’ Equity
              
              $
              76,934
              
              
              $
              79,845
 
 See
accompanying notes to consolidated financial statements
 
  3
 Table of Contents
  
 
 
 
 EARTH
BIOFUELS, INC.
 Statements of Operations
 (Unaudited)
 (Amounts
in 000’s)
 Three Months Ended March 31,2008
              
              
              2007(Restated)Sales
      revenue
              
              $
              7,421
              
              
              $
              6,645Cost
      of sales (exclusive of items shown separately below)
              
              
              5,984
              
              
              
              6,292Gross
      profit
              
              
              1,437
              
              
              
              353Compensation
              
              
              1,979
              
              
              
              5,114Other
      selling, general and administrative
              
              
              3,245
              
              
              
              3,356Depreciation
      and amortization
              
              
              677
              
              
              
              952Total
      operating expenses
              
              
              5,901
              
              
              
              9,422Net
      loss from operations
              
              
              (4,464
              )
              
              
              (9,069
              )Other
      income (expense)Interest
      expense
              
              
              (5,154
              )
              
              
              (16,124
              )Loss
      on sale of fixed assets
              
              
              —
              
              
              
              (120
              )Loss
      on equity investments
              
              
              —
              
              
              
              (315
              )Other
      income
              
              
              (56
              )
              
              
              101Total
      other income (expense)
              
              
              (5,210
              )
              
              
              (16,458
              )Net
      loss
              
              
              (9,674
              )
              
              
              (25,527
              )Other
      Comprehensive expenseUnrealized
      losses on marketable  securities
              
              
              —
              
              
              
              (127
              )Total
      Comprehensive loss
              
              $
              (9,674
              )
              
              $
              (25,654
              )Net
      loss per common shareBasic
      and diluted net loss
              
              $
              (0.042
              )
              
              $
              (0.13
              )Weighted
      average shares
              
              
              225,769
              
              
              
              202,989
 
 
 See accompanying
notes to consolidated financial statements
 
 
  4
 Table of Contents
  
 
 
 
 
 EARTH
BIOFUELS, INC.
 CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
 For
the Three Months Ended March 31, 2008 and For The Year Ended December 31,
2007
 (Unaudited)
 (Amounts
in 000’s)
 
 Common
      Stock Shares
              Common
      Stock at Par
              Additional
      Paid in Capital
              Other
      Comprehensive Income (Loss)
              Treasury
      Stock
              Accumulated
      Deficit
              Note
      Receivable
                from
      Parent
              TotalsBalance
      December 31, 2006 (restated)
              233,047
              233
              145,555
              (570)
              (463)
              (79,572)
              —
              65,183Cumulative
      adjustment for the implementation of FIN 48
              —
              —
              —
              —
              —
              (2,225)
              
              (2,225)Adjusted
      Balance, January 1, 2007
              233,047
              233
              145,555
              (570)
              (463)
              (81,797)
              —
              62,958Parent
      and affiliate note receivable
              —
              —
              —
              —
              —
              —
              (4,111)
              (4,111)Shares
      issued for cash
              7,872
              8
              1,522
              —
              —
              —
              —
              1,530Shares
      issued for services
              7,800
              8
              3,991
              —
              —
              —
              —
              3,999Shares
      forfeited
              (6,000)
              (6)
              —
              —
              —
              —
              —
              (6)Shares
      issued for related parties
              8,219
              8
              1,801
              —
              —
              —
              —
              1,809Shares
      issued for converted debt
              16,922
              17
              102
              —
              —
              —
              —
              119Exercise
      of warrants
              250
              —
              —
              —
              —
              —
              —
              —Unrealized
      losses on marketable securities
              —
              —
              —
              (127)
              —
              —
              —
              (127)Reclassification
      adjustment for losses
                included
      in net income, net of $0 tax effect
              —
              —
              —
              697
              —
              —
              —
              697Treasury
      stock, net of sales and purchases
              (1,556)
              —
              —
              —
              307
              —
              —
              307Share
      issued in connection with demand notes
              10,000
              10
              286
              —
              —
              —
              —
              296Net
      changes in discounts on convertible debts
              —
              —
              865
              —
              —
              —
              —
              865Net
      loss
              —
              —
              —
              —
              —
              (122,480)
              —
              (122,480)Balance
      December 31, 2007
              276,554
              $            
               278
              $                          
          154,122
              $                             —
              $                 
          (156)
              $                              
                   (204,278)
              $                       
         (4,111)
              $                   (54,144)Shares
      issued for services
              30,578
              31
              1,187
              —
              —
              —
              —
              1,218Issuance
      of 100,000 shares of Series A convertible preferred stock including,
      common stock warrants  and beneficial conversion
      feature
              2,000
              2
              (37)
              —
              —
              —
              —
              (35)Shares
      issued for investments
              609
              1
              23
              —
              —
              —
              —
              24Treasury
      Stock
              (1,299)
              (1)
              —
              —
              (70)
              —
              —
              (71)Parent
      and affiliate note receivable
              
              
              
              
              
              
              (361)
              (361)Net
      loss
              —
              —
              —
              —
              —
              (9,674)
              
              (9,674)Balance
                March
      31, 2008
              308,442
              $                       311
              $                               155,295
              $        
               
                              —
              $            (226)
              $                                             (213,952)
              $                      
           (4,472)
              $                 
      (63,044)
 
 
 See
accompanying notes to consolidated financial statements
   5
 Table of Contents
 EARTH
BIOFUELS, INC
 CONSOLIDATED
STATEMENTS OF CASH FLOWS
 For
the Three Months Ended March 31, 2008 and 2007
 (Unaudited)
 (Amounts
in 000’s)
 Three Months Ended March 31,
                2008 2007Cash
      Flows from Operating Activities:
              
              
              
              
              (Restated)Total
      Comprehensive loss
              
              $
              (9,674
              )
              
              $
              (25,527
              )Loss
      on sales of fixed assets
              
              
              —
              
              
              
              121Depreciation
              
              
              677
              
              
              
              737Amortization
      of debt issuance costs
              
              
              220
              
              
              
              215Goodwill
      impairment
              
              
              —
              
              
              
              315Share-based
      compensation expense
              
              
              1,214
              
              
              
              3,818Debt
      discount amortization
              
              
              2,929
              
              
              
              3,556Changes
      in assets and liabilities:Decrease
      (increase) in:Trade
      accounts receivable
              
              
              519
              
              
              
              (500
              )Inventory
              
              
              12
              
              
              
              (17
              )Prepaid
      expenses & other current assets
              
              
              1551
              
              
              
              (586
              )Other
      Assets
              
              
              25
              
              
              
              (2,166
              )Increase
      (decrease) in:Accounts
      payable and accrued expenses
              
              
              3,021
              
              
              
              (1,088
              )Accrued
      interest  payable
              
              
              —
              
              
              
              10,885Other
      liabilities
              
              
              51
              
              
              
              8Net
      cash provided by (used in) operating activities
              
              
              545
              
              
              
              (10,229
              )Cash
      Flows From Investing Activities:Purchases
      of equity securities
              
              
              —
              
              
              
              (71
              )Purchases
      of property, plant and equipment
              
              
              —
              
              
              
              (2,243
              )Investments
      in and advances to related parties
              
              
              (39
              )
              
              
              (2,296
              )Proceeds
      from the sale of property, plant and equipment
              
              
              —
              
              
              
              75Increase
      in notes receivable
              
              
              (361
              )
              
              
              (5,441
              )Net
      cash used in investing activities
              
              
              (400
              )
              
              
              (9,976
              )Cash
      Flows From Financing Activities:Proceeds
      from issuance of common stock
              
              
              —
              
              
              
              1,534Proceeds
      from term debt facilities and line of credit
              
              
              —
              
              
              
              29,000Repayments
      of long term debt and line of credit
              
              
              (132
              )
              
              
              (8,653
              )Proceeds
      (purchases) of treasury stock
              
              
              (70
              )
              
              
              463Proceeds
      from issuance of preferred stock
              
              
              100
              
              
              
              —Cash
      paid for debt issuance cost
              
              
              —
              
              
              
              (509
              )Net
      cash provided by financing activities
              
              
              (102
              )
              
              
              21,835Net
      increase (decrease) in cash
              
              
              43
              
              
              
              1,630Cash
      and cash equivalentsBeginning
      of period
              
              
              42
              
              
              
              291End
      of period
              
              $
              85
              
              
              $
              1,921Supplemental
      Cash Flow Disclosures:Cash
      paid for income taxes
              
              $
              —
              
              
              $
              —Cash
      paid for interest
              
              $
              1,205
              
              
              $
              1,574
 See
accompanying notes to consolidated financial statements
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
  6
 Table of Contents
  
 
 EARTH
BIOFUELS, INC.
  NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS
 (UNAUDITED)
 
 
 NOTE 1 — ORGANIZATION AND
MANAGEMENT’S PLANS
 
 Organization
 
 Earth
Biofuels, Inc., (“Earth” or “EBOF”) was incorporated in the state of Nevada on
July 15, 2002. On September 13, 2005, Earth issued
146,100,000 shares of common stock to Apollo Resources International, Inc.,
a Utah corporation, (“Apollo”) in exchange for 80% of the outstanding shares of
common stock of Earth Biofuels, Inc., a Mississippi corporation. With the
acquisition, Apollo (“the parent”) owned approximately 88% of the issued and
outstanding shares of Earth. This transaction has been accounted for as a
recapitalization effected through a reverse merger, such that Earth Biofuels
Operating, Inc. is the “accounting acquirer” for financial reporting purposes.
On October 7, 2005, Earth Biofuels, Inc. (the Mississippi Company) changed
its name to Earth Biofuels Operating, Inc. Effective November 14, 2005; the
domicile of Earth was moved to Delaware by means of a merger of Earth with and
into Earth Biofuels, Inc., a Delaware corporation. As of March 31, 2008, Apollo
Resources International, Inc owned 20% of the outstanding shares, however, due
to the company’s ability to exercise significant influence over EBOF’s operating
and financial policies, and has indirect controlling financial interest, Apollo
is still considered the “Parent of EBOF”.
 
 The
principal business of Earth is the domestic production, supply and distribution
of petroleum diesel-based alternative fuels consisting of pure biodiesel fuel
(B100) for sale directly to wholesalers, and to be used as a blend stock to make
B20. Earth’s primary bio-diesel operations are located in Oklahoma and Texas.
Earth also produces and distributes liquefied natural gas, or LNG, which is
natural gas in its liquid form. The primary LNG operations are in Arizona and
California.
 
 Going
Concern
 
 Earth has
incurred significant losses from operations through March 31, 2008 and
has limited financial resources. The Company also has an accumulated deficit of
$213,952, negative current ratios and negative tangible net worth at March 31,
2008. These factors raise substantial doubt about our ability to continue as a
going concern. . In addition, investors holding $52.5 million in senior
unsecured notes filed with the bankruptcy courts a Chapter 7 – Involuntary
Liquidation against EBOF during the second quarter of 2007. However, on November
14, 2007, EBOF negotiated and executed a settlement agreement (the “Agreement”)
with the above note holders.  The Agreement required the creditors to
dismiss their petition of bankruptcy.
 
 Under the
terms of the Agreement, EBOF and subsidiaries granted certain security interests
to the creditors and will execute a restructuring plan within 180 days. In
addition, one of the accredited investors of the original eight accredited
investors purchased four of the original investors interest, whereby reducing
the number of credit holders to three. The Company is currently in negotiations
with the remaining investors to settle the outstanding debts. The Company
intends to sell certain operating assets and liabilities of the LNG business
through a reverse merger and public offering of the LNG Business, and raise $35
million in the newly formed public company. Management expects that the LNG
Business will be released as a guarantor of the EBOF notes totaling $52.5 by
providing the note holders with a security interest in the newly formed public
company (the “Restructuring”).  The Restructuring will allow the
Company to build new fueling stations, expand geographically and improve the
Company’s sales and marketing efforts.
 
 Management
believes its LNG Business has substantial market value that is not necessarily
reflected by the accompanying financial statements.  The LNG company
acquisitions have produced revenues over the past two years in excess of $50
million, and this market has been the focus of Earth LNG’s underlying company
efforts for over ten years.
  7
 Table of Contents
  The
Company is also in the process of refinancing the term debt related to the
Durant, Oklahoma biodiesel plant, and retrofitting the plant to allow for usage
of other types of raw materials besides soybean oil.  Due to the
significant increase in feedstock prices during the year this plant was idle for
most of 2007, resulting in reduced profit margins.
 
 Earth
believes the LNG business will be a major part of establishing future financial
stability of the Company. The Company also believes the above measures will
significantly enhance the liquidity position, profitability and allow for
repayment to the $52.5M notes holders. Earth’s management is attempting to seek
strategic alternatives, including the pursuit of additional financing for
strategic acquisitions or a merger with other businesses. Management intends to
raise capital through other offerings, secure collateralized debt financing and
use these sources of capital to grow and enhance its alternative fuel production
and distribution operations. If additional funds are raised by issuing debt, we
may be subject to restrictive covenants that could limit our operating
flexibility. Earth’s performance will also be affected by prevailing economic
conditions. Many of these factors are beyond Earth’s control. There can be no
assurance that adequate funds will be available when needed and on acceptable
terms, or that a strategic alternative can be arranged. The accompanying
financial statements do not reflect any adjustments that might result from the
outcome of this uncertainty.
  There can
be no assurance that any of management’s plans as described above will be
successfully implemented or that the Company will continue as a going
concern.
  
 NOTE
2  — SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
 
 The
accompanying consolidated financial statements and the supporting and
supplemental material are the responsibility of the management of Earth
Biofuels, Inc.
 
 Principles of
Consolidation  — Earth’s consolidated financial statements include
the accounts of Earth and it’s wholly and majority owned subsidiaries. All
significant intercompany accounts and transactions have been eliminated in
consolidation.
 
 Use of Estimates  — The
preparation of consolidated 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 the reported amounts of revenues and
expenses during the reporting period. Actual results could differ from those
estimates.
 
 Cash Equivalents  —
Earth considers all highly liquid investments with an original maturity of three
months or less to be cash equivalents.
  8
 Table of Contents
  
 Accounts Receivable  —
Earth uses the allowance method of accounting for doubtful accounts.
The balance is based on historical collections and management’s review of
the current status of existing receivables and estimate as to their
collectibility.
 
 Accounts Receivable  — Tax
Credits  —   Earth files federal excise tax returns each
quarter, claiming refundable biodiesel mixture tax credits. These credits are
accounted for on a gross basis and included as part of sales revenues when
earned.
  Marketable Securities — In
accordance with SFAS  No.  115, “Accounting for Certain Investments in
Debt and Equity Securities”, securities are marked to market with gains and
losses being reflected as unrealized for “available for sale” securities, and
realized gains or losses for “trading securities”. At December 31, 2007 the
market value of investments in equity securities was approximately $73,000. The
change in fair value during the period has been determined to be other than
temporary based on the deteriorations in the credit ratings of the investee, and
the related losses on the investment totaling $1,071,000 are included in
earnings as of December 31, 2007.  Realized losses totaling
approximately $25,000 were recorded as of the three months ended March 31,
2008.
 
 Inventory — Inventories
of fuel purchased and processed are stated at the lower of cost (on a first-in,
first-out, moving-average basis) or market.
 
 Notes Receivable from Parent
and Affiliates  — Notes receivable from Parent and Affiliates
consist of advances made to Apollo Resources pursuant to inter-company credit
agreements. The notes are due upon demand and consist of market interest rates
ranging from 6% to 15%. Amounts advanced to related parties were used to fund
operations and investments. . The amounts due from the parent totaling
approximately $4.5 million was reflected as a reduction in equity in conformity
with the EITF 85-1 and SAB Topic 4-G, which requires that notes or other
receivables from a parent or another affiliate be treated as a deduction from
stockholders’ equity in the balance sheet. In addition during the three months
ended March 31, 2008, LNG executed a purchase agreement with it’s
parent Apollo, whereby the parent is responsible for purchasing natural
gas at daily natural gas spot prices.  Net receivables due from Apollo
Resources increased by approximately $361,000 at March 31, 2008.
  Property, Plant and
Equipment  — Property, plant and equipment are carried at cost.
Depreciation of property, plant and equipment is provided using the straight
line method at rates based on the following estimated useful lives:
 Asset
              LifeBuildings
      and improvements
              8 -
      39  yearsFixtures
      and equipment
              4 -
      20  years
 
 The cost
of asset additions and improvements that extend the useful lives of property and
equipment are capitalized. Routine maintenance and repairs items are charged to
current operations. The original cost and accumulated depreciation of asset
dispositions are removed from the accounts and any gain or loss is reflected in
the statement of operations in the period of disposition.
 
 Impairment of Long-Lived
Assets  — In accordance with Statement of Financial Accounting
Standards No.  144 “Accounting for the Impairment or Disposal of Long-Lived
Assets”, Earth reviews the carrying value of its long-lived assets annually or
whenever events or changes in circumstances indicate that the historical
cost-carrying value of an asset may no longer be appropriate. Earth assesses
recoverability of the carrying value of the asset by estimating the future net
cash flows expected to result from the asset, including eventual disposition. If
the future net cash flows are less than the carrying value of the asset, an
impairment loss is recorded equal to the difference between the asset’s carrying
value and fair value.
 
 Goodwill and Other Intangible
Assets  — Earth accounts for goodwill and other intangible assets in
accordance with SFAS  No.  142, “Goodwill and Other Intangible
Assets.” Goodwill and other intangible assets are periodically tested for
impairment. Earth assesses goodwill for impairment by periodically comparing the
fair value of its reporting units to their carrying amounts to determine if
there is potential impairment. Fair values for reporting units are
  9
 Table of Contents
  determined
based on discounted cash flows, market multiples or appraised values as
appropriate. The fair value of definite lived intangible assets is determined by
using a “relief from royalty” approach.
 
 Accounting for
Derivatives  — Statement of Financial Accounting Standards (“SFAS”)
No.  133, “Accounting for Derivative Instruments and Hedging Activities”
(“SFAS  133”), as amended, requires all derivatives to be recorded on the
balance sheet at fair value. These derivatives, including embedded derivatives
in our structured borrowings, are separately valued and accounted for on our
balance sheet. Fair values for exchange-traded securities and derivatives are
based on quoted market prices. Where market prices are not readily available,
fair values are determined using market based pricing models incorporating
readily observable market data and requiring judgment and
estimates.
 
 In
September 2000, the Emerging Issues Task Force (“EITF”) issued EITF Issue 00-19,
“Accounting for Derivative Financial Instruments Indexed to and Potentially
Settled in, a Company’s Own Stock,” (“EITF  00-19”) which requires
freestanding contracts that are settled in a company’s own stock, including
common stock warrants, to be designated as an equity instrument, asset or a
liability. Under the provisions of EITF  00-19, a contract designated as an
asset or a liability must be carried at fair value on a company’s balance sheet,
with any changes in fair value recorded in earnings. A contract designated as an
equity instrument must be included within equity, and no fair value adjustments
are required.
 
 In
accordance with SFAS  133 and EITF 00-19, during the year ended
December  31, 2006 we determined that several of the outstanding warrants
to purchase our common stock and the embedded conversion
feature, and certain features of our other financial instruments should be
separately accounted for as derivative liabilities. These financial instruments
were subsequently repaid or converted such that there was no derivative
liability as of year end December  31, 2006. Our financial statements for
the year ended December  31, 2006 reflect the realized changes in the fair
value of these derivatives in our consolidated statements of operations as “Gain
(loss) on derivative liability”.
 
 Revenue  — Sales are
recorded at net realizable value, net of allowances for returns, upon shipment
of products to customers. Earth records revenue from federal incentive programs
related to the production of biodiesel when Earth has produced and sold the
biodiesel and completed all the requirements of the applicable incentive
program.  Revenues also consist of liquefied natural gas which is sold to
end users, and is recognized based on actual volumes of lng sold.  Revenue
is recognized in accordance with SEC Staff Accounting Bulletin (SAB) No. 
104 “Revenue Recognition” (“SAB  104”), when persuasive evidence of an
arrangement exists, the fee is fixed or determinable, collectibility is
probable, delivery of a product has occurred and title and risk of loss has
transferred or services have been rendered. Revenues include shipping and
handling costs billed to the customers.
 
 Cost of Product Sales  —
   Cost of sales consists primarily of raw materials costs
incurred to produce or process our product. Shipping and handling costs are
included as a component of costs of product sales in our consolidated statements
of operations because we include in revenue the related costs that we bill our
customers.
 
 Accounting for Share-Based
Compensation  — Earth measures all share-based payments, including
grants of employee stock options, using a fair-value based method in accordance
with Statement of Financial Accounting Standards No.  123R, “Share-Based
Payments.” The cost of services received in exchange for awards of equity
instruments is recognized in the statement of operations based on the grant date
fair value of those awards amortized over the requisite service period. Earth
utilizes a standard option pricing model, the Black-Scholes model, to measure
the fair value of stock options granted.
 
 Earth
determines the measurement date for share-based transactions with non-employees
according to the terms of EITF  96-18, “Accounting for Equity Instruments
That Are Issued to Other Than Employees for Acquiring, or in Conjunction with
Selling, Goods or Services”. Earth measures fair value of equity instruments
using the stock price and other measurement assumptions as of the earlier of
either of the date at which a commitment for performance by the counterparty to
earn the equity instruments is, or the date at which the counterparty’s
performance is complete.
  10
 Table of Contents
  Income Taxes  — Earth
and its subsidiaries file a consolidated federal tax return. Income taxes are
provided based upon the asset and liability method of accounting. Deferred tax
assets and liabilities are recognized for temporary differences between
financial statement carrying amounts and the tax bases of assets and
liabilities, and are measured using the tax rates expected to be in effect when
the differences reverse. Deferred tax assets are also recognized for operating
loss and tax credit carryforwards. The effect on deferred tax assets and
liabilities of a change in tax rates is recognized in the results of operations
in the period that includes the enactment date. A valuation allowance is used to
reduce deferred tax assets when uncertainty exists regarding their
realization.
 
 Net Loss Per Common
Share  — Basic and diluted net loss per common share are presented
in conformity with the SFAS  No.  128, “Earnings Per Share”. Diluted
net loss per share is the same as basic net loss per share as the inclusion of
outstanding options and warrants until their exercise would be anti-dilutive.
Share and per-share data presented throughout the financial statements and notes
reflect a 6-for-1 forward split that Earth declared in November, 2005. Basic net
income per share is computed by dividing net income available to common
shareholders (numerator) by the weighted average number of common shares
outstanding during the year (denominator). Diluted net income per share is
computed using the weighted average number of common shares and dilutive
potential common shares outstanding during the year. Outstanding options and
warrants were not included in the computation of diluted loss per share for
the three months ended March 31, 2008 and 2007 because their
inclusion would be anti-dilutive.
 
 Treasury Stock  — The
Company accounts for treasury stock using the cost method. Under the cost
method, the gross cost of the shares reacquired is charged to a contra equity
account. The stock was acquired for reasons other than its retirement, however,
its ultimate disposition has not yet been decided.
 
 Registration Payments— In
December 2006, The FASB issued No. EITF 00-19-2 “Accounting for Registration
Payment Arrangements”.   The Company adopted EITF 00-19-2 for the year
ended December 31, 2006.  In connection with the Securities Purchase
Agreements and the related Registration Agreements of the company, registration
penalties were incurred for non timely filing of a registration statement, and
effectiveness of a registration statement, equal to 2.5% per month with a
maximum penalty of 12.5%.   As of March 31, 2008 and December 31, 2007
these penalties total $13.4 million and are being classified as accrued interest
with a related charge to interest expense.
 
 Significant
Concentrations — Financial instruments that potentially subject us
to a concentration of credit risk consist principally of trade accounts
receivable. We perform ongoing credit evaluations of our customers and generally
do not require collateral on accounts receivable, as the majority of our
customers are government entities.  We maintain reserves for potential
credit losses, but historically have not experienced any significant losses
related to any particular geographic area.
 
 Municipal
customers represent approximately 46% of the consolidated revenues of the
Company. Total sales to these customers for the three months ended March 31,
2008 was approximately $3,413, and for the twelve months ended December 31, 2007
was approximately $11.9 million.
 
 Significant
Concentrations — Financial instruments that potentially subject us
to a concentration of credit risk consist principally of trade accounts
receivable. We perform ongoing credit evaluations of our customers and generally
do not require collateral on accounts receivable, as the majority of our
customers are government entities.  We maintain reserves for potential
credit losses, but historically have not experienced any significant losses
related to any particular geographic area.
 
 NOTE 
3  — INVENTORIES
 
 At March
31, 2008 and year ended December 31, 2007, respectively, inventories consisted
of the following:
 
 March
      31,
                2008
              
              
              December
      31, 2007Description
              
              ($ in 000’s)
              
              
              ($ in 000’s)Biodiesel
      inventory, finished goods
              
              $
              110
              
              
              $
              127Liquid
      Natural Gas, finished goods
              
              
              37
              
              
              
              32Total
              
              $
              147
              
              
              $
              159
 
 NOTE 
4  — PREPAID EXPENSES AND OTHER ASSETS
 
 Prepaid
expenses and other assets consist of the following at March 31, 2008 and year
ended December 31, 2007:
  March
      31,
                2008
              
              
              December
      31,
                2007Description
              
              ($ in 000’s)
              
              
              ($ in 000’s)Deposits
      on business related assets and office spaces
              
              
              808
              
              
              
              1,193Escrowed
      interest related to term debt facilities
              
              $
              26
              
              
              $
              1,205Current
      portion only deferred financing fees
              
              
              1,057
              
              
              
              —Other
      prepaid assets
              
              
              114
              
              
              
              241Total
              
              
              2,005
              
              
              
              2,639Less
      current portion
              
              
              (1,526
              )
              
              
              (2,417
              )Long
      term prepaid expenses and other assets
              
              $
              479
              
              
              $
              222
 
 
 
 
 
 
 NOTE  5 
— PROPERTY, PLANT AND EQUIPMENT
 
 Property,
plant and equipment as of March 31, 2008 and year ended December 31, 2007
consist of the following:
 
 
 March
      31, 2008
              
              
              December
      31, 2007Property, Plant and
      Equipment
              
              ($ in 000’s)
              
              
              ($ in 000’s)Land
              
              $
              681
              
              
              $
              681Buildings
      and improvements
              
              
              24,880
              
              
              
              24,882Fixtures
      and equipment
              
              
              10,854
              
              
              
              10,494Total
      cost
              
              
              36,415
              
              
              
              36,057Accumulated
      Depreciation
              
              
              (12,010
              )
              
              
              (10,979
              )Net
      property, plant and equipment
              
              $
              24,405
              
              
              $
              25,078
 
 Depreciation
expense for the three months ended March 31, 2008 was $ 677,459.
 
 NOTE 6 —
INVESTMENTS, ADVANCES AND NOTES RECEIVABLE FROM RELATED
PARTIES
 
  Amounts
representing the Corporation’s percentage interest in the underlying net assets
of other significant subsidiaries, and less-than-majority-owned companies in
which a significant ownership percentage interest is held, are included in
“Investments and advances”; there were no significant operations during 2007 or
for the three months ended March 31, 2008, and as such Earth’s share of the net
losses of these companies is $0 in the consolidated
  11
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  statement
of income. Evidence of loss in value that might indicate impairment of
investments in companies accounted for on the equity method is assessed to
determine if such evidence represents a loss in value of the Company’s
investment that is other than temporary. Examples of key indicators include a
history of operating losses, negative earnings and cash flow outlook, and the
financial condition and prospects for the investee’s business segment or
geographic region. If evidence of another than temporary loss in fair value
below carrying amount is determined, impairment is recognized. In the absence of
market prices for the investment, discounted cash flows are used to assess fair
value.
 
 Investments
and advances and impairment amounts consist of the following entities and
amounts as of and for the three months ended March 31, 2008 and year ended
December 31, 2007:
 March
      31, 2008
              
              
              TotalDescription
              Method
              %
      Ownership
              Investments
      and Advance
                (Amounts
      in 000’s)
              Impairment
      Amount
                (Amounts
      in 000’s)Truckers
      Corner, Hillsboro, Texas
              Equity
              49%
              $                                                               
             6,484
              $                                             
                   
         —American
      Earth
              Equity
              100%
              —
              —Systems
      Management, San Antonio, Texas
              Cost
              Advances
      on letter of intent
              —
              —Vertex
      Processing, LP, Houston, Texas
              Cost
              Advances
      on letter of intent
              —
              —Biodiesel
      Investment Group, Danville, Illinois
              Cost
              10%
              4,976
              —Miscellaneous
      investments-Cellulonsic
              Cost
              Advances
      on letters of Intent
              289
              —Earth
      Ethanol -Liquification, Moses Lake
              Cost
              Advances-
      on letter of intent
              —
              —HPS
      Development, L.L.C., Louisiana
              Cost
              Impairment
      related to exchange of investment for Note receivable
              —
              —DFI-Albemarle
      Bio-Refinery, Inc., North Carolina
              Cost
              Notes
      receivable related to letter of intent
              —
              —Blue
      Wireless
              Cost
              Investment
      in related party 5%
              30
              —Total
              
              
              $11,779
              —December
      31, 2007
              
              
              TotalDescription
              Method
              %
      Ownership
              Investments
      and Advance
                (Amounts
      in 000’s)
              Impairment
      Amount
                (Amounts
      in 000’s)Truckers
      Corner, Hillsboro, Texas
              Equity
              49%
              $                                                                      
      6,445
              $                                                              
      —American
      Earth
              Equity
              100%
              —
              (77)Systems
      Management, San Antonio, Texas
              Cost
              Advances
      on letter of intent
              —
              (832)Vertex
      Processing, LP, Houston, Texas
              Cost
              Advances
      on letter of intent
              —
              (2,542)Biodiesel
      Investment Group, Danville, Illinois
              Cost
              10%
              4,976
              —Miscellaneous
      investments-Cellulonsic
              Cost
              Advances
      on letters of Intent
              289
              —Earth
      Ethanol -Liquification, Moses Lake
              Cost
              Advances-
      on letter of intent
              —
              (750)HPS
      Development, L.L.C., Louisiana
              Cost
              Impairment
      related to exchange of investment for Note receivable
              —
              (17,823)DFI-Albemarle
      Bio-Refinery, Inc., North Carolina
              Cost
              Notes
      receivable related to letter of intent
              —
              (Amount
      included below in bad debt expense for $5,525)Blue
      Wireless
              Cost
              Investment
      in related party 5%
              30
              —Total
              
              
              $                                                                    
      11,740
              $(22,024)
 
  12
 Table of Contents
  
 Investments 
—
 
  Trucker’s Corner  — On
April  20, 2006, Earth acquired a 25% limited partnership interest in
Trucker’s Corner, L.P. in exchange for a capital contribution of $1.1 
million in cash, 125,000  shares of Earth’s common stock valued at
$1,120,000, and 250,000  shares of Apollo Resources (Earth’s parent) common
stock. During 2007 Earth increased it’s investment to 50% upon the additional
advances of monies for construction of the related facility.. In February 2008
the company completed the  financing needed to finish the construction
of “Willie’s Place at Carl’s Corner” truck stop located 70 miles south of Dallas
on Interstate 35E. the construction on the remaining final phase of the project
has already begun and management expects the truck stop to open this summer,
2008. This new roadside destination will feature 13 Ultra-High Flow
Master/Satellite dispensers for fueling twelve trucks at a time including a wide
load island. There will also be 4 standard-sized fueling stations with 8 pumps.
All fuel sold at “Willie’s Place” will have some percentage of biofuels,
including “BioWillie®” Premium Biodiesel and ethanol, enabling more drivers to
participate in the green movement in the United States. In addition to the truck
stop fueling facilities, “Willie's Place at Carl’s Corner” will feature two
restaurants, a convenience store, saloon, gift shop featuring official Willie
Nelson merchandise and memorabilia, and the 750 seat performance hall which
still remains from the original “Carl’s Corner” truck stop. Additionally, this
destination for travelers will feature wireless internet access, clean
restrooms, hot showers, laundry facilities, plenty of parking, and a video game
and TV entertainment area. XM radio will also broadcast during live performances
from their studio located within the theater.
  American Earth Fuels
Company  — Earth had planned to begin acquiring and operating retail
service stations through its majority-owned subsidiary, American Earth Fuels
Company (AEFC). Upon further analysis it was determined not to be profitable
business venture and the company was dissolved in 2007.
 
 Biodiesel Investment
Group  — On September  21, 2006, Earth invested approximately
$5  million for an equity interest in a newly-formed company named
“Biodiesel Investment Group”. Biodiesel Investment Group and Bunge North
America, Inc. (“Bunge”), one of the nation’s leading agribusiness firms, have
partnered to start the construction of a biodiesel plant with an annual capacity
of 45 million gallons. Once completed, the plant will be Illinois’ largest
biodiesel production plant. It is anticipated that Earth will enter into an
off-take agreement with the new Illinois LLC for some portion of the biodiesel
production output of the plant. Earth plans to market its share of the new
plant’s production to local and other new markets under its “BioWillie” brand
name.  On March 14, 2008, The Company sold its investment for approximately
$5 million dollars with no gain or loss recorded.  Per the agreement, The
Company will receive cash and stock payments over the next two
years.
 
 
 Earth Ethanol/Liquefaction
Corporation — In 2006, Earth Ethanol, Inc. a 100% owned subsidiary
of Earth entered into an agreement with Liquefaction Corporation to construct
and operate an ethanol production facility located near Moses Lake, Washington.
Due to lack of contributions contemplated under the agreement the business
venture was cancelled by Liquefaction.
 
 Earth Biofuels Technologies—
 During 2006, Earth signed an agreement to become the exclusive
licensor in the United States for the proprietary biodiesel production
technology of Biodiesel Brazil, a company owned by the renowned Dr. Miquel J.
Dabdoub.  A professor from the University of São Paulo in Brazil, Dr.
Dabdoub is founder and chairman of Biodiesel Brazil and a world authority on the
production of biodiesel. Dr. Dabdoub holds a number of patents and proprietary
technologies relating to the production and usage of biodiesel fuel. As a
world-renowned biodiesel authority and the holder of proprietary technologies
relating to the construction of biodiesel facilities, he is an expert in the
efficiencies, output capacities, and quality control measures relating to
biodiesel production and processing. Earth holds the exclusive rights to
Dr. Dabdoub’s technologies throughout North America, and together in 2006,
a new entity was formed.. Accordingly, the purpose of the entity is to utilize
Dr. Dabdoub’s proprietary technologies, to design and construct biodiesel
production facilities, both for us directly and for third
parties.  Additionally, we will use Mr. Dabdoub’s expertise to assess
potential acquisitions of biodiesel production facilities, and to assist in the
due diligence process for our other business opportunities. This company is to
be funded from construction
  13
 Table of Contents
  contracts
obtained. There were no properties under construction as of the three months
ended March 31, 2008. The operations of this entity are consolidated with
Earth.
 
 Advances on Letters of
Intent  —
 
 During
2006, Earth signed a letter of intent to acquire a biodiesel production facility
from Systems Management Solutions, Inc. This agreement was terminated in
2007.
 
 In 2006,
Earth entered into a letter of intent with Vertex Energy, L.P., which
contemplated a joint venture in which a newly created company would own and
operate a biodiesel production facility on the Houston Ship Channel in Houston,
Texas. As contemplated by the letter of intent, Vertex Energy would acquire a
49% interest in the newly created company in exchange for contributing to the
new operating company real property and improvements, including an existing
chemical processing facility. Earth would acquire a 51% interest in the
operating company in exchange for the payment of $2,500,000 and the issuance of
1,500,000 shares of its common stock to Vertex Energy. These shares were
issued in October, 2006 and had a fair market value of $4,320,000. Advances
totaling $658,000 had also been made towards this investment. On
February 5, 2007, Vertex Energy, LP & Benjamin P. Cowart alleged breach
of contract and a motion for new trial was granted. We believe these allegations
are substantively without merit, and are vigorously contesting the claims
brought by the plaintiff, and are exercising all available rights and remedies
against them; however, the ultimate outcome of this matter is uncertain. Due to
the lack of continuing operations at this location the investment amount is
deemed impaired. The company has recorded losses of $2,435,000 during 2006, and
$2,542,000 during 2007, resulting in total estimated impairments of $4,978,000.
Should Vertex prevail in the above proceedings Earth would receive the facility
in question.
 
 On August
31, 2006, Earth entered into letters of intent with HPS Development, L.L.C.
("HPS") which contemplated a joint venture in which a newly created limited
liability company (the "LLC") would own and operate a fuel ethanol distillery
located on the Mississippi River in Plaquemines Parish, Louisiana (the
"Agreement"). As contemplated by the Agreement, HPS was to contribute real
property and improvements in an ethanol distillery for a 50% interest in
LLC.  Earth was to contribute cash totaling $50 million and issue
5,829,005 shares of common stock to HPS as well as the assumption of $40.0
million in debt obligation to be incurred by the operating company in connection
with the renovation of the facility.  We anticipated the renovation of
this facility would take 12 to 14 months, after which time we estimated the
plant would have an ethanol production capacity of 60-80 MMGPY.
 
 Through
June 2007, Earth had invested $27 million in the joint venture without a
security interest.  The Agreement between the parties was disputed and
in June 2007 a settlement agreement was reached whereby HPS would return $4
million in cash and provide an $18 million note to Earth.  In
addition, HPS signed an agreement not to compete valued at $5 million. At of
December 31, 2007, the $18 million note was considered to be impaired and
accordingly, Earth has provided a reserve against this note.  As a
result, Earth recorded a $23 million loss on the LLC investment for the year
ended December 31, 2007, and $0 for the three months ended March 31,
2008.
 
 The
Company’s investment in an Ethanol production facility located
in Albemarle, North Carolina was converted to promissory notes and
subsequently deemed impaired due to lack of activity. The investment totaling
$5,525,000 was written off during 2007 and is included in bad debt
expense.
 
 Notes receivable from
related parties  —
 
 Notes
receivable from related parties consists of advances made to the parent Apollo,
and other related parties pursuant to intercompany credit agreements and notes
related to investments bearing market rates and terms. Total notes receivable as
of March 31, 2008 and year ended December 31, 2007 are as
follows:
 
 
 
 
  14
 Table of Contents
  
 
 
 
 March
      31, 2008
              
              
              December
      31, 2007Description
              
              ($
      in 000’s)
              
              
              ($
      in 000’s)DFI
              
              $
              —
              
              
              $
              5,525AIRO
              
              
              —
              
              
              
              930Other
      related parties
              
              
              —
              
              
              
              370Total
              
              
              —
              
              
              
              6,825Less
      amounts written off to bad debt expense
              
              
              —
              
              
              
              (6,825
              )Long
      term notes receivable from related parties
              
              $
              —
              
              
              $
              0
 
 
 
 Investment  — related
party  —
 
 This
consists of an equity investment with less than 5% ownership interest in Blue
Wireless, a publicly traded company. The Chief Executive Officer of Earth is
also the Chairman of the Board for the related investment. Earth will account
for this investment using the cost method.
 
  NOTE 7 —
INTANGIBLE ASSETS
  Goodwill
recorded on Earth’s balance sheet reflects the purchase price of Earth’s
acquisitions exceeding the fair market value of the net assets. At March 31,
2008, Earth had recorded approximately $35,533,000 in goodwill related to its
acquisition of its LNG businesses.
 
 Earth
determined that, based on the impairment tests performed on Earth as a separate
business unit from the LNG business, the intangible assets related to goodwill
from the acquisition of Distribution Drive totaling $3,981,280 and the $2
million license for the brand name of biodiesel products have been impaired
totaling approximately $6 million.  As such the carrying amounts of
these assets have been written down to zero and charged against earnings. In
addition, a non-compete agreement had been obtained as a result of the
settlement with the HPS investment above.   This intangible was also
deemed to be impaired and $5,000,000 was charged against
earnings.  Total impairments as of March 31, 2008, and December 31,
2007 were $0 and approximately $11million, respectively.
 
 
 NOTE 8 —
DEMAND NOTES —
  On
December 13, 2007, Earth entered into a loan agreement to which Earth issued
10,000,000 shares of common stock in connection with proceeds received of
$550,000. The note and interest of 10% is due at maturity on March 15,
2008.The value of the shares totaling approximately $286,000 was allocated as a
discount on the note. The amount of the note net of discounts as of March 31,
2008 was approximately $550,000.  The maturity date was extended to
June 15, 2008. Amortization totaled $286,000 for the three months ended March
31, 2008.
 
 Earth has
several other demand notes net of discounts totaling $426,403 as of March 31,
2008. The notes are un-collateralized, with interest at 8%, all of which is due
upon demand.
 
 NOTE 9 —
LINE OF CREDIT
  15
 Table of Contents
   On
February 28, 2007, our LNG subsidiary obtained a term note totaling $15 million,
and line of credit facility totaling $5 million. The line of credit was
used to repay a former line of credit due in 2006.  The balance on the
new line of credit as of March 31, 2008 and December 31, 2007was approximately
$1.4 million, and $1.5 million respectively. The revolving credit
facility is advanced at the rate of 85% of accounts receivable. Interest of
prime plus 2% is payable monthly.
 
 In
addition, on March 23, 2007, Earth obtained a $9 million term loan
facility, and a $2.5 million letter of credit secured by the Durant, Oklahoma
biodiesel plant. The line of credit balance as of March 31, 2008, and December
31, 2007 was $0.
 
 
 
 NOTE 
10  — CONVERTIBLE DEBT
 
 Convertible
debt consists of the following as of March 31, 2008 and year ended
December 31, 2007:
 
 Description
              
              March
      31,
                2008
              
              
              December
      31,
                2007($
      in 000’s)
              
              
              ($
      in 000’s)8%
      convertible promissory notes, due August 31, 2011
              
              $
              52,500
              
              
              $
              52,500Discount
      on convertible promissory notes
              
              
              (25,146
              )
              
              
              (27,789
              )Current
      portion of convertible promissory notes
              
              $
              27,354
              
              
              $
              24,711
 
 On
July 24, 2006, Earth entered into a securities purchase agreement pursuant
to which Earth issued $52.5 million aggregate senior convertible notes that
were due in 2011 to eight institutional investors. The notes initially carry an
8% coupon, payable quarterly, and are convertible into shares of common stock at
$2.90 per share. In connection with the issuance of the notes, Earth also issued
five-year warrants to purchase 9,051,725  shares of common stock to the
investors and five-year warrants to purchase 1,357,759  shares of common
stock to Earth’s placement agent, at $2.90  per share.
 
 On
August 11, 2006, Earth entered into a securities purchase agreement
pursuant to which Earth issued $1.1 million aggregate senior convertible
notes that are due in 2011 to two institutional investors. The notes initially
carry an 8% coupon, payable quarterly, and are convertible into shares of common
stock at $2.90 per share.   In connection with the issuance of the
notes, Earth also issued five-year warrants to purchase 232,759 shares of common
stock to the investors at $2.90 per share.
 
 At the
date of original issuance the warrants had a relative fair value of $18,808,359,
and intrinsic value of the beneficial conversion feature of
$24,098,240, to arrive at a total debt discount of $42,906,599. Included in
interest expense is $10,770,000 of discount amortization in 2007 related to this
debt.
 
 Due to
ongoing renegotiations with the above investors, Earth did not make the first
quarterly interest payments due October  1, 2006, or register the
underlying securities within 30  days from closing in accordance with the
original securities purchase agreement dated July 24,
2006 and August 11, 2006. As such, penalties and interest have accrued at the
default rate of 15% interest, plus 1.5% for the amount outstanding for
registration penalties, and an 18% late charge. Additionally there is a
redemption penalty of 20% due upon settlement of the notes.
 
 Subsequent
to the second quarter of 2007, certain of the note holders above, filed with the
bankruptcy courts a Chapter 7 - Involuntary Liquidation against the
company.   On November 14, 2007, Earth Biofuels, Inc. (the “Company”)
negotiated and executed a settlement agreement (the “Agreement”) with the group
of creditors who had petitioned for an involuntary bankruptcy against the
company on July 11 of this year.    The Agreement requires
the creditors to dismiss their petition of bankruptcy. Under the terms of the
Agreement, the Company will grant certain security interests to the creditors
and will execute a restructuring plan within 120 days. A confession of judgment
was signed
  16
 Table of Contents
  by the
company noting the entire amount of debt and penalties due under the original
notes was $100,651,173. Total accrued interest and penalties were approximately
$48,151,000 as of December 31, 2007 and March 31, 2008.
 
 On
November 29, 2007, certain of there note holders converted the $1.1 million in
aggregate senior notes to common stock of Earth.   The notes, interest
and penalties were settled through the issuance of 16,818,155 shares valued at
approximately $1,210,000.  A gain on the conversion was recorded
totaling approximately $454,000 was recorded for the year ended December 31,
2007.
 
 
 Accrued
unpaid penalties and interest related to the above judgment for March 31, 2008
and year ended December 31, 2007 is as follows:
 
 Accrued interest payable on convertible
      debts
              
              2008Interest
              
              $
              9,148Late
      charges
              
              
              15,120Redemption
      fee
              
              
              10,500Registration
      penalties
              
              
              13,383Total
      interest expense
              
              $
              48,151
 
 In
connection with the 8% senior convertible notes issued on July 24,
2006, Earth incurred loan costs in the amount of $3,452,000, of which the
unamortized balance as of December 31, 2007 totaling $2,620,000 was charged
against earnings due to the above proceedings.
 
 NOTE 11 —
TERM DEBT FACILITIES
  On
February 28, 2007, our LNG subsidiary obtained a term note totaling $15
million. The $15 million term loan is due and payable in 3 years, with
interest accruing at LIBOR plus 1,000 basis points and payable monthly in
advance. The loan is secured by the LNG plant facility in Topock, Arizona. In
connection with this facility Warrant Purchase and Registration Right agreements
were issued to purchase 13,549,816 of the Company’s common stock at
$.36 per share for 10  years. At the date of original issuance the
warrants had a relative fair value of $3,674,702.
  In
addition, on March 23, 2007, Earth obtained a $9 million term loan facility
secured by the Durant, Oklahoma biodiesel plant. The principal amount is due in
3 years with interest payable at LIBOR plus 1,000 basis points. In connection
with this facility, Warrant Purchase and Registration Right agreements were
issued to purchase 6,774,908 of the Company’s common stock at $.36 per share for
10 years. At the date of original issuance the warrants had a relative fair
value of $1,654,643.
 
 In June
2007, the lender on the above term loan facilities totaling $15 million and $9
million, respectively, exchanged their rights to purchase the warrants in lieu
of additional financing fees totaling $5.4 million. These financing fees are
payable at maturity of the debt and are being accrued monthly.  
Accrued financing fees of approximately $1,414,000 are included in accounts
payable at March 31, 2008.
  The
Company has not met underlying debt covenants related to fixed charge ratios and
advances to subsidiaries.   The debtor has noted these defaults and
has not relinquished their rights per the underlying debt agreements.  As a
result, the notes are included in current liabilities.
  Subsequent
to default, the Company received additional funding in the fourth quarter of
2007 from the lender in the amount of $4.7 million.  Notes payable for
both term notes totaled $28,700,000 at December 31, 2007, and March 31,
2008.  In connection with the above term notes interest
reserves were escrowed totaling $1,205,000 for interest payments due the next
twelve months. These facilities are also cross-collaterized.  In
addition, Earth incurred loan costs
  17
 Table of Contents
  in the
amount of $2,854,443 which will be amortized over the term of the
notes.
 
 NOTE 12 —
CONVERTIBLE PREFERRED SHARES
 
 Preferred
Stock issuances
  On March
28, 2008, we entered into a private financing transaction (“financing
transaction”) pursuant to a Securities Purchase Agreement (the “Purchase
Agreement”).  Pursuant to the Purchase Agreement we issued to the investors
(i) 100,000 shares of our newly authorized Series A Convertible
Preferred Stock, $.001 par value (the “convertible preferred stock”),
(ii) Stock Purchase Warrants to purchase an additional 2,000,000 shares of
common stock at an initial exercise price of $.0375 per share, and (iii) we
issued 2,000,000 shares of common stock. We received $100,000 in gross proceeds
in the initial closing. Holders of the Series A Preferred Stock shall be
entitled to receive dividends or other distributions with the holders of the
Corporation’s common stock, par value $.001 (the “Common Stock”) on an as
converted basis when, as, and if declared by the Directors of the
Corporation.
 
 In
connection with the sale of the securities to the investors, we entered into a
Registration Rights Agreement with the investors dated as of March 28, 2008 (the
“Registration Rights Agreement”), which requires us to use our best efforts to
register under the Securities Act of 1933, as amended (the “Securities Act”),
the shares of common stock issued and issuable upon conversion of the
convertible preferred stock. The Registration Rights Agreement also provides the
investors with demand and piggyback registration rights under the Securities Act
for shares of common stock issuable upon conversion of the convertible preferred
stock.
  Due to
certain rights granted to its holders, the convertible redeemable preferred
stock is classified as non-permanent equity in the Consolidated Balance Sheets,
pursuant to Rule 5-02.28 of the Securities and Exchange Commission’s
Regulation S-X and as further clarified by the Emerging Issues Task Force Issue
No. D-98, Classification
and Measurement of Redeemable Securities. Pursuant to FASB Staff Position
FAS 150-5, Issuer’s Accounting
Under FAS 150 for Freestanding Warrants and Other Similar Instruments That Are
Redeemable, the redeemable preferred shares are classified as liabilities
also due to certain rights granted to its holders.  The shares are
redeemable at any time after April 27, 2008 at 1.35 times the original amount or
$135,000.
  The
100,000 shares of convertible preferred stock currently outstanding are
convertible into an aggregate of 5,000,000 shares of our common stock at a
conversion price of $.02 per share.  In accordance with EITF Issue 98-5,
Accounting for Convertible
Securities with Beneficial Conversion Features or Contingently Adjustable
Conversion Ratios the value of the beneficial conversion feature was
recorded.
 
 NOTE 13 —
STOCKHOLDERS’ EQUITY
 
 Warrants—
 
 Warrants
granted by the Company consisted of the following for the three months ended
March 31, 2008.
 
 Description
              Remaining
      Life
              Exercise
      Price
              2007
      WarrantsMay
      4, 2006 convertible debt-(debt repaid), warrants issued to
      investor
              8 -
      9 years
              $                 2.00
              920,810May
      26, 2006 convertible debt-(debt repaid), warrants issued to investor and
      placement agent
              8 -
      9 years
              $                 3.84
              768,750June
      7, 2006 convertible debt-(debt repaid), warrants issued to investor and
      placement agent
              8 -
      9 years
              $                 2.93
              1,545,000July 10,
      2006 convertible debt (debt repaid), warrants issued to investor and
      placement agent
              9-10
      years
              $                 2.50
              1,515,000July 21,
      2006 warrants issued for consulting fees
              9-10
      years
              $                 0.25
              4,000,000July 24,
      2006 convertible debt, warrants issued to investors
              9-10
      years
              $                 2.90
              9,051,725January
      19, 2007 notes payable, warrants issued to noteholders
              10
      years
              $                  
      .01
              375,000February
      , 2008 warrants issued to investor
              10
      years
              $                  
      .10
              1,000,000March
      28, 2008 Preferred share issuance
              5
      years
              $               .0375
              2,000,000
 
  A summary
of the Company’s stock warrant activity and related information at March 31,
2008 and December 31, 2007 is as follows:
 Number
      of Shares Under Warrant
              Exercise Price
              Weighted Average Exercise
    PriceWarrants
      outstanding at December 31, 2006
              17,990,940
              $.25
      - 3.84
              $      
                   
      2.27Issued
              20,699,724
              $.01
      - .36
              $      
                      
      25Exercised
              (439,655)
              $.01
              $                  
      1.26)Repurchased
              (20,324,724)
              $.30-.3
      6
              $       
                
      (.25)Expired
              —
              —
              —Warrants
      outstanding and exercisable at
                December
      31, 2007
              17,926,285
              $.01
      - $3.84
              $      
                 
      2.25Issued
              3,000,000
              $.0375-.10
              $                   
      .06Warrants
      outstanding and exercisable at
                March
      31, 2008
              20,926,285
              $.01
      - $3.84
              $     
                
    1.93
 
 
 
 The
weighted average exercise price for all warrants outstanding as of
December 31, 2007 was $2.25 per share. During the year ended December 31,
2007, 20,324,724 shares were repurchased, and 439,635 shares were exercised. The
weighted average exercise price for all warrants outstanding as of
March 31, 2008 was $1.93 per share.
 
 All
warrants have a five-year or ten year expiration. The warrant fair value was
determined by using the Black Scholes option pricing model. Variables used in
the Black-Scholes option-pricing model include (1) risk-free interest rate,
(2) expected warrant life is the actual remaining life of the warrants as
of the year end, (3) expected volatility was 100%-400%, and (4)  zero
expected dividends.
 
 Due to
net losses or anti-dilutive features these warrants and conversion options were
not presented on the Consolidated Statement of Operations.
 
 Share
based Compensation  —
 
 During
the three months ended March 31, 2008, Earth issued 13,850,000 common shares,
valued at approximately $554,000 million of Earth’s common stock to
employees for services rendered, of which all shares were restricted,
  18
 Table of Contents
  and
16,728,000 common shares, valued at approximately $661,627, of Earth’s common
stock for consulting services, of which 12,475,320 were not
restricted.
 
 
 
 Registration
Rights  —
 
 Earth was
obligated under Registration Rights Agreements to file, on the 30th  day
following the agreements a Registration Statement with the SEC registering for
resale shares of common stock, and shares of common stock underlying investor
warrants and certain of the placement agent warrants, issued in connection with
the private offerings. If (i)  Earth did not file the Registration
Statement within the time period prescribed, or (ii)  Earth failed to file
with the SEC a request for acceleration in accordance with Rule  461
promulgated under the Securities Act of 1933, within five trading days of the
date that Earth is notified (orally or in writing, whichever is earlier) by the
SEC that the Registration Statement will not be “reviewed,” or is not subject to
further review, or (iii)  the Registration Statement filed or required to
be filed under the Registration Rights Agreement was not declared effective by
the SEC on or before 120  days following March  23, 2005, or
(iv)  after the Registration Statement is first declared effective by the
SEC, it ceases for any reason to remain continuously effective as to all
securities registered there under, or the holders of such securities are not
permitted to utilize the prospectus contained in the Registration Statement to
resell such securities, for more than an aggregate of 45 trading days during any
12-month period (which need not be consecutive trading days) (any such failure
or breach being referred to as an “Event,” and for purposes of clause  (i)
or (iii)  the date on which such Event occurs, or for purposes of
clause  (ii) the date on which such five-trading day period is exceeded, or
for purposes of clause  (iv) the date on which such 45-trading day-period
is exceeded being referred to as “Event Date”), then in addition to any other
rights the holders of such securities may have under the Registration Statement
or under applicable law, then, on each such Event Date and on each monthly
anniversary of each such Event Date (if the applicable Event shall not have been
cured by such date) until the applicable Event is cured and except as disclosed
below, Earth is required to pay to each such holder an amount in cash, as
partial liquidated damages and not as a penalty, equal to 1.5% per month of the
aggregate purchase price paid by such holder pursuant to the Securities Purchase
Agreement relating to such securities then held by such holder. If Earth fails
to pay any partial liquidated damages in full within seven days after the date
payable, Earth is required to pay interest thereon at a rate of 15%  per
annum (or such lesser maximum amount that is permitted to be paid by applicable
law) to such holder, accruing daily from the date such partial liquidated
damages are due until such amounts, plus all such interest thereon, are paid in
full. The partial liquidated damages are to apply on a daily pro-rata basis for
any portion of a month prior to the cure of an event.
 
 The
Registration Rights Agreement also provides for customary piggy-back
registration rights whereby holders of shares of Earth’s common stock, or
warrants to purchase shares of common stock, can cause Earth to register such
shares for resale in connection with Earth’s filing of a Registration Statement
with the SEC to register shares in another offering. The Registration Rights
Agreement also contains customary representations and warranties, covenants and
limitations. There have been no stock options granted as of March 31,
2008.
 
 
 NOTE 14 —
RELATED PARTY TRANSACTIONS
  As of
March 31, 2008, Earth had payables to the following related party totaling
$50,419 as follows: This affiliate was the prior owner of the LNG Business and
is currently an investor in EBOF and Apollo Resources.  This affiliate
provides shipping services of LNG to various customers.  Total
shipping costs incurred during the three months ended March 31, 2008 using this
affiliates was approximately $1,184,000.  As of March 31, 2008, the
Company had a deposit with this affiliate totaling $450,000 which is included in
prepaid and other long-term assets, accounts payable due this affiliate vendor
totaling $594,000 and advances payable to this affiliate totaling
$50,419.
 
 NOTE 15 —
COMMITMENTS AND CONTINGENCIES
  Settlements  —
  19
 Table of Contents
  On
November 14, 2007, Earth Biofuels, Inc. (the “Company”) negotiated and executed
a settlement agreement (the “Agreement”) with the group of creditors who had
petitioned for an involuntary bankruptcy against the company on July 11 of this
year.   The Agreement requires the creditors to dismiss their petition
of bankruptcy. Under the terms of the Agreement, the Company will grant certain
security interests to the creditors and will execute a restructuring plan within
180 days.
 
 Royalties 
—
 
 As part
of the “BioWillie” license agreement, Earth pays $25,000 in monthly advances on
biodiesel royalty amounts payable equal to two cents per gallon of fuel sold
under the BioWillie trademark. The contract is renewable every 2 years. For the
three months ended March 31, 2008, royalty payments totaled $0.
 
 Leases 
—
 
 At
December 31, 2005, Earth held non cancelable operating leases covering
properties with minimum lease commitments as indicated below.
 
 On
October 17, 2005, EBO leased a truck stop in Grenada, Mississippi from RBB
Properties, LLC which is controlled by R. Bruce Blackwell, a shareholder and
Director of Earth. The lease agreement provides for monthly payments of $10,000
over a five year term. EBO is responsible for operations and repair and
maintenance of the facility.
 
 Minimum
lease payments for the next five years are approximately $120,000.
 
 Total
rent expense for the three months ended March 31, 2008 was approximately
$55,623.
 
 Litigation 
—
 
 On May 2,
2006, Earth entered into a letter of intent with Vertex Energy, L.P., which
contemplated a joint venture in which a newly created company would own and
operate a biodiesel production facility on the Houston Ship Channel in Houston,
Texas. As contemplated by the letter of intent, Vertex Energy would acquire a
49% interest in the newly created company in exchange for contributing to the
new operating company real property and improvements, including an existing
chemical processing facility. Earth would acquire a 51% interest in the
operating company in exchange for the payment of $2,500,000 and the issuance of
1,500,000 shares of its common stock to Vertex Energy. In Harris County
District Court, Vertex Energy, LP & Benjamin P. Cowart alleged breach of
contract on January 26, 2007, and a motion for new trial was granted. We believe
these allegations are substantively without merit, and are vigorously contesting
the claims brought by the plaintiff, and are exercising all available rights and
remedies against them; however, the ultimate outcome of this matter is
uncertain. Vertex Energy filed its First Amended Petition on February 8,
2008, enjoining Jason Gehrig to the case. Earth is currently in the discovery
motion stage with Vertex Energy regarding disclosures, interrogatories, and
requests for production. The investment in this company and related plant was
deemed impaired due to lack of operations and was charged to earnings totaling
$$2,435,000 during 2006, and $2,543,000 during 2007, resulting in total
estimated impairments of $4,978,000. Should Vertex prevail in the above
proceedings Earth would receive the facility in question.
 
 In April
2007, JM Allen & Associates, Inc. filed a civil action in the District
Court of Rusk County, Texas for the 4th Judicial District of Texas,
entitled JM Allen & Associates, Inc. v. Earth Biofuels, Inc., Case
No.  2007-160, alleging fraudulent inducement and non-performance under a
series of oral alleged agreements to provide labor and materials in the
aggregate amount of $1,900,000; and also filed a request for disclosure,
admissions, interrogatories, and request for production of documents. On
February 1, 2008, Earth entered into a settlement agreement with JM Allen for
$410,000. This amount has been included in accounts payable and accrued
expenses.
 
 On May
22, 2007, Pacific Biodiesel Texas, LP filed a Demand for Arbitration with the
American Arbitration Association claiming $513,309 is due them do to a breach of
their Sales and Purchase Agreement with Earth to purchase all Claimant’s
biodiesel output for a 12 month period. Pacific Biodiesel Texas, LP filed their
First Amended Demand for Arbitration on January 24, 2008 increasing their claim
to $1,225,765. Both parties executed an award agreement
  20
 Table of Contents
  dated
April 1, 2008, whereby Earth will pay $552,800 to Pacific Biodiesel in full
settlement of their claim. Accordingly, $552,800 has been included in accounts
payable and accrued expenses.
 
 On July
24, 2006, Earth entered into a securities purchase agreement pursuant to which
Earth issued $52.5 million aggregate senior convertible notes that were due
in 2011 to eight institutional investors.   Due to ongoing renegotiations
with the above investors, Earth did not make the first quarterly interest
payments due October 1, 2006, or register the underlying securities within
30  days from closing in accordance with the original securities purchase
agreement. Subsequent to the second quarter of 2007, certain of the note
holders, filed with the bankruptcy courts a Chapter 7 - Involuntary Liquidation
against the company.   On November 14, 2007, Earth Biofuels, Inc. (the
“Company”) negotiated and executed a settlement agreement (the
“Agreement”).  The Agreement required the creditors to dismiss their
petition of bankruptcy. Under the terms of the Agreement, the Company will grant
certain security interests to the creditors and will execute a restructuring
plan within 160 days. A confession of judgment was signed by the company noting
the entire amount of debt and penalties due under the original notes of
$100,651,173. Total accrued penalties were approximately $48,151,000 as of March
31, 2008.
 
 YA Global
Investments, LP, formerly Cornell Capital Partners, LP, filed their Complaint
against Earth Biofuels on February 1, 2008 in the Supreme Court of the State of
New York in the County of New York. The Plaintiff alleges claims of 3 counts of
breach of contract against the Defendant; wherein, the parties are currently in
the pleading stage. This investor was one of the original accredited investors
in the Securities Purchase Agreement dated July 24, 2006, holding notes totaling
$3 million.
 
 Earth has
become subject to various claims and other legal matters in the course of
conducting its business. No material individual claims are currently pending;
however, the company has recorded approximately $1,000,000 in regards to claims
deemed likely in accounts payable and accrued expenses as of March 31,
2008.
 
 We may
become party to various legal actions that arise in the ordinary course of our
business. During the course of our operations, we are also subject to audit by
tax authorities for varying periods in various federal, state, local, and
foreign tax jurisdictions. Disputes may arise during the course of such audits
as to facts and matters of law. It is impossible at this time to determine the
ultimate liabilities that we may incur resulting from any lawsuits, claims and
proceedings, audits, commitments, contingencies and related matters or the
timing of these liabilities, if any. If these matters were to be ultimately
resolved unfavorably, an outcome not currently anticipated, it is possible that
such outcome could have a material adverse effect upon our consolidated
financial position or results of operations. However, we believe that the
ultimate resolution of such actions will not have a material adverse affect on
our consolidated financial position, results of operations, or
liquidity.
 
 NOTE 
16  — INCOME TAXES
 
 In 2007,
the Company adopted Financial Accounting Standards Board Interpretation
No. 48, Accounting for Uncertainty in Income Taxes (“FIN
48”).  As such, the Company has determined that certain tax
liabilities relating to a supply contract relating to the Apollo Resources
purchase of the LNG Business in December 2005 should be recorded in the
accompanying financial statements totaling $17,233,000 of which $11,550,000 was
recorded as an addition to goodwill, $1,641,000 represents interest, and
$2,225,000 represents prior periods estimated penalties and
interest.  The outcome of this tax estimate is uncertain at this time.
The Company recorded an adjustment to retained earning of $2,225,000 as a part
of the transitional accounting promulgated by FIN 48 at December 31, 2007. In
addition, additional interest has been accrued totaling approximately $229,000
as of March 31, 2008.  The Company will adjust the accrual for this tax
contingency in the period that the facts and circumstances warrant or the
liability is settled with taxing authorities. The Company's tax years for 2005
through 2006 are subject to examination by various tax authorities. A number of
years may elapse before an uncertain tax position is finally resolved. It is
often difficult to predict the final outcome or the timing of resolution of any
particular uncertain tax position, but the Company believes that its reserves
for income taxes reflect the most probable outcomes. The Company adjusts the
reserve, as well as the related interest, in light of changing facts and
circumstances. Settlement of any particular position would usually require the
use of cash and result in the reduction of the related reserve. The resolution
of a matter would be recognized as an adjustment to the provision for income
taxes and the effective tax rate in the period of resolution. As
of March 31, 2008, it is possible that the Company's liability for
uncertain tax positions will be reduced by as much as $17.2
million during the year ended December 31, 2012 as a result of the
settlement of tax positions with various
  21
 Table of Contents
 tax
authorities.
 
 In
addition to the above FIN 48 income tax liabilities, the Company has net
deferred tax assets calculated at an expected rate of 35% of approximately $48.4
million and $46.6 million as of March 31, 2008 and December 31, 2007,
respectively. As the ultimate realization of this net tax asset is uncertain,
the Company has provided a valuation allowance for the entire amount at March
31, 2008 and December 31, 2007, respectively.
 
 The net
deferred tax assets generated by loss carry-forwards has been fully reserved.
The cumulative net operating loss carry-forward is approximately $123.9 million
as of March 31, 2008, and will expire in the years 2024 through
2027.  The valuation allowance for deferred tax assets was increased
by approximately $2.2 million and $27.3 million for the three months ended March
31, 2008 and for the year ended December 31, 2007, respectivley.
 Deferred
tax assets and liabilities result from differences between the financial
statement carrying amounts and the tax bases of existing assets and liabilities.
The tax effect of temporary differences that give rise to deferred tax assets
and liabilities as of March 31, 2008 and year ended December 31, 2007 are
as follows:
 
 March 31, 2008
              
              
              December 31, 2007Deferred
      tax assets:
              
              (in
      000’s)
              
              
              (in
      000’s)Impairment
      of investments and intangibles
              
              $
              4,870
              
              
              $
              4,870Net
      operating loss carryforwards
              
              
              46,953
              
              
              
              43,618Deferred
      tax assets
              
              
              51,823
              
              
              
              48,488Less
      valuation allowance
              
              
              (51,783
              )
              
              
              (48,448
              )Total
      deferred tax assets
              
              
              40
              
              
              
              39Deferred
      tax liabilities:Depreciation
      and amortization
              
              
              (40
              )
              
              
              (39
              )Total
      deferred tax liabilities
              
              
              (40
              )
              
              
              (39
              )Net
      deferred tax assets (liabilities)
              
              $
              —
              
              
              $
              —
 
 
 NOTE 17 —
SEGMENT INFORMATION
  Earth
maintains one operating segment whose business is conducted through a separate
legal entity that is wholly owned by Earth. This segment is Earth LNG, Inc. LNG
is managed separately, as this business has distinct customer base and requires
different strategic and marketing efforts. The accounting policies of the
segment are the same as those described in the summary of significant accounting
policies. The segment company contains liquefied natural gas production,
distribution and marketing operations. The subsidiary revenues are in excess of
10% of consolidated revenues. There are no inter-segment revenues or
expenses.
 
 Certain
segment data is included in the table below as follows:
 
 LNG
              
              
              Earth
      Biofuels
              
              
              Consolidated($
      in 000’s)
              
              
              ($
      in 000’s)
              
              
              ($
      in 000’s)Three
      months ended March 31, 2008Revenue
              
              $
              7,421
              
              
              $
              —
              
              
              $
              7,421Income
      (Loss) from operations
              
              $
              172
              
              
              $
              (4,636
              )
              
              $
              4,464Interest
      Expense
              
              $
              1,649
              
              
              $
              3,505
              
              
              $
              5,154Net
      Loss for the three months ended March 31, 2008
              
              $
              (1,468
              )
              
              $
              (8,206
              )
              
              $
              (9,674
              )Property,
      plant and equipment, net
              
              $
              8,663
              
              
              $
              15,742
              
              
              $
              24,405Total
      Assets
              
              $
              48,707
              
              
              $
              28,227
              
              
              $
              76,934Current
      Liabilities
              
              $
              43,071
              
              
              $
              96,773
              
              
              $
              139,844Year
      Ended December  31, 2007Revenue
              
              $
              26,068
              
              
              $
              1,018
              
              
              $
              27,086Income
      (Loss) from operations
              
              $
              102
              
              
              $
              (32,215
              )
              
              $
              (32,113
              )Interest
      Expense
              
              $
              (2,671
              )
              
              $
              (56,215
              )
              
              $
              (58,886
              )Net
      Loss for the twelve months ended December 30, 2007
              
              $
              (5,296
              )
              
              $
              (117,184
              )
              
              $
              (122,480
              )Property,
      plant and equipment, net
              
              $
              9,033
              
              
              $
              16,045
              
              
              $
              25,078Total
      Assets
              
              $
              50,846
              
              
              $
              28,999
              
              
              $
              7
      9,845Current
      Liabilities
              
              $
              40,750
              
              
              $
              93,239
              
              
              $
              133,989
  
 Municipal
customers represent approximately 46% of the consolidated revenues related to
LNG. The total sales to this customer for the year ended 2006 was approximately
$3.4 million.
   NOTE 18 —
SUBSEQUENT EVENTS
  On March
28, 2008, and subsequently amended on April 9, 2008, the board of directors
approved a Certificate of Amendment to Series A Preferred Stock of Earth. The
Company is authorized to issue 15,000,000 shares of $0.001 par value preferred
stock (“Preferred Stock”).  The Board of Directors of the Company has
designated 935,000 shares of the Preferred Stock as Series A Preferred Stock,
the number of shares designated and rights of each class are briefly described
as follows:
 
 Series A Convertible
Preferred Stock
 
 On April
10, 2008, the Company designated 935,000 shares of Preferred Stock as Series A
Convertible Preferred Stock (“Series A Preferred Stock”). The Series A Preferred
Stock is convertible into shares of Common Stock at an initial conversion price
of $.02. Holders of Series A Preferred Stock are entitled to one vote for each
share of Series A Convertible Preferred Shares held, are entitled to elect up to
two members to the Company’s Board of Directors, and, absent such election, are
provided certain voting and veto rights to any vote by the Board of Directors.
As of April 10, 2008, there were 935,000 shares of Series A Preferred Stock
designated and as of March 28, 2008 100,000 shares of Series A Preferred
Stock were issued and outstanding.
  22
 
 ITEM
2.                   Management’sDiscussion and Analysis
 
 Forward Looking
Statements
  This
Annual Report on Form 10-KSB and all other reports filed by Earth Biofuels, Inc
, a  Delaware corporation (“EARTH”), from time to time with the
Securities and Exchange Commission (collectively the “Filings”) contain or may
contain forward looking statements and information that are based upon beliefs
of, and information currently available to, the management of EARTH as well as
estimates and assumptions made by EARTH management. When used in the filings the
words “may”, “will”, “should”, “estimates”,  “anticipate”, “believe”,
“estimate”, “expect”, “future”, “intend”, “plan” or the negative of these terms
and similar expressions as they relate to EARTH or its management, identify
forward looking statements. Such statements reflect the current view of EARTH
and with respect to future events and are subject to risks, uncertainties,
assumptions and other factors relating to EARTH, its ability to raise capital,
its ability to market to biodegradable diesel fuel and other risk factors.
Should one or more of these risks or uncertainties materialize, or should the
underlying assumptions prove incorrect, actual results may differ significantly
from those anticipated, believed, estimated, expected, intended or
planned.
  Although
EARTH believes that the expectations reflected in the forward looking statements
are reasonable, we cannot guarantee future results, levels of activity,
performance or achievements. Except as required by applicable law, including the
securities laws of the United States, management does not intend to update any
of the forward-looking statements to conform these statements to actual results.
The following discussion should be read in conjunction with EARTH’s consolidated
financial statements and the related notes filed herewith.
 
 The
following discussion and analysis should be read in conjunction with Earth’s
Financial Statements, together with the notes to those statements, included in
Item  7 of this Annual Report on Form  10-KSB.
 
 Overview
 
 The
principal business of Earth is the domestic production, supply and distribution
of alternative based fuels consisting of biodiesel and liquid natural gas. Earth
produces pure biodiesel fuel (B100) for sale directly to wholesalers, and to be
used as a blend stock to make B20 biodiesel. Biodiesel is a non-toxic
biodegradable diesel fuel made from soybean and other vegetable oils, and used
recycled oils and fats. Earth utilizes vegetable oils such as soy and canola oil
as raw material (feedstock) for the production of biodiesel fuel. Earth’s
primary bio-diesel operations are located in Oklahoma and Texas. Earth also
produces and distributes liquefied natural gas, or LNG, which is natural gas in
its
  23
 Table of Contents
  liquid
form. Liquid natural gas is primarily methane with only small amounts of other
hydrocarbons. Earth’s primary operations are in Arizona and
California.
 
 Our
primary sources of revenue for the years ended 2007 and 2006 are from the sale
of biodiesel fuels and LNG. Our sales revenue is a function of the volume we
sell and the price at which we sell. The volume of our sales is largely
dependent upon demand and our ability to distribute the product. The selling
prices we realize for our products are largely determined by the market supply
and demand, which in turn, is influenced by industry factors over which we have
little, if any, control, such as the price of gasoline and other alternative
energy sources. We blend and market our biodiesel directly to fuel stations. For
our biodiesel products the distribution strategy includes supplying B100 for
storage and blending terminals, controlling the blending point, and obtaining
exclusive agreements with terminal chains throughout the United States. For our
LNG products the production facility is located in Topock, AZ, which is just one
mile east of the Arizona-California border. The plant has a maximum capacity of
95,000 gallons per day, and is currently running at approximately 94%
efficiency. The facility is strategically located in close proximity to its
primary metropolitan markets along the west coast to minimize transportation
costs.
 
 Our gross
profit is derived from our total revenues less our cost of sales. Our cost of
sales is affected by the price of our purchases of biodiesel and natural gas on
the open market, which are also affected by supply and demand, and the cost of
raw materials used in the production process, such as soy oil and natural gas.
As we implement our facility construction and expansion strategy, we expect our
cost of sales to be impacted by our cost of raw materials used in
production.
 
 Continuing
Losses.   We have had net losses from operations each year
since inception in 2005, and there can be no assurance that we will be
profitable in the future. Our financial results depend upon many factors that
impact our results of operations including sales prices of natural gas, soy oil
and corn, the volume of sales of liquefied natural gas, biodiesel and ethanol,
availability and the level and success of production, development and
distribution activities and financial resources to meet cash flow needs. In
addition, investors holding $52.5 million in senior unsecured notes filed with
the bankruptcy courts a Chapter 7 – Involuntary Liquidation against EBOF
during the second quarter of 2007. However, on November 14, 2007, EBOF
negotiated and executed a settlement agreement (the “Agreement”) with the above
note holders.  The Agreement required the creditors to dismiss their
petition of bankruptcy.
 
 Under the
terms of the Agreement, EBOF and subsidiaries granted certain security interests
to the creditors and will execute a restructuring plan within 180 days. In
addition, one of the accredited investors of the original eight accredited
investors purchased four of the original investors interest, whereby reducing
the number of credit holders to three. The Company is currently in negotiations
with the remaining investors to settle the outstanding debts. The Company
intends to sell certain operating assets and liabilities of the LNG business
through a reverse merger and public offering of the LNG Business, and raise $35
million in the newly formed public company. Management expects that the LNG
Business will be released as a guarantor of the EBOF notes totaling $52.5 by
providing the note holders with a security interest in the newly formed public
company (the “Restructuring”).  The Restructuring will allow the
Company to build new fueling stations, expand geographically and improve the
Company’s sales and marketing efforts.
 
 Management
believes that the LNG Business has substantial market value that is not
necessarily reflected by the accompanying financial statements.  The
LNG company acquisitions have produced revenues over the past two years in
excess of $50 million, and this market has been the focus of Earth LNG’s
underlying company efforts for over ten years. While cash flows from operations
were flat year over the first of the 2007 year, the second half of 2007
demonstrated positive trends due to renewed and new customer contracts,
significant cost restructurings and management improvements. This company is the
largest producer and wholesaler of vehicle-quality liquid natural gas in the
United States and is one of only five production facilities in the country that
produces clean liquid natural gas. This company offers turnkey fuel solutions,
and leases storage, fuel dispensing equipment and fuel loading facilities. The
LNG markets include transportation alternative fuel for transit systems,
seaports, local delivery fleets and locomotive switch engines. This gas also has
industrial and agricultural applications. Earth currently produces
87,000 gallons per day, with a maximum capacity of 95,000 gallons per
day.
  24
 Table of Contents
  The
supply of LNG in the United States and Canada is limited. We believe that
increasing our LNG supply will enable us to increase sales to existing customers
and to secure new customers. We use our LNG supply relationships and
strategically located LNG production capacity to give us an advantage. We also
are in the process of building an LNG liquefaction plant in California that will
enhance our ability to serve California, Arizona and other western U.S. markets
and will help us to optimize the allocation of LNG supply we sell to our
customers.  In the future, we may also acquire natural gas reserves or
rights to natural gas production to supply our LNG plants.
 
 During
the first two quarters of 2007 the company obtained approximately $31 million in
credit facilities.  The credit facilities consisted of two term loans
totaling $24 million, due in 3 years and are secured by the LNG plant facility
in Topock, Arizona, and the biodiesel plant located in Durant Oklahoma. There is
also $7 million in revolving credit facilities which are advanced at the
rate of 85% of accounts receivable.   The term loan credit
facilities were amended during the fourth quarter of 2007, and the facility was
increased by $4.7 million.
 
 The
Company is also in the process of refinancing the term debt related to the
Durant, Oklahoma biodiesel plant, and retrofitting the plant to allow for usage
of other types of raw materials besides soybean oil.  Due to the
significant increase in feedstock prices during the year this plant was idle for
most of 2007, resulting in reduced profit margins.  Management is
currently focusing on retrofitting the plant to be able to process yellow
grease. Yellow grease is basically cooking grease, is easily accessible, and
represents a significant reduction in cost from the existing market prices for
soybean oil and other feedstock’s. In addition, the Company is actively seeking
acquisition of companies which handle this material, and to provide turnkey
solutions for distributions throughout Texas and other markets of the Bio-Willie
diesel brand fuel.
 
 Earth
believes the LNG business will be a major part of establishing future financial
stability of the Company. The Company also believes the above measures will
significantly enhance the liquidity position, profitability and allow for
repayment to the $52.5 notes holders. Earth’s management is attempting to seek
strategic alternatives, including the pursuit of additional financing for
strategic acquisitions or a merger with other businesses. The Company has
incurred significant losses from operations and as of March 31, 2008, and
has limited financial resources. These factors raise substantial doubt about our
ability to continue as a going concern. Management intends to raise capital
through other offerings, secure collateralized debt financing and use these
sources of capital to grow and enhance its alternative fuel production and
distribution operations. If additional funds are raised by issuing debt, we may
be subject to restrictive covenants that could limit our operating flexibility.
Earth’s performance will also be affected by prevailing economic conditions.
Many of these factors are beyond Earth’s control. There can be no assurance that
adequate funds will be available when needed and on acceptable terms, or that a
strategic alternative can be arranged. The accompanying financial statements do
not reflect any adjustments that might result from the outcome of this
uncertainty.
 
 Results
of Operations
 
 Comparison
of Three Months Ended March 31, 2008 to the Three Months Ended March 31,
2007
 The
following table sets forth selected data as a percentage of total revenues
(unless otherwise noted) for the periods indicated. All information is derived
from the accompanying consolidated statements of operations.
 
 Three
      Months EndedMarch
      31,2008
              
              
              2007Revenues:Sales
      revenue
              
              
              100
              %
              
              
              99
              %Energy
      production credits
              
              
              —
              %
              
              
              1
              %Total
      revenues
              
              
              100
              %
              
              
              100
              %Cost
      of sales
              
              
              81
              %
              
              
              95
              %Gross
      profit
              
              
              19
              %
              
              
              5
              %Compensation
              
              
              27
              %
              
              
              77
              %Other
      selling, general and administrative
              
              
              44
              %
              
              
              51
              %Depreciation
      and amortization
              
              
              9
              %
              
              
              1
              %Write-off
      of intangibles
              
              
              —
              %
              
              
              —
              %Net
      loss from operations
              
              
              (60
              )%
              
              
              (125
              )%Impairment
      of   investment
              
              
              —
              %
              
              
              —
              %Bad
      debt expense
              
              
              —
              %
              
              
              —
              %Interest
      expense
              
              
              69
              %
              
              
              242
              %Net
      (loss)
              
              
              (130
              )%
              
              
              (384
              )%
 
 
 Revenue.   Total
revenue for the three months ended March 31, 2008 increased $0.8 million,
or 12%, to approximately $7.4 million from approximately $6.6 million
in the three months ended March 31, 2007. The increase in total revenue is
primarily the result of increased sales of LNG, due to new contracts obtained
during 2007.
 
 Cost of
Sales.    The types of expenses included in the cost
of sales line item include the cost of raw materials, inbound freight charges,
purchasing and receiving costs, terminal fees for storage and loading of
biodiesel, petro fees, chemicals, and related costs of production. Our cost of
sales excludes depreciation, amortization and compensation related to the
production of alternative fuels. Cost of sales for the three months ended March
31, 2008 decreased $0.3 million, or 5%, to approximately $6 million from
approximately $6.3 million for 2007. Our cost of goods sold is mainly affected
by the cost of biodiesel, vegetable oil, natural gas and other raw materials.
The decrease in cost of sales is primarily the result of decreased sales of
biodiesel, and resulting decrease in purchases of feedstock. Biodiesel cost of
sales were $0 in 2008 from approximately $.7 million in 2007.  LNG
costs of sales were approximately $5.9 million in 2008, down from approximately
$5.6 million in 2007.
 
 Compensation.  
Compensation for the three months ended March 31, 2008 decreased
approximately $3.1million, or 61%,related primarily to reduction in work force
and reduction in EBOF shares issued to employees in 2008. The shares issued as
share based compensation were valued at market consistent with SFAS  No.
123(R), “Share-Based Payment” (“SFAS  No. 123(R)”).
 
 Other Selling, General and
Administrative Expenses.   The types of expenses included in
the selling, general and administrative expenses include office expenses,
insurance, professional services and shares issued to consultants for consulting
services, travel expenses and other miscellaneous expenses. Other selling,
general and administrative expenses for the three months ended March 31, 2008
decreased approximately $0.1 million from approximately $3.4 million for
the same period in 2007. The 2008 costs decrease consists of reductions in
consulting, marketing, professional, administrative, and travel expenses. The
shares issued as share based compensation were valued at market consistent with
SFAS No. 123(R), “Share-Based Payment” (“SFAS
No. 123(R)”).
 
 Depreciation and
Amortization.   Depreciation and amortization for the three
months ended March 31, 2008 decreased to approximately $0.3 million from $1.0
million for the same period in 2007. The decrease in depreciation and
amortization is related primarily to purchases of plant and
equipment.
 
 
 Interest Expense. 
Interest expense consisted primarily of interest fees, late charges, redemption
premiums and registration penalties related to defaults on agreements for the
three months ended March 31, 2007. Interest expense also consists of the
amortization of debt discounts associated with beneficial conversion features
and various bank fees for new loans.  Interest expense related primarily to
term debt facilities for the three months ended March 31, 2008 was approximately
$5.2 million.
  Comparison of Three
Months Ended March 31, 2007 To Three Months
Ended March 31, 2006
  The
following table sets forth selected data as a percentage of total revenues
(unless otherwise noted) for the periods indicated. All information is derived
from the accompanying consolidated statements of operations.
  Three
      Months EndedMarch 31,
      20072007
              
              
              2006Revenues:Sales
      revenue
              
              
              99
              %
              
              
              96
              %Energy
      production credits
              
              
              1
              %
              
              
              4Total
      revenues
              
              
              100
              %
              
              
              100
              %Cost
      of sales
              
              
              95
              %
              
              
              109
              %Gross
      profit
              
              
              5
              %
              
              
              (9
              )%Compensation
              
              
              77
              %
              
              
              54Other
      selling, general and administrative
              
              
              51
              %
              
              
              30
              %Depreciation
      and amortization
              
              
              1
              %
              
              
              4
              %Net
      loss from operations
              
              
              (125
              )%
              
              
              (97
              )%Net
      (loss)
              
              
              (384
              )%
              
              
              (123
              )%
  Revenue.  Total
revenue for the three months ended March 31, 2007 decreased
$2 million, or 23%, to approximately $6.6 million from approximately
$8.6 million in 2006. The decrease in total revenue is primarily the result
of decreased sales of biodiesel.
 
 Cost of
Sales.  Cost of sales for three months ended March 31,
2007 decreased $3 million, or 33%, to approximately $6.3 million from
approximately $9.4 million for 2006. Our cost of goods sold is mainly
affected by the cost of biodiesel, vegetable oil, and other raw materials. The
decrease in cost of sales is primarily the result of decreased sales of
biodiesel.
  Compensation.  Compensation
for three months ended March 31, 2007 increased approximately
$.5 million and related primarily to shares issued to consultants for
employees and consulting services. The shares issued as share based compensation
were valued at market consistent with SFAS No. 123(R), “Share-Based Payment”
(“SFAS No. 123(R)”).
  Other Selling, General and
Administrative Expenses.  Other selling, general and
administrative expenses for three months ended March 31, 2007 increased
approximately $762,000 million from approximately $2.6 million for the
same period in 2006. The 2007 costs increase consist of expenses related to
travel, marketing and professional fees.
  Depreciation and
Amortization.  Depreciation and amortization for three months
ended March 31, 2007 increased to approximately $952,000 million from
$374,000 for the same period in 2006. The increase in depreciation and
amortization is related primarily to purchases of plant and
equipment.
  Interest
Expense.  Interest expense related primarily to short term
convertible debts and long term debts for three months ended March 31, 2007
was approximately $16 million from $75,000 for the same period in 2006.
Interest expense consisted primarily of interest fees and the amortization of
debt discounts.
 
 
 Liquidity
and Capital Resources
 
 Overview.   Our
principal sources of liquidity consist of cash and cash equivalents, cash
provided by operations and issuances of debt and equity securities. In addition
to funding operations, our principal short-term and long
  25
 Table of Contents
  term
liquidity needs have been, and are expected to be, the debt service requirements
of our senior convertible notes, the acquisition and construction of new
facilities, capital expenditures and general corporate purposes. For the three
month period ending March 31, 2008 our cash and cash equivalents increased by
approximately $43,000 from December 31, 2007. Net cash provided by operating
activities was $545,000 in 2008 compared to net cash used by operating
activities of $10.2 million for the three month period ending March 31,
2007.   The increase in net cash provided by operating activities
relates primarily to increased sales of lng products during the second half of
2007, and for the three months ended March 31, 2008.
 
 Net cash
used in investing activities was $10 million for the three months ended March
31, 2007, compared to net cash used in investing activities of $400,000 for the
same period in 2008. The decrease in net cash used in investing activities
relates to the completion of the Durant facility in 2007, and thus reduced
purchases of fixed assets in the amount of approximately $2.2 million from
2008.   In addition, notes receivable and advances and investments in
2007 totaling approximately $7.7 million, as opposed to increases for the same
of $361,000 for the same period in 2008.
 
 Net cash
provided by financing activities was $21.8 million for the three months ended
March 31, 2007, compared to net cash used by financing activities of $102,000
for the same period in 2008. Cash flows provided by financing activities during
2007 relate primarily to the issuance of term debt facilities and lines of
credit totaling $29 million, less the repayment of prior debts of
$8.7 million.  In addition, $1.5 million relates to proceeds from
the issuance of common stock in 2007.
 
 We
incurred net losses and positive cash flows from operations of approximately
$(9.7) million and $545,000 respectively, for the three months ended 2008. Of
the net losses approximately $1.2 million relates to shares issued to employees
and non employees for services rendered, $2.9 million relates to the
amortization of debt discounts. We had approximately $85,000 in cash and cash
equivalents at March 31, 2008. Our working capital deficit at March 31, 2008 was
approximately $136 million.
 
 Current
and Future Financing Needs—
 
 The
success of our operations and business growth and expansion strategy depends
upon our ability to raise additional equity and debt financing and our ability
to generate sufficient cash flow from operations. We expect to continue to
devote capital resources to fund our business plan. In order to support the
initiatives envisioned in our business plan, we intend to raise additional funds
through the sale of equity, debt or a combination of the two. Our operating
performance and ability to raise additional financing depends on many factors
beyond our control, including the prevailing economic conditions, state of the
capital markets, the market price of our common stock and other risks and
uncertainties including the prices of various commodities, particularly the
prices of ethanol, soybean, corn, natural gas and unleaded gasoline, our
dependence on key suppliers and adverse changes in governmental incentives and
governmental regulation. We might not have access to the funding required for
the expansion of our business or such funding might not be available to us on
acceptable terms. We might finance the expansion of our business with additional
indebtedness or by issuing additional equity securities. The amount of any
additional indebtedness could be substantial. We could face financial risks
associated with incurring additional indebtedness, such as reducing our
liquidity and access to financial markets and increasing the amount of cash flow
required to service our debt, or associated with issuing additional stock, such
as dilution of ownership and earnings. An increase in our debt would decrease
the amount of funds available for our growth strategy, thereby making it more
challenging to implement our strategy in a timely manner, or at all. If future
cash flows and capital resources are insufficient to meet our debt obligations
and commitments, we may be forced to reduce or delay activities and capital
expenditures, obtain additional equity capital or debt financing. In the event
that we are unable to do so, we may be left without sufficient liquidity and we
may not be able to continue operations.
 
 During
2007, EBOF defaulted under its $52.5 million senior unsecured notes indenture.
Subsequent to the quarter ended June 30, 2007, these note holders filed
with the bankruptcy courts a Chapter 7 – Involuntary Liquidation against
EBOF. On November 14, 2007, EBOF negotiated and executed a settlement agreement
(the “Agreement”) with the above note holders.  The Agreement required
the creditors to dismiss their petition of bankruptcy. Under the terms of the
Agreement, EBOF and subsidiaries granted certain security interests to the
creditors and will execute a restructuring plan within 180
days.
  26
 Table of Contents
  In
addition, one of the accredited investors of the original eight accredited
investors purchased four of the original investors interest, whereby reducing
the number of credit holders to three. The Company is currently in negotiations
with the remaining investors to settle the outstanding debts. The Company
intends to sell certain operating assets and liabilities of the LNG business
through a reverse merger and public offering of the LNG Business, and raise $35
million in the newly formed public company. Management expects that the LNG
Business will be released as a guarantor of the EBOF notes totaling $52.5 by
providing the note holders with a security interest in the newly formed public
company (the “Restructuring”).  The Restructuring will allow the
Company to build new fueling stations, expand geographically and improve the
Company’s sales and marketing efforts.
 
 Management
believes that the LNG Business has substantial market value that is not
necessarily reflected by the accompanying financial statements.  The
LNG company acquisitions have produced revenues over the past two years in
excess of $50 million. While cash flows from operations were flat year over the
current year, the second half of 2007 demonstrated positive trends due to
renewed and new customer contracts, significant cost restructurings and
management improvements. This company is the largest producer and wholesaler of
vehicle-quality liquid natural gas in the United States and is one of only five
production facilities in the country that produces clean liquid natural gas.
This company offers turnkey fuel solutions, and leases storage, fuel dispensing
equipment and fuel loading facilities. The LNG markets include transportation
alternative fuel for transit systems, seaports, local delivery fleets and
locomotive switch engines. This gas also has industrial and agricultural
applications. Earth currently produces 87,000 gallons per day, with a
maximum capacity of 95,000 gallons per day.
 
 The
supply of LNG in the United States and Canada is limited. We believe that
increasing our LNG supply will enable us to increase sales to existing customers
and to secure new customers. We use our LNG supply relationships and
strategically located LNG production capacity to give us an advantage. We also
are in the process of building an LNG liquefaction plant in California that will
enhance our ability to serve California, Arizona and other western U.S. markets
and will help us to optimize the allocation of LNG supply we sell to our
customers.  In the future, we may also acquire natural gas reserves or
rights to natural gas production to supply our LNG plants.
 
 During
the first two quarters of 2007 the company obtained approximately $31 million in
credit facilities.  The credit facilities consisted of two term loans
totaling $24 million, due in 3 years and are secured by the LNG plant facility
in Topock,, Arizona, and the biodiesel plant located in Durant Oklahoma. There
is also $7 million in revolving credit facilities which are advanced at the
rate of 85% of accounts receivable.   The term loan credit
facilities were amended during the fourth quarter of 2007, and the facility was
increased by $4.7 million.
 
 The
Company is also in the process of refinancing the term debt related to the
Durant, Oklahoma biodiesel plant, and retrofitting the plant to allow for usage
of other types of raw materials besides soybean oil.  Due to the
significant increase in feedstock prices during the year this plant was idle for
the first quarter of 2008, resulting in reduced profit
margins.  Management is currently focusing on retrofitting the plant
to be able to process yellow grease. Yellow grease is basically cooking grease,
is easily accessible, and represents a significant reduction in cost from the
existing market prices for soybean oil and other feedstock’s.
 
 In
addition, the Company is actively seeking acquisition of companies which handle
this material, and to provide turnkey solutions for distributions throughout
Texas and other markets of the Bio-Willie diesel brand fuel.
 
 Earth
believes the LNG business will be a major part of establishing future financial
stability of the Company. The Company also believes the above measures will
significantly enhance the liquidity position, profitability, and allow for
repayment of creditors.
 
 We have
spent, and expect to continue to spend, substantial amounts in connection with
implementing our business strategy.  Based on our current 2008
business plan, which includes cash flows from operations and net proceeds from
new equity investors, we expect to continue as a going concern.
 
 Critical
Accounting Policies and Estimates
  27
 Table of Contents
  Our
discussion and analysis of our financial condition and results of operations is
based upon our consolidated financial statements, which have been prepared in
accordance with accounting principles generally accepted in the United States,
requires management to make estimates and assumptions that affect the amounts
reported in the accompanying financial statements and related
footnotes.
 
 Management
bases its estimates and assumptions on historical experience, observance of
industry trends and various other sources of information and factors. Estimates
are based on information available as of the date of the financial statements
and, accordingly, actual results could differ from these estimates, sometimes
materially. Critical accounting policies are defined as those that are
reflective of significant judgments and uncertainties, and potentially could
result in materially different results under different assumptions and
conditions. The most critical accounting policies and estimates are described
below.
 
 Revenue Recognition  —
The geographic location of our customer base is primarily in the Texas and
California markets, although management intends to expand operations throughout
the Southeastern and Southwestern United States. Sales are recorded at net
realizable value, net of allowances for returns, upon shipment of products to
customers. We record revenue from federal incentive programs related to the
production of biodiesel when we have produced, sold, blended the biodiesel, and
completed all the requirements of the applicable incentive program. The Company
enters into contracts with various customers, primarily municipalities, to sell
LNG at index-plus basis market prices (primarily the prevailing index price of
natural gas at that time plus basis). The contracts generally range from two to
five years. The most significant cost component of LNG is the price of natural
gas.
 
 Business Combinations  —
Business combinations are accounted for using the purchase method. Under the
purchase method, we report the acquired entities’ assets and liabilities at fair
market value as of the date of purchase. Any excess of the fair market value of
the consideration given over the fair market value of the net assets acquired is
reported as goodwill. If the fair market value of the consideration given is
less than the fair market value of the net assets acquired, the resulting excess
of fair value of acquired net assets over the cost of the acquired entity is
allocated, on a pro rata basis, against certain assets acquired in the business
combination. If any excess over cost remains after reducing certain assets to
zero, the remaining excess is recognized as an extraordinary gain.
 
 Accounting for Stock Based
Compensation  — We use the principles defined in SFAS  123,
“Accounting for Stock-Based Compensation,” to account for stock options, awards
and warrants. Under this pronouncement, we determine the fair value of awards,
options and warrants using the Black-Scholes Option Price Calculation model, and
recognize the fair market value of the options, awards and warrants when granted
or vested.
 
 Accounting for Derivatives —
Statement of Financial Accounting Standards (“SFAS”) No.  133, “Accounting
for Derivative Instruments and Hedging Activities” (“SFAS 133”), as
amended, requires all derivatives to be recorded on the balance sheet at fair
value. These derivatives, including embedded derivatives in our structured
borrowings, are separately valued and accounted for on our balance sheet. Fair
values for exchange-traded securities and derivatives are based on quoted market
prices. Where market prices are not readily available, fair values are
determined using market based pricing models incorporating readily observable
market data and requiring judgment and estimates.
 
 In
September 2000, the Emerging Issues Task Force (“EITF”) issued EITF Issue 00-19,
“Accounting for Derivative Financial Instruments Indexed to and Potentially
Settled in, a Company’s Own Stock,” (“EITF 00-19”) which requires freestanding
contracts that are settled in a company’s own stock, including common stock
warrants, to be designated as an equity instrument, asset or a liability. Under
the provisions of EITF 00-19, a contract designated as an asset or a liability
must be carried at fair value on a company’s balance sheet, with any changes in
fair value recorded in earnings. A contract designated as an equity instrument
must be included within equity, and no fair value adjustments are required. In
accordance with SFAS  133 and EITF 00-19, we determined that several of the
outstanding warrants to purchase our common stock and the embedded conversion
feature and certain other features of several of our financial instruments
should be separately accounted for as assets or liabilities. Our financial
statements reflect the fair value of these warrants and the conversion and other
embedded derivatives features on our balance sheet and the unrealized changes in
the values of these derivatives in our consolidated statements of operations as
“Gain (loss) on derivative liability.”
  28
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  As the
notes which included derivatives were paid or converted during the quarter,
there is no derivative liability at December 31, 2006.
 
 Net Loss Per Share Data 
— Basic and diluted net loss per common share are presented in conformity with
the SFAS  No.  128, “Earnings Per Share”. Diluted net loss per share
is the same as basic net loss per share as the inclusion of outstanding warrants
until their exercise would be anti-dilutive. Share and per-share data presented
throughout the financial statements and notes reflect a 6-for-1 forward split
that Earth declared in November, 2005.
 
 Reclassifications  —
Certain previously reported amounts have been reclassified to conform to the
current presentation.
 
 Use of Estimates  — The
preparation of financial statements in conformity with generally accepted
accounting principles requires management to make certain estimates and
assumptions that affect the amounts reported in the financial statements and
accompanying notes. Actual results could differ from those
estimates.
 
 Recent
Accounting Pronouncements
 
 On
February  16, 2006 the FASB issued SFAS  155, “Accounting for Certain
Hybrid Instruments,” which amends SFAS  133, “Accounting for Derivative
Instruments and Hedging Activities,” and SFAS  140, “Accounting for
Transfers and Servicing of Financial Assets and Extinguishments of Liabilities.”
SFAS 155 allows financial instruments that have embedded derivatives to be
accounted for as a whole eliminating the need to bifurcate the derivative from
its host) if the holder elects to account for the whole instrument on a fair
value basis. SFAS 155 also clarifies and amends certain other provisions of
SFAS 133 and SFAS 140. This statement is effective for all financial
instruments acquired or issued in fiscal years beginning after
September 15, 2006. The adoption of this new standard did not have a
material impact on the Company’s financial position, results of operations or
cash flows.
 
 The
Financial Accounting Standards Board (FASB) issued interpretation no. 48,
Accounting for Uncertainty in Income Taxes- an interpretation of FASB Statement
No. 109 (FIN 48). FIN 48 clarifies the accounting for uncertainty in income
taxes recognized in an enterprise’s financial statements in accordance with FASB
Statement No. 109, Accounting for Income Taxes (SFAS 109). This Interpretation
prescribes a recognition threshold and measurement attribute for the financial
statement recognition and measurement of a tax position taken or expected to be
taken in a tax return. This Interpretation also provides guidance on
derecognition, classification, interest and penalties, accounting in interim
periods, disclosure, and transition. FIN 48 is effective for fiscal years
beginning after December 15, 2006.  The adoption of this new standard
had a material impact on its financial position and results of operations, which
are more accurately described under Item 7-Financial Statements and footnotes
related to income taxes and intangible assets, such as goodwill.
 
 Off-Balance
Sheet Arrangements
 
 As of
March 31, 2008, Earth had no obligations that would qualify to be disclosed as
off-balance sheet arrangements.
 
 Contractual
obligations
 
 Current Debt Obligations—
 
 On
July 24, 2006, Earth entered into a securities purchase agreement pursuant
to which Earth issued $52.5 million aggregate senior convertible notes that were
due in 2011 to eight institutional investors. The notes carried an 8% coupon,
payable quarterly, and are convertible into shares of common stock at
$2.90 per share. In connection with the issuance of the notes, Earth also
issued five-year warrants to purchase 9,051,725  shares of common stock to
the investors and five-year warrants to purchase 1,357,759  shares of
common stock to Earth’s placement agent, at $2.90  per share. Due to
ongoing renegotiations with the above investors, Earth did not make the first
quarterly interest payments due October 1, 2006, or register the underlying
securities within 30 days from closing in accordance with the original
securities purchase agreements.  Subsequent to year end, Earth brought
all coupon rate interest current totaling $1,574,222, plus the second interest
payments due.
  29
 Table of Contents
  However, 
subsequent interest and principal payments due under the notes were not made and
as such, penalties and interest totaling approximately $48 million have accrued
at the default rate of 15% interest, plus 1.5% for the amount outstanding for
registration penalties, and an 18% late charge.  Subsequent to the quarter
ended June 30, 2007, the note holders of our $52.5 million in private
placement offerings dated July 24, 2006, filed with the bankruptcy courts a
Chapter 7 - Involuntary Liquidation against the company. On November 14,
2007, Earth Biofuels, Inc .negotiated and executed a settlement agreement with
the group of creditors who had petitioned for an involuntary bankruptcy against
the company on July 11 of this year. The Agreement requires the creditors to
dismiss their petition of bankruptcy. Under the terms of the Agreement, the
Company will grant certain security interests to the creditors and will execute
a restructuring plan within 160 days. A confession of judgment was signed by the
company noting the entire amount of debt and penalties due under the original
notes was $100,651,173. Total accrued penalties were approximately $48,151,000
as of December 31, 2007and at March 31, 2008.
 
 On
February 28, 2007, our LNG subsidiary obtained a term note totaling $15 million,
and line of credit facility totaling $5 million. The $15  million term
loan is due and payable in 3  years, with interest accruing at LIBOR plus
1,000  basis points and payable monthly in advance. The loan is secured by
the LNG plant facility in Topock, Arizona. In connection with this facility
Warrant Purchase and Registration Right agreements were issued to purchase
13,549,816 of the Company’s common stock at $.36  per share for 10 
years. At the date of original issuance the warrants had a relative fair value
of $3,674,702. Amortization on the related debt discount totaled $202,560 for
the year ended December 31, 2007. The line of credit was used to repay a former
line of credit due in 2006.  The balance on the new line of credit as
of December 31, 2007 was approximately $1.5 million.
 
 In
addition, on March 23, 2007, Earth obtained a $9  million term loan
facility, and a $2 million letter of credit secured by the Durant, Oklahoma
biodiesel plant. The principal amount is due in 3  years with interest
payable at LIBOR plus 1,000 basis points. In connection with this facility,
Warrant Purchase and Registration Right agreements were issued to purchase
6,774,908 of the Company’s common stock at $.36  per share for 10 years. At
the date of original issuance the warrants had a relative fair value of
$1,654,643. Amortization on the related debt discount totaled $95,888 for the
year ended December 31, 2007. The line of credit balance as of December 31, 2007
was approximately $0.
 
 In June
2007, the lender on the above term loan facilities totaling $15 million and $9
million respectively, exchanged their rights to purchase the warrants in lieu of
additional financing fees totaling $5.4 million. These financing fees are
payable at maturity of the debt and are being accrued monthly.   In
addition the Company has not met underlying debt covenants related to fixed
charge ratios and advances to subsidiaries.   The debtor has noted
these defaults and has not relinquished their rights per the underlying debt
agreements. However, subsequent to default, the Company received additional
funding in the fourth quarter of 2007 from the debtor in the amount of $4.7
million, which increased the above amount of the existing term loan
facilities.
 
 In
connection with the above facilities interest reserves were escrowed as of
December 31, 2007 totaling $1,205,000 for interest payments due the next twelve
months. These facilities are also cross-collaterized. In addition, Earth
incurred loan costs in the amount of $2,854,443 which will be amortized over the
term of the notes.
 
 On
December 13, 2007, Earth entered into a loan agreement to which Earth issued
10,000,000 shares of common stock in connection with proceeds received of
$550,000. The note and interest of 10% is due at maturity on March 15,
2008. These shares were issued in reliance upon the exemption from registration
afforded by Section  4(2) of the Securities Act. The value of the shares
totaling approximately $286,000 was allocated as a discount on the
note.
 
 Earth has
several other demand notes totaling $415,000 as of December 31,
2007.  The notes are un-collateralized, with interest at 8%, all of
which is due upon demand.
 
 On March
28, 2008, the Company entered into a private financing transaction (“financing
transaction”) pursuant to a Securities Purchase Agreement (the “Purchase
Agreement”).  Pursuant to the Purchase Agreement we issued to the investors
(i) 100,000 shares of our newly authorized Series A Convertible
Preferred Stock, $.001 par value (the “convertible preferred stock”),
(ii) Stock Purchase Warrants to purchase an additional 2,000,000 shares of
common stock
  30
 Table of Contents
  at an
initial exercise price of $.0375 per share, and (iii) we issued 2,000,000
shares of common stock. We received $100,000 in gross proceeds in the initial
closing. Holders of the Series A Preferred Stock shall be entitled to receive
dividends or other distributions with the holders of the Corporation’s common
stock, par value $.001 (the “Common Stock”) on an as
converted basis when, as, and if declared by the Directors of the
Corporation.
 
 In
connection with the sale of the securities to the investors, we entered into a
Registration Rights Agreement with the investors dated as of March 28, 2008 (the
“Registration Rights Agreement”), which requires us to use our best efforts to
register under the Securities Act of 1933, as amended (the “Securities Act”),
the shares of common stock issued and issuable upon conversion of the
convertible preferred stock. The Registration Rights Agreement also provides the
investors with demand and piggyback registration rights under the Securities Act
for shares of common stock issuable upon conversion of the convertible preferred
stock.
 
 Due to
certain rights granted to its holders, the convertible redeemable preferred
stock is classified as non-permanent equity in the Consolidated Balance Sheets,
pursuant to Rule 5-02.28 of the Securities and Exchange Commission’s
Regulation S-X and as further clarified by the Emerging Issues Task Force Issue
No. D-98, Classification
and Measurement of Redeemable Securities. Pursuant to FASB Staff Position
FAS 150-5, Issuer’s Accounting
Under FAS 150 for Freestanding Warrants and Other Similar Instruments That Are
Redeemable, the redeemable preferred shares are classified as liabilities
also due to certain rights granted to its holders.  The shares are
redeemable at any time after April 27, 2008 at 1.35 times the original amount or
$135,000.
  At the
initial conversion price, the 100,000 shares of convertible preferred stock
currently outstanding are convertible into an aggregate of 5,000,000 shares of
our common stock. The convertible preferred stock is convertible into shares of
our common stock at an initial conversion price of $.02 per
share.
 
 Leases —
 
 On
October  17, 2005, Earth leased a truck stop in Grenada, Mississippi from
RBB Properties, LLC which is controlled by R. Bruce Blackwell, a shareholder and
director of Earth. The lease agreement provides for monthly payments of $10,000
over a five year term. EBO is responsible for operations and repair and
maintenance of the facility.
  Minimum
lease payments for the next five years are approximately $120,000.
 
 Total
rent expense for the three months ended March 31, 2008 was approximately
$55,623.
 
 Forward
Looking Statements
 
 Certain
disclosure and analysis in this report, including information incorporated by
reference, includes forward-looking statements that are subject to various risks
and uncertainties. In addition to statements of historical fact, this Quarterly
Report on Form 10-Q contains forward-looking statements. The presentation
of future aspects of Earth’s business found in these statements is subject to a
number of risks and uncertainties that could cause actual results to differ
materially from those reflected in such statements. Readers are cautioned not to
place undue reliance on these forward-looking statements, which reflect
management’s analysis only as of the date hereof. Without limiting the
generality of the foregoing words such as “may,” “will,” “expect,” “believe,”
“anticipate,” “intend,” or “could” or the negative variations thereof or
comparable terminology are intended to identify forward-looking
statements.
 
 These
forward-looking statements are subject to certain events, circumstances,
assumptions, risks and uncertainties that may cause Earth’s actual results to be
materially different from any future results expressed or implied by Earth in
those statements. Some of these risks might include, but are not limited to, the
following:
  31
 Table of Contents
  
 
 ·
              Volatility
      or decline of Earth’s stock price;
 
 ·
              Potential
      fluctuation in quarterly results;
 
 ·
              Ability
      of Earth to earn revenues or
profits;
 
 ·
              Sufficiency
      of revenues to cover operating
costs;
 
 ·
              Availability
      and cost of raw materials;
 
 ·
              Any
      impact of competition, competitive products, and
  pricing;
 
 Adequacy
of capital to continue or expand its business, inability to raise additional
capital or financing to implement its business plans;
 
 ·
              Ability
      to commercialize its technology or to make
  sales;
 
 ·
              Overall
      expected growth in the alternative fuels
  industry;
 
 ·
              Changes
      in interest rates and capital market
conditions;
 
 ·
              Changes
      in laws and other regulatory
actions;
 
 ·
              Acquisitions
      of business enterprises, including the ability to integrate acquired
      businesses effectively;
 
 ·
              Litigation
      with or legal claims and allegations by outside parties; 
      and
 
 ·
              Other
      assumptions described in this report, as well as other reports filed with
      the United States Securities and Exchange Commission, underlying such
      forward-looking statements.
 
 There is
no assurance that Earth will be profitable, Earth may not be able to
successfully develop, manage or market its products and services, Earth may not
be able to attract or retain qualified executives and technology personnel,
Earth’s products and services may become obsolete, government regulation may
hinder Earth’s business, and additional dilution in outstanding stock ownership
may be incurred due to the issuance of more shares, warrants and stock options,
or the exercise of warrants and stock options, and other risks inherent in
Earth’s businesses.
 
 Earth
undertakes no obligation to publicly revise these forward-looking statements to
reflect events or circumstances that arise after the date hereof. Readers should
carefully review the factors described in other documents Earth files from time
to time with the Securities and Exchange Commission, including the Quarterly
Reports on Form  10-QSB and Annual Report on Form  10-KSB filed by
Earth and any Current Reports on Form 8-K filed by Earth.
 
 
 ITEM
3.              Quantitative and Qualitative Disclosures About Market
Risk
  ITEM
4.            Controlsand Procedures
 
 Disclosure
Controls and Procedures
 
 We
maintain disclosure controls and procedures and internal controls that are
designed to provide reasonable, but not absolute, assurance that information
required to be disclosed in our Exchange Act reports is recorded, processed,
summarized and reported within the time periods specified in the Securities and
ExchangeCommission's rules and forms and that such information is accumulated
and communicated to our management, including our  Chief Executive
  32
 Table of Contents
  Officer
and Chief Financial Officer, as appropriate, to allow timely decisions regarding
required disclosure. We carried out an evaluation, under the supervision of and
with the participation of our management, including our Chief Executive Officer
and Chief Financial Officer, of the effectiveness of the design and operation of
our disclosure controls and procedures as of the end of the period covered by
this report. Based on the foregoing, our Chief Executive Officer and Chief
Financial Officer concluded that our disclosure controls and procedures were not
effective.
 
 The
Company did not maintain a sufficient complement of personnel with an
appropriate level of technical accounting knowledge, experience, and training in
the application of generally accepted accounting principles commensurate with
the Company’s complex financial accounting and reporting requirements and low
materiality thresholds. This was evidenced by a significant number of out-of
period adjustments noted during the year-end closing process related to deferred
income taxes, impairment on notes receivable and accruals of contingent
liabilities. This material weakness also contributed to the restatement of the
financial statements for the three month periods ended March 31, 2007 and June
30, 2007, respectively, related to contingent liabilities, interest accruals and
impairments of receivables.
 
 A
material weakness in the period-end financial reporting process could result in
the Company not being able to meet its regulatory filing deadlines and, if not
remediated, has the potential to cause a material misstatement or to miss a
filing deadline in the future. Because of the inherent limitations in a
cost-effective control system, misstatements due to error or fraud may occur and
not be detected.
 
 Our
management, including our CEO and CFO, does not expect that our Disclosure
Controls or our internal controls will prevent or detect all errors and all
fraud. A control system, no matter how well designed and operated, can provide
only reasonable, not absolute, assurance that the control system’s objectives
will be met. Further, the design of a control system must reflect the fact that
there are resource constraints, and the benefits of controls must be considered
relative to their costs. Because of the inherent limitations in all control
systems, no evaluation of controls can provide absolute assurance that all
control issues and instances of fraud, if any, within the company have been
detected. These inherent limitations include the realities that judgments in
decision-making can be faulty, and that breakdowns can occur because of simple
error or mistake. Controls can also be circumvented by the individual acts of
some persons, by collusion of two or more people, or by management override of
the controls. The design of any system of controls is based in part upon certain
assumptions about the likelihood of future events, and there can be no assurance
that any design will succeed in achieving its stated goals under all potential
future conditions. Over time, controls may become inadequate because of changes
in conditions or deterioration in the degree of compliance.
 
 The
Company has developed and implemented remediation plans to address our material
weaknesses.  Management took the following actions during the last
quarter of 2006 and the first two quarters of 2007 to improve the internal
controls over financial reporting.
 
 1.   Reorganize
and restructure the Accounting department by (a)  revising the reporting
structure and establishing clear roles, responsibilities, and accountability,
(b)  hiring additional technical accounting personnel to address Earth’s
complex accounting and financial reporting requirements, and (c)  assessing
the technical accounting capabilities in the operating units to ensure the right
complement of knowledge, skills, and training.
 
 2.  Improve
period-end closing procedures by (a)  requiring all significant non-routine
transactions to be reviewed by Corporate Accounting, (b)  ensuring that
account reconciliations and analyses for significant financial statement
accounts are reviewed for completeness and accuracy by qualified accounting
personnel, (c)  implementing a process that ensures the timely review and
approval of complex accounting estimates by qualified accounting personnel and
subject matter experts, where appropriate, and (d)  developing better
monitoring controls.
 
 In light
of this, management has augmented the resources in Accounting by utilizing
external resources in technical accounting areas and implemented additional
closing procedures for the year ended December 31, 2007, and for the three
months ended March 31, 2008. As a result, management believes that there are no
material inaccuracies or omissions of material fact and, to the best of its
knowledge, believes that the consolidated financial statements for the
  33
 Table of Contents
  three
months ended March 31, 2008 fairly present in all material respects the
financial condition and results of operations for the Company in conformity with
accounting principles generally accepted in the United States of
America.
 
 There
were no changes in our internal controls (except as noted above) that have
materially affected, or are reasonably likely to materially affect these
controls subsequent to the date of their evaluation, including any corrective
actions with regard to significant deficiencies and material
weaknesses.
 
 
 PART II
OTHER INFORMATION
  Item 1.LegalProceedings
  On May 2, 2006, Earth
entered into a letter of intent with Vertex Energy, L.P., which contemplated a
joint venture in which a newly created company would own and operate a biodiesel
production facility on the Houston Ship Channel in Houston, Texas. As
contemplated by the letter of intent, Vertex Energy would acquire a 49% interest
in the newly created company in exchange for contributing to the new operating
company real property and improvements, including an existing chemical
processing facility. Earth would acquire a 51% interest in the operating company
in exchange for the payment of $2,500,000 and the issuance of
1,500,000 shares of its common stock to Vertex Energy. In Harris County
District Court, Vertex Energy, LP & Benjamin P. Cowart alleged breach
of contract on January 26, 2007, and a motion for new trial was granted. We
believe these allegations are substantively without merit, and are vigorously
contesting the claims brought by the plaintiff, and are exercising all available
rights and remedies against them; however, the ultimate outcome of this matter
is uncertain. Vertex Energy filed its First Amended Petition on February 8,
2008, enjoining Jason Gehrig to the case. Earth is currently in the discovery
motion stage with Vertex Energy regarding disclosures, interrogatories, and
requests for production. The investment in this company and related plant was
deemed impaired due to lack of operations and was charged to earnings totaling
$$2,435,000 during 2006, and $2,543,000 during 2007, resulting in total
estimated impairments of $4,978,000. Should Vertex prevail in the above
proceedings Earth would receive the facility in question.
 
 In April
2007, JM Allen & Associates, Inc. filed a civil action in the District Court
of Rusk County, Texas for the 4th Judicial District of Texas, entitled JM
Allen & Associates, Inc. v. Earth Biofuels, Inc., Case No. 
2007-160, alleging fraudulent inducement and non-performance under a series of
oral alleged agreements to provide labor and materials in the aggregate amount
of $1,900,000; and also filed a request for disclosure, admissions,
interrogatories, and request for production of documents. On February 1, 2008,
Earth entered into a settlement agreement with JM Allen for $410,000. This
amount has been included in accounts payable and accrued expenses.
 
 On May
22, 2007, Pacific Biodiesel Texas, LP filed a Demand for Arbitration with the
American Arbitration Association claiming $513,309 is due them do to a breach of
their Sales and Purchase Agreement with Earth to purchase all Claimant’s
biodiesel output for a 12 month period. Pacific Biodiesel Texas, LP filed their
First Amended Demand for Arbitration on January 24, 2008 increasing their claim
to $1,225,765. Both parties executed a settlement agreement dated April 1, 2008,
whereby Earth will pay $552,800 to Pacific Biodiesel in full settlement of their
claim. Accordingly, $552,800 has been included in accounts payable and accrued
expenses.
 
 On
July 24, 2006, Earth entered into a securities purchase agreement pursuant
to which Earth issued $52.5 million aggregate senior convertible notes that
were due in 2011 to eight institutional investors.   Due to ongoing
renegotiations with the above investors, Earth did not make the first quarterly
interest payments due October 1, 2006, or register the underlying
securities within 30 days from closing in accordance with the original
securities purchase agreement. Subsequent to the second quarter of 2007, certain
of the note holders, filed with the bankruptcy courts a Chapter 7 -
Involuntary Liquidation against the company.   On November 14, 2007,
Earth Biofuels, Inc. (the “Company”) negotiated and executed a settlement
agreement (the “Agreement”).  The Agreement required the creditors to
dismiss their petition of bankruptcy. Under the terms of the Agreement, the
Company will grant certain security interests to the creditors and will execute
a restructuring plan within 180 days. A confession of judgment was signed by the
company noting the entire amount of debt and penalties due under the original
notes of
  34
 Table of Contents
  $100,651,173.
Total accrued penalties were approximately $48,151,000 as of December 31,
2007.
 
 YA Global
Investments, LP, formerly Cornell Capital Partners, LP, filed their Complaint
against Earth Biofuels on February 1, 2008 in the Supreme Court of the State of
New York in the County of New York. The Plaintiff alleges claims of 3 counts of
breach of contract against the Defendant; wherein, the parties are currently in
the pleading stage. This investor was one of the original accredited investors
in the Securities Purchase Agreement dated July 24, 2006.
 
 Earth has
become subject to various claims and other legal matters in the course of
conducting its business. No material individual claims are currently pending;
however, the company has recorded approximately $585,000 in regards to claims
deemed probable to occur in accounts payable and accrued expenses as of March
31, 2008.
 
 We may
become party to various legal actions that arise in the ordinary course of our
business. During the course of our operations, we are also subject to audit by
tax authorities for varying periods in various federal, state, local, and
foreign tax jurisdictions. Disputes may arise during the course of such audits
as to facts and matters of law. It is impossible at this time to determine the
ultimate liabilities that we may incur resulting from any lawsuits, claims and
proceedings, audits, commitments, contingencies and related matters or the
timing of these liabilities, if any. If these matters were to be ultimately
resolved unfavorably, an outcome not currently anticipated, it is possible that
such outcome could have a material adverse effect upon our consolidated
financial position or results of operations. However, we believe that the
ultimate resolution of such actions will not have a material adverse affect on
our consolidated financial position, results of operations, or
liquidity.
 
 Item 1A.RiskFactors
  Feed
stocks, natural gas, petroleum products and chemical prices have fluctuated in
response to changing market forces. The impacts of these price fluctuations on
earnings have varied. For any given period, the extent of actual benefit or
detriment will be dependent on the price movements of individual types of feed
stocks, taxes and other government impacts, price adjustment lags in long-term
contracts, and natural gas production volumes. Accordingly, changes in benchmark
prices for these raw materials only provide a broad indicator of changes in the
earnings experienced in any particular period. In these very competitive
environments, earnings are primarily determined by margin capture rather than
absolute price levels of products sold. Operating margins are a function of the
difference between what a produces pays for its raw materials and the market
prices for the range of products produced. These prices in turn depend on global
and regional supply/demand balances, inventory levels, plant operations,
import/export balances and weather. Such conditions, along with the
capital-intensive nature of the industry and very long lead times associated
with many of our projects, underscore the importance of obtaining a strong
financial position.
 
 Our
business is highly dependent on commodity prices, which are subject to
significant volatility and uncertainty, and on the availability of raw materials
supplies, so our results of operations, financial condition and business outlook
may fluctuate substantially. Our results of operations depend substantially on
the prices of various commodities, particularly the prices for biodiesel,
feedstock, such as soybean, corn, natural gas and unleaded gasoline. The prices
of these commodities are volatile and beyond our control. As a result of the
volatility of the prices for these items, our results may fluctuate
substantially. We may experience periods during which the prices of our products
decline and the costs of our raw materials increase, which in turn may result in
operating losses and adversely affect our financial condition. We may attempt to
offset a portion of the effects of such fluctuations by entering into forward
contracts to supply biodiesel, corn, feedstock, such as soybean, natural gas or
other items or by engaging in transactions involving exchange-traded futures
contracts, but these activities involve substantial costs, substantial risks and
may be ineffective to mitigate these fluctuations. If a substantial imbalance
occurs, our results of operations, financial conditions and business outlook
could be negatively impacted. Our ability to operate at a profit is largely
dependent on market prices for biodiesel, and the value of your investment in us
may be directly affected by these market prices.
 
 Earth’s
revenue and operating results may vary significantly from quarter-to-quarter due
to a number of factors. In future quarters, operating results may be below the
expectations of public market analysis or investors, and the price of its common
stock may decline.
  35
 Table of Contents
  
 Factors
that could cause quarterly fluctuations include:
 ·
              The
      ability to quickly bring new production capacity on
  stream;
 ·
              the
      fluctuating prices of feed stocks and natural
  gas;
 ·
              the
      ability to raise the necessary capital to fund working capital, execute
      mergers, acquisitions and asset purchases; The market in which Earth
      competes is intensely competitive and actions by competitors could render
      its services less competitive, causing revenue and income to decline; The
      ability to compete depends on a number of factors outside of Earth’s
      control, including:
 o
              the
      prices at which others offer competitive services, including aggressive
      price competition and discounting;
 o
              actions
      taken by the Federal Government or State Governments to remove subsidies
      and tax credits associated with the biodiesel
  business;
 o
              large
      swings in the price of oil which will affect the price at which Earth can
      purchase fuel supplies;
 o
              the
      ability of competitors to undertake more extensive marketing
      campaigns;
 o
              the
      extent, if any, to which competitors develop proprietary tools that
      improve their ability to compete;
and
 o
              the
      extent of competitors’ responsiveness to customer
  needs.
 
 Earth may
not be able to compete effectively on these or other factors. If Earth is unable
to compete effectively, market position, and therefore revenue and
profitability, would decline. Earth must continually enhance its services to
meet the changing needs of its customers or face the possibility of losing
future business to competitors.
 
 Changes
in production technology could require us to commit resources to updating our
biodiesel plants or could otherwise hinder our ability to compete in the
biodiesel industry or to operate at a profit. Advances and changes in the
technology of biodiesel production are expected to occur.   Such
advances and changes may make our biodiesel production technology less desirable
or obsolete.
 
 Our
expansion plans, including with respect to the sites in Texas, Oklahoma,
Tennessee, Kentucky, Illinois and Mississippi, are subject to significant risks
and uncertainties with respect to timing of completion, financing of
construction costs and our ability to timely realize the benefits we anticipate
of these additional sites. Accordingly, investors should not place undue
reliance on our statements about our expansion plans or their feasibility in the
timeframe anticipated or at all.
 
 Our
construction costs could increase to levels that would make construction of new
facilities too expensive to complete or unprofitable. Our construction costs
could materially exceed budgets, which may adversely affect our financial
condition and our anticipated operating results. We believe that contractors,
engineering firms, construction firms and equipment suppliers increasingly are
receiving requests and orders from other biodiesel/ethanol companies and,
therefore, we may not be able to secure their services or products on a timely
basis or on acceptable financial or commercial terms. We may suffer significant
delays or cost overruns as a result of a variety of factors, such as shortages
of workers or materials, transportation constraints, adverse weather, unforeseen
difficulties or labor issues, any of which could prevent us from commencing
operations as expected at our facilities. Any new facility that we may complete
may not operate as planned.
 
 We may
not be able to protect and enforce our intellectual property rights, which could
result in the loss of our rights or increased costs. Our future success depends
to a significant degree upon the protection of our proprietary technology. 
The misappropriation of our proprietary technology would enable third parties to
benefit from our technology without paying us for it.   Although we
have taken steps to protect our proprietary technology, they may be inadequate
and the unauthorized use thereof could have a material adverse effect on our
business.    If we resort to legal proceedings to enforce
our intellectual property rights, the proceedings could be burdensome and
expensive, even if we were to prevail.
 
 Excess
production capacity in the ethanol industry resulting from new plants under
construction or decreases in the demand for ethanol could adversely affect our
business. According to the RFA, domestic ethanol production capacity has
increased from 1.8 billion gallons per year at December 31, 2001 to an estimated
4.5 billion gallons per year in April 2006. The RFA estimates that, as of May
2006, approximately 2.0 billion gallons per year of additional
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  production capacity, an increase of 50% over current production levels, is under
construction at 41 new and existing facilities. This estimate does not include
our plans to build a production capacity. Excess capacity in the ethanol
industry would have an adverse effect on our results of operations, cash flows
and financial condition. In a manufacturing industry with excess capacity,
producers have an incentive to manufacture additional products for so long as
the price exceeds the marginal cost of production (i.e., the cost of producing
only the next unit, without regard to interest, overhead or fixed costs). This
incentive can result in the reduction of the market price of ethanol to a level
that is inadequate to generate sufficient cash flow to cover costs. Excess
ethanol production capacity also may result from decreases in the demand for
ethanol, which could result from a number of factors, including regulatory
developments and reduced gasoline consumption in the United States. Reduced
gasoline consumption could occur as a result of increased prices for gasoline or
crude oil, which could cause businesses and consumers to reduce driving or
acquire vehicles with more favorable gasoline mileage or as a result of
technological advances, such as the commercialization of hydrogen fuel-cells,
which could supplant gasoline-powered engines.
 
 Our gross
margins will be principally dependent on the spread between ethanol and corn
prices. The current spread between ethanol and corn prices is currently at a
historically high level, driven in large part by high oil prices. We do not
expect the spread between ethanol and corn prices to continue at the current
level. Any reduction in the spread between ethanol and corn prices, whether as a
result of an increase in corn prices or a reduction in ethanol prices, would
adversely affect our financial performance.
 
 Our
profit margins may be adversely affected by fluctuations in the selling price
and production cost of gasoline. Ethanol is marketed both as a fuel additive to
reduce vehicle emissions from gasoline and as an octane enhancer to improve the
octane rating of the gasoline with which it is blended. As a result, ethanol
prices are influenced by the supply of and demand for gasoline. Our results of
operations may be materially adversely affected if the demand for or the price
of gasoline decreases. Conversely, a prolonged increase in the price of or
demand for gasoline could lead the U.S. government to relax import restrictions
on foreign ethanol that currently benefit us.
 
 Future
success will depend upon Earth’s ability to enhance existing products and to
introduce new products to meet the requirements of customers in a rapidly
developing and evolving market. Present or future products may not satisfy the
needs of the market. If Earth is unable to anticipate or respond adequately to
its customers’ needs, lost business may result and financial performance will
suffer.
 
 Earth is
dependent on a limited number of key personnel, and the loss of these
individuals could harm its competitive position and financial performance. Our
future success depends, to a significant extent, on the continued services of
our key personnel, including plant managers.  Competition for personnel
throughout the industry is intense and we may be unable to retain our current
management and staff or attract, integrate or retain other highly qualified
personnel in the future. If we do not succeed in retaining our current
management and our staff or in attracting and motivating new personnel and plant
managers, our business could be materially adversely affected.
 
 We
will be highly dependent upon an engineering and construction firm or firms to
design and build the plants and train our personnel to operate the plants, but
we currently have no binding agreement with any such firm. Various firms have
indicated an interest in negotiating a design-build contract which would provide
for the firm to serve as our general contractor and would provide or engage
another firm to supply essential design and engineering services and would set
forth the terms on which the firm would design and build our plant. However, the
leading ethanol plant contracting firms are engaged in many other projects and
we may have difficulty obtaining these services on a satisfactory timeline.
Thus, there is no assurance that we will be able to identify a satisfactory
contractor or to negotiate and execute a satisfactory design-build contract. If
we are unable to execute a design-build contact or if the contractor terminates
its relationship with us, we could be forced to abandon our project. Any delay
in the construction of our plant or commencement of our operations would delay
our ability to generate revenue, service our debt, compete effectively and make
distributions to our shareholders.
 
 Earth’s
business consists of the production, marketing, distribution and sale of
biodiesel fuel through Earth’s network of wholesale and retail outlets and,
accordingly, its success depends upon the efforts, abilities,
business
  37
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  generation
capabilities and project execution of its executive officers. Earth’s success is
also dependent upon the managerial, operational and administrative skills of its
executive officers. The loss of any executive officer could result in a loss of
customers or revenue, and could therefore harm Earth’s financial
performance.
 
 Significant
increases in the cost of the project may require us to obtain additional debt or
equity capital which may be difficult and expensive to obtain, or may not be
available at all, and which could delay and diminish our profitability and
decrease the value of your shares.
 
 Earth’s
ability to secure debt and equity financing could have an adverse effect on
Earth’s financial health.
 
 The
inability to raise capital to fund working capital needs may:
 
 ·
              Increase
      Earth’s vulnerability to general adverse economic and industry
      conditions;
 
 ·
              Limit
      Earth’s ability to fund future working capital and other general corporate
      requirements;  and
 
 ·
              Limit
      Earth’s flexibility in planning for, or reacting to, changes in Earth’s
      business and the industry in which it
operates.
 
 Our
limited operating history makes evaluating our business and prospects difficult.
Our limited operating history and recent acquisitions make it difficult to
evaluate our current business and prospects or to accurately predict our future
revenues or results of operations.    Our revenue and income
potential are unproven, and our business plan is constantly
evolving.    The market for alternative fuels is evolving
and we may need to continue to modify our business plan to adapt to these
changes.   As a result, we are more vulnerable to risks,
uncertainties, expenses and difficulties than more established companies. Some
of these risks relate to our potential inability to: effectively manage our
business and operations; successfully maintain our low-cost structure as we
expand the scale of our business; and manage rapid growth in personnel and
operations.
 
 Because
our common stock is listed on the NASD OTC Bulletin Board, many investors may
not be willing or allowed to purchase it or may demand steep
discounts.   Sufficient additional financing may not be available to
us or may be available only on terms that would result in further dilution to
the current owners of our common stock.   If we are unable to raise
additional funds when we need them, we may have to severely curtail our
operations and expansion plans.
 
 As a
result of being a public company, we have incurred and will continue to incur
significant legal, accounting and other expenses. We have incurred and will
continue to incur costs associated with our public company reporting
requirements and costs associated with related corporate governance
requirements, including requirements under the Sarbanes-Oxley Act of 2002, as
well as new rules implemented by the SEC.   In addition, complying
with these rules, regulations and requirements will occupy a significant amount
of the time of our board of directors and management.   We also expect
these rules and regulations may make it more difficult and more expensive for us
to obtain director and officer liability insurance and we may be required to
accept reduced policy limits and coverage or incur substantially higher costs to
obtain the same or similar coverage. As a result, it may be more difficult for
us to attract and retain qualified individuals to serve on our board of
directors or as executive officers. We cannot predict or estimate the amount of
additional costs we may incur or the timing of such costs.
 
 If we
fail to remain current on our reporting requirements, we could be removed from
the over-the-counter bulletin board, which would limit the ability of
broker-dealers to sell our securities and the ability of stockholders to sell
their securities in the secondary market. Companies trading on the
over-the-counter bulletin board, such as us, must be reporting issuers under
Section 12 of the Securities Exchange Act of 1934, as amended, and must be
current in their reports under Section 13 in order to maintain price quotation
privileges on the over-the-counter bulletin board.
 
 There is
significant volatility in our stock price. The trading price of our common stock
on the over-the-counter bulletin board has been and continues to be subject to
wide fluctuations.    The market price of our common stock
could be subject to significant fluctuations in response to various factors and
events, including, among other things, the depth and liquidity of the trading
market of our common stock, quarterly variations in actual or anticipated
operating
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  results,
growth rates, changes in estimates by analysts, market conditions in the
industry, announcements by competitors, regulatory actions and general economic
conditions.   In addition, the stock market from time to time
experiences significant price and volume fluctuations, which may be unrelated to
the operating performance of particular companies.   As a result of
the foregoing, our operating results and prospects from time to time may be
below the expectations of public market analysts and investors.   Any
such event would likely result in a material adverse effect on the price of our
common stock. In addition, the trading price of our common stock will continue
to be volatile in response to factors including the following, many of which are
beyond our control: variations in our operating results; announcements of
technological innovations, new products or new services by us or our
competitors; changes in expectations of our future financial performance,
including financial estimates by securities analysts and investors; our failure
to meet analysts’ expectations; changes in operating and stock price performance
of other energy companies similar to us; fluctuations in oil and gas prices;
conditions or trends in the oil and gas and alternative fuels industry;
additions or departures of key personnel; and future sales of our common
stock.
 
 There is
a limited market for our common stock. If a substantial and sustained
market for our common stock does not develop, our stockholders’ ability to sell
their shares may be materially and adversely affected.
 
 Any
disruption in our operations could result in a reduction of sales volume and
could cause us to incur substantial losses.
 
 We are
subject to various stringent federal, state and local environmental laws and
regulations, including those relating to the discharge of materials into the
air, water and ground, the generation, storage, handling, use, transportation
and disposal of hazardous materials, and the health and safety of our employees.
In addition, some of these laws and regulations require our facilities to
operate under permits that are subject to renewal or modification. These laws,
regulations and permits can often require expensive pollution control equipment
or operational changes to limit actual or potential impacts to the environment.
A violation of these laws and regulations or permit conditions can result in
substantial fines, natural resource damages, criminal sanctions, permit
revocations and/or facility shutdowns. We cannot assure you that we will be at
all times in complete compliance with these laws, regulations or permits. In
addition, we expect to make significant capital expenditures on an ongoing basis
to comply with these stringent environmental laws, regulations and
permits.
 
 In
addition, the hazards and risks associated with producing and transporting our
products (such as fires, natural disasters, explosions, abnormal pressures and
spills) may result in personal injury claims or damage to property, natural
resources and third parties. As protection against operating hazards, we will
maintain insurance coverage against some, but not all, potential losses. The
occurrence of events which result in significant personal injury or damage to
our property, natural resources or third parties that is not fully covered by
insurance could have a material adverse impact on our results of operations and
financial condition.
 
 When
construction of a proposed plant nears completion, we will need to hire a
significant number of employees to operate the plant. Our success depends in
part on our ability to attract and retain competent personnel. We must hire
qualified managers, engineers and accounting, human resources, operations and
other personnel. Competition for employees in the ethanol industry is intense.
If we are unable to hire, train and retain qualified and productive personnel,
we may not be able to operate the plant efficiently and the amount of ethanol we
produce and market may decrease.
 
 There can
be no assurance that Earth’s business will generate sufficient cash flow from
operations or that future borrowings will be available to it in an amount
sufficient to enable it to obtain debt or to fund other liquidity
needs.
 
 
 
 Item
2.     UNREGISTERED SALES OF
EQUITY SECURITIES AND USE OF PROCEEDS
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  On
March 31, 2006, we issued 1,800,000 shares of our common stock to
Dr. Miguel Dabdoub in connection with the purchase of a membership interest
in Earth Biofuels Technology Company, LLC. These shares were issued in reliance
upon the exemption from registration afforded by Section 4(2) of the Securities
Act.
 
 On
March 31, 2006, pursuant to the closing of the merger with Southern Bio
Fuels, we issued 2,933,333 shares of our common stock to the sole
stockholder of Southern Bio Fuels. The sale of these shares of our common stock
to accredited investors was made in reliance upon the exemption from
registration afforded by Section 4(2) of the Securities Act of 1933, as amended,
or the Securities Act.
 
 On
April 8, 2006, we entered into a securities purchase agreement, pursuant to
which we issued 6,400,000  shares of our common stock to accredited
investors, in consideration for the payment of approximately $3.2  million.
We will use the proceeds, in concert with other funds, to acquire a 50% equity
interest in an entity which will own and operate a planned ethanol plant in New
Orleans, Louisiana. Contemporaneously with the execution and delivery of the
securities purchase agreement, we entered into a registration rights agreement,
pursuant to which we agreed to provide certain registration rights with respect
to the shares of common stock issued pursuant to the securities purchase
agreement. The sale of these shares of our common stock to accredited investors
was made in reliance upon the exemption from registration afforded by Section
4(2) of the Securities Act of 1933, as amended, or the Securities
Act.
 
 On
June 12, 2006, we issued 125,000 shares of our common stock in
connection with our April 20, 2006 acquisition of a 25% limited partnership
interest in Trucker’s Corner, L.P. In addition, Trucker’s Corner received $1.1
million from us and 25,000 shares of Apollo Resources’ common stock from
Apollo Resources International, Inc. (Earth’s parent). Our shares of common
stock were issued in reliance upon the exemption from registration afforded by
Section 4(2) of the Securities Act.
 
 On
June 12, 2006, we issued 537,500 shares of our common stock to Biodiesel
Venture, L.P. and 537,500 shares of our common stock to Willie H. Nelson in
connection with a sublicense agreement entered into on April 1, 2006 with
Biodiesel Venture, L.P., pursuant to which Biodiesel Venture granted us an
exclusive sublicense to use the trademark “BioWillie” which is licensed to
Biodiesel Venture pursuant to a master license with Mr. Nelson, the owner
of the trademark. These shares were issued in reliance upon the exemption from
registration afforded by Section 4(2) of the Securities Act.
 
 On
July 13, 2006, holders of convertible notes issued during January through
June of 2006, exercised their conversion option and the Company issued an
aggregate of 3,000,000 shares of common stock in exchange for the conversion of
notes with an aggregate principal amount of $1.5 million. These shares were
issued in reliance upon the exemption from registration afforded by
Section 4(2) of the Securities Act. The related debt which was converted to
shares included registration rights therein.
 
 In
addition, on July 21, 2006, Apollo Resources entered into a securities purchase
agreement with Greenwich Power, LLC and Greenwich Power II, LLC, pursuant
to which Apollo Resources issued notes exchangeable for shares of our common
stock held by Apollo Resources and options to purchase our common stock held by
Apollo Resources. In connection with this transaction, Apollo Resources agreed
to cause us to grant these Apollo Resources note holders registration rights
with respect to the shares of common stock underlying the convertible notes and
options. We have acknowledged and agreed to comply with the terms of the
registration rights agreements between Apollo and these note holders. In
connection with this transaction, Lance Backrow, who is the sole manager of both
Greenwich Power entities, purchased a warrant to purchase 4,000,000 shares
of our common stock at an exercise price of $0.25 per
share.  Mr. Backrow paid us $100,000 for the issuance of this
warrant. We granted Mr.  Backrow certain registration rights with respect
to the shares of common stock issuable upon exercise of this
warrant.
 
 During
the quarters ended June 30, and September 30, 2006, respectively we
issued convertible notes and warrants to institutional investors in reliance
upon the exemption from registration afforded by Section 4(2) of the Securities
Act as follows:
 
 ·
              On
      May 4, 2006, we issued a $1.0 million convertible, secured promissory
      note, bearing interest at 7%, payable within thirty days upon demand by
      the holder, and convertible into shares of our common stock at a
      conversion price of $1.086 per share. We also issued the investor a
      warrant to purchase
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  ·
              920,810 shares
      of our common stock, exercisable until May 31, 2001 at the lesser of
      $2.00 per share or 80% of the average trading price of our common
      stock for the thirty trading days prior to the exercise of the warrant. We
      used the net proceeds from the sale in connection with our biodiesel and
      ethanol plant acquisition strategy and for other general corporate
      purposes. We granted the note holder certain registration rights with
      respect to the shares of common stock underlying the convertible note and
      the warrant. The note and warrant and a corresponding guarantee given by
      Apollo Resources, our majority stockholder, were subsequently cancelled by
      the holder in connection with Apollo Resources’ closing on July 21,
      2006 of a securities purchase agreement with Greenwich
    Power.
 
 ·
              On
      May 26, 2006, we issued $5.0 million principal amount of
      8% senior convertible promissory notes to a single institutional
      investor. The notes carried an 8% coupon, payable quarterly, and were
      redeemable by us at par at any time prior to their initial maturity date
      in August 2006. The notes were not convertible until after August 2006, at
      which time the maturity date was extendable to November 2006 at the
      holder’s option. The notes were convertible into our common stock at a
      conversion price equal to the greater of $1.00  per share or 75% of
      the weighted average price per share of our common stock on a five-day
      volume weighted average prior to closing. We also issued five-year
      warrants to purchase 750,000  shares of common stock to the investor
      and five-year warrants to purchase 18,750 shares of common stock to our
      placement agent, both at an exercise price of $3.84  per
      share.
 
 ·
              We
      used the net proceeds from the sale in connection with our biodiesel and
      ethanol plant acquisition strategy and for other general corporate
      purposes. We granted the investor certain registration rights with respect
      to the shares of common stock issuable upon conversion of the convertible
      notes and exercise of the warrants. The remaining unpaid principal and
      accrued and unpaid interest on these notes were repaid in full with a
      portion of the net proceeds from the senior convertible promissory notes
      we issued in July 2006.   The warrants remain
      outstanding.
 
 ·
              On
      June 2, 2006, we issued a convertible note with a principal amount of
      $500,000 to one individual. The note bore interest at 8% per year, which
      was payable on July 28, 2006, August 28, 2006, January 28, 2007 and
      April 28, 2007. The note had a maturity date of April 28, 2007. The
      note was convertible into shares of our common stock at a conversion price
      equal to the lesser of $0.50 per share or 70% of the weighted average
      price per share of our common stock. We used the net proceeds from the
      sale in connection with our biodiesel and ethanol plant acquisition
      strategy and for other general corporate purposes. We granted the note
      holder certain registration rights with respect to the shares of common
      stock underlying the convertible notes. On July 13, 2006, the holder
      of the note exercised its option to convert the notes, and we issued an
      aggregate of 1,000,000 shares of our common stock to such holder in
      exchange for the cancellation of the
note.
 
 ·
              On
      June 7, 2006, we issued $10 million aggregate principal amount of
      senior convertible notes to four institutional investors. The notes
      carried an 8% coupon, payable quarterly, and were redeemable by us at par
      at any time prior to their initial maturity date in September 2006. The
      notes were not convertible until after September 2006, at which time the
      maturity date was extendable to December 2006 at the holder’s option. The
      notes were convertible into our common stock at a conversion price equal
      to the greater of $1.00  per share or 70% of the weighted average
      price per share of our common stock on a five-day volume weighted average
      prior to closing. We also issued to the investors five-year warrants to
      purchase an aggregate of 1,500,000 shares of common stock to the investors
      and five-year warrants to purchase 45,000 shares of common stock to our
      placement agent, at an exercise price of $2.93 per share. We used the net
      proceeds from the sale, in concert with other funds, to continue to
      execute our business plan, specifically the construction or acquisition of
      additional biodiesel and ethanol facilities, and for other general
      corporate purposes, including working capital. We granted the investor
      certain registration rights with respect to the shares of common stock
      underlying the convertible notes and warrants. The remaining unpaid
      principal and accrued and unpaid interest on these notes were repaid in
      full with a portion of the net proceeds from the senior convertible
      promissory notes we issued in July 2006. The warrants remain
      outstanding.
 
 ·
              On
      July 10, 2006, Earth entered into a securities purchase agreement,
      pursuant to which Earth issued an 8% senior convertible note with a
      principal amount of $5.0 million to one institutional
      investor.
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  ·
              Earth
      also issued five-year warrants to purchase an aggregate of
      1,500,000 shares of common stock to the investor and five-year
      warrants to purchase 15,000  shares of common stock to Earth’s
      placement agent, both at an exercise price of $2.50 per share. On
      July 24, 2006, Earth used a portion of the net proceeds from its
      July 24, 2006 offering to repay in full the remaining unpaid
      principal and accrued and unpaid interest on this
  note.
 
 ·
              On
      July 13, 2006, holders of convertible notes issued during January
      through June of 2006, exercised their conversion option and Earth issued
      an aggregate of 3,000,000 shares of common stock in exchange for the
      conversion of notes with an aggregate principal amount of $1.5
      million.
 
 ·
              On
      July 24, 2006, Earth entered into a securities purchase agreement pursuant
      to which Earth issued $52.5 million aggregate senior convertible
      notes that are due in 2011 to eight institutional investors. The notes
      initially carry an 8% coupon, payable quarterly, and are convertible into
      shares of common stock at $2.90 per share. In connection with the
      issuance of the notes, Earth also issued five-year warrants to purchase
      9,051,725 shares of common stock to the investors and five-year
      warrants to purchase 1,357,759  shares of common stock to Earth’s
      placement agent, at $2.90 per share. Earth used the net proceeds from this
      offering to repay in full the remaining unpaid principal and accrued and
      unpaid interest on its $20.0 million aggregate principal amount of senior
      convertible promissory notes issued in May, June and July 2006, and
      expects to use the remaining proceeds from the offering for its program of
      building and acquiring interests in biodiesel and ethanol production
      facilities, and for other general corporate
  purposes.
 
 ·
              On
      August 11, 2006, Earth entered into a securities purchase agreement
      pursuant to which Earth issued $1.1 million aggregate senior
      convertible notes that are due in 2011 to two institutional investors. The
      notes initially carry an 8% coupon, payable quarterly, and are convertible
      into shares of common stock at $2.90 per share. In connection with the
      issuance of the notes, Earth also issued five-year warrants to purchase
      232,759 shares of common stock to the investors at $2.90  per share.
      The shares issued to an accredited investor included registration rights
      therein.   On November 29, 2007 these notes were converted
      pursuant to the original conversion terms and pursuant to a Settlement
      Agreement with the Company, whereby conversion shares and make whole
      shares were issued totaling 16,818,155 shares to extinguish the
      debt.
 
 ·
              In
      connection with the 8%  senior convertible notes issued in July 2006,
      Earth incurred loan costs in the amount of $3,452,000, of which the
      unamortized balance was written off during 2007 due to the above legal
      proceedings and involuntary bankruptcy
filings.
 
 ·
              On
      January 18, 2007, we issued warrants for 375,000 shares of our common
      stock to three investors in connection with a loan agreement totaling
      $750,000.   The loan was repaid at maturity during the second
      quarter of 2007. As of December 31, 2007, 250,000 shares of common stock
      were issued in connection with the exercise of above warrants. These
      shares were issued in reliance upon the exemption from registration
      afforded by Section 4(2) of the Securities
  Act.
 
 ·
              On
      February 28, 2007, our LNG subsidiary obtained a term note totaling
      $15 million, and line of credit facility totaling $5 million. The
      $15 million term loan is due and payable in 3 years, with
      interest accruing at LIBOR plus 1,000 basis points and payable
      monthly in advance. The loan is secured by the LNG plant facility in
      Topock, Arizona. In connection with this facility Warrant Purchase and
      Registration Right agreements were issued to purchase 13,549,816 of the
      Company’s common stock at $.36 per share for 10 years. At the date of
      original issuance the warrants had a relative fair value of $3,674,702.
      Amortization on the related debt discount totaled $202,560 for the year
      ended December 31, 2007.
 
 ·
              In
      addition, on March 23, 2007, Earth obtained a $9 million term loan
      facility, and a $2 million letter of credit secured by the Durant,
      Oklahoma biodiesel plant. The principal amount is due in 3 years with
      interest payable at LIBOR plus 1,000 basis points. In connection with this
      facility, Warrant Purchase and Registration Right agreements were issued
      to purchase 6,774,908 of the Company’s common stock at $.36 per share
      for 10 years. At the date of original issuance the warrants had a relative
      fair.
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  ·
              value
      of $1,654,643. Amortization on the related debt discount totaled $95,888
      for the year ended December 31,
2007.
 
 ·
              In
      June 2007, the lender on the above term loan facilities totaling $15
      million and $9 million respectively, exchanged their rights to purchase
      the warrants in lieu of additional financing fees totaling $5.4 million.
      These financing fees are payable at maturity of the debt and are being
      accrued monthly.
 
 ·
              On
      December 13, 2007, Earth entered into a loan agreement to which Earth
      issued 10,000,000 shares of common stock in connection with proceeds
      received of $550,000. The note and interest of 10% is due at maturity
      on March 15, 2008. These shares were issued in reliance upon the exemption
      from registration afforded by Section 4(2) of the Securities
      Act.
 
 ·
              The
      Company has guaranteed secured notes issued to the parent Apollo Resources
      International, Inc. (“ARI”) (the parent). The secured notes were issued in
      the total amount of $3,550,000 to ARI and guaranteed by the Company on
      February 12, 2007. As of December 31, 2007 the notes have been repaid
      through the sale of underlying collateral, and from the issuance of
      7,218,750 additional shares of the Company’s stock, resulting in a net
      contingent liability of approximately $1.4 million still owed to the third
      party, and recorded in accounts payable on the Consolidated Balance Sheets
      of Earth. The fair market value of the additional shares issued and
      the remaining contingent liability was recorded as a reduction of amounts
      due to the parent from prior advances, resulting in no charges to earnings
      for Earth.
 
 ·
              During
      the three months ended March 31, 2008, Earth issued 13,850,000 common
      shares, valued at approximately $554,000 million of Earth’s common
      stock to employees for services rendered, of which all shares were
      restricted, and 16,728,000 common shares, valued at approximately
      $661,627, of Earth’s common stock for consulting services, of which
      12,475,320 were not restricted.
 
 ·
              On
      March 28, 2008, the Company entered into a private financing transaction
      (“financing transaction”) pursuant to a Securities Purchase Agreement (the
      “Purchase Agreement”).  Pursuant to the Purchase Agreement we issued
      to the investors (i) 100,000 shares of our newly authorized
      Series A Convertible Preferred Stock, $.001 par value (the
      “convertible preferred stock”), (ii) Stock Purchase Warrants to
      purchase an additional 2,000,000 shares of common stock at an initial
      exercise price of $.0375 per share, and (iii) we issued 2,000,000
      shares of common stock. We received $100,000 in gross proceeds in the
      initial closing. Holders of the Series A Preferred Stock shall be entitled
      to receive dividends or other distributions with the holders of the
      Corporation’s common stock, par value $.001 (the “Common Stock”) on an as
      converted basis when, as, and if declared by the Directors of the
      Corporation.
 
 In connection with the
sale of the securities to the investors, we entered into a Registration Rights
Agreement with the investors dated as of March 28, 2008 (the “Registration
Rights Agreement”), which requires us to use   our best efforts to
register under the Securities Act of 1933, as amended (the “Securities Act”),
the shares of common stock issued and issuable upon conversion of the
convertible preferred stock. The Registration Rights Agreement also provides the
investors with demand and piggyback registration rights under the Securities Act
for shares of common stock issuable upon conversion of the convertible preferred
stock.
 
 Due to certain rights granted to its holders, the convertible redeemable
preferred stock is classified as non-permanent equity in the Consolidated
Balance Sheets, pursuant to Rule 5-02.28 of the Securities and
Exchange  Commission’s Regulation S-X and as further clarified by the
Emerging Issues Task Force Issue No. D-98, Classification and Measurement of
Redeemable Securities. Pursuant to FASB Staff Position FAS 150-5, Issuer’s Accounting Under FAS 150
for Freestanding Warrants and Other Similar Instruments That Are
Redeemable, the redeemable preferred shares are classified as liabilities
also due to certain rights granted to its holders.  The shares are
redeemable at any time after April 27, 2008 at 1.35 times the original amount or
$135,000.
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 Table of Contents
  At
the initial conversion price, the 100,000 shares of convertible preferred stock
currently outstanding are convertible into an aggregate of 5,000,000 shares of
our common stock. The convertible preferred stock is   
convertible    into shares of our common stock at an initial
conversion price of $.02 per share.
 
 Item 3.
              Defaultsupon Senior
  Securities
  See
footnote 2 in “Going Concern” under Item 1.
  Item 4.
              Submissionof Matters to a Vote of Security
      Holders
  On March
28, 2008, and subsequently amended on April 9, 2008, the board of directors
approved a Certificate of Amendment to Series A Preferred Stock of Earth. The
Company is authorized to issue 15,000,000 shares of $0.001 par value preferred
stock (“Preferred Stock”).  The Board of Directors of the Company has
designated 935,000 shares of the Preferred Stock as Series A Preferred Stock,
the number of shares designated and rights of each class are briefly described
as follows:
 
 Series A Convertible
Preferred Stock
 
 On April
10, 2008, the Company designated 935,000 shares of Preferred Stock as Series A
Convertible Preferred Stock (“Series A Preferred Stock”). The Series A Preferred
Stock is convertible into shares of Common Stock at an initial conversion price
of $.02. Holders of Series A Preferred Stock are entitled to one vote for each
share of Series A Convertible Preferred Shares held, are entitled to elect up to
two members to the Company’s Board of Directors, and, absent such election, are
provided certain voting and veto rights to any vote by the Board of Directors.
As of April 10, 2008, there were 935,000 shares of Series A Preferred Stock
designated and as of March 28, 2008 100,000 shares of Series A Preferred
Stock were issued and outstanding.
 
 In November
2007, our board of directors approved and recommended to our stockholders an
amendment to our stock option plans.
 
 
 Item 5.
              Other Information
  None
 
 
 
 ITEM 6.
              EXHIBITS
  The
following documents are filed as part of this report:
  ExhibitNumber
              
              Description
 
 3.01
              Certificate
      of Incorporation (filed as Exhibit 3.1 to the Report on
      Form 10-QSB for the period ending September 30, 2005 and
      incorporated herein by reference)3.02
              Bylaws
      (filed as Exhibit 3.2 to the Report on Form 10-QSB for the
      period ending September 30, 2005 and incorporated herein by
      reference)10.1
      – 10.87 (1)10.88(4)
              Acquisition
      Agreement between Liquefaction Corporation, et al and Earth Ethanol
      (incorporated by reference to Exhibit 1.01 of the Current Report on
      Form 8-K filed by Earth Biofuels, Inc. with the SEC on
      December 21, 2006).10.89
      (4)
              Pledge
      Agreement, Promissory Notes and Warrant Agreements with and from Two
      Ponds, Gilcreast and Bryant Russell Construction10.90(3)
              Letter
      from Nexxus re offer to Capitalize Biofuels with $150 million in
      Exchange for Common Stock and Escrow Agreement dated January 9, 2007
      (Exhibit previously labeled 14.)10.91(3)
              Credit
      Agreement dated March 23 2007 by and between Durant Biofuels, LLC and
      Lenders and related Amendment No. 1, Amended and Restated Collateral
      Agreement, and Warrant Purchase and Registration Rights Agreement (Exhibit
      previously labeled 15.)10.92(3)
              Credit
      Agreement dated February 28, 2007 by and between Earth LNG, Inc. and
      Lenders, and related Guarantee and Collateral Agreement and Warrant
      Purchase and Registration Rights Agreement (Exhibit previously labeled
      16.)10.93(3)
              Loan
      and Security Agreement with Greenfield Commercial Credit LLC dated
      March 1, 2007, and related Revolving Credit Loan note and Guaranty
      (Exhibit previously labeled 17.)10.94(7)
              Settlement
      Agreement with Pacific Biodiesel10.95(7)
              Amended
      Medley Agreement10.96(7)
              Interim
      Restructuring Agreement; dismissals; Order Granting Joint Motion of Debtor
      and Petitioning Creditors Holding 94% of Notes to Approve Interim
      Settlement Agreement and Dismiss Involuntary Bankruptcy Petition Pursuant
      to 11 U.S.C. §§ 105(a) and 3039j)(2) and Federal Rule of Bankruptcy
      Procedure 9019,10.97(7)
              Amended
      and Restated 2006 Stock Option and Award Plan10.98(7)
              Harborview
      Note Payable and Award Plan10.99
              Master
      Swap Agreement between Apollo Resources International and Arizona
      LNG.10.99
      A
              Asset
      Purchase Agreement among Biodiesal Investment Group, Blackhawk Biofuels,
      LLC, etal10.99
      B(6)
              Series
      A Preferred Stock First Amended and Restated Securities Purchase Agreement
      and Warrant Purchase Agreement, and Certificate of Amendment to Series A
      Preferred Stock of Earth.12.1(3)
              Report
      of Independent Registered Public Accounting Firm to the audit committee of
      Earth LNG, Inc. (Exhibit previously labeled 18.)14
              Code
      of Ethics – (Exhibit previously labeled 11.)20.1(5)
              Series
      of 7 Secured Notes (incorporated by reference to Exhibit 7.4 of the
      Current Report on Form 8-K filed by Earth Biofuels, Inc. with the SEC
      on November 19, 2007).21
              Subsidiaries31.1
              Certification
      of Chief Executive Officer pursuant to Rule 13a-14(a) under the
      Securities Act of 1934.31.2
              Certification
      of Chief Financial Officer pursuant to Rule 13a-14(a) under the
      Securities Act of 1934.32.1
              Certification
      of 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
              Certification
      of 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 registrants Report on Form 10-QSB for the period
      ending September 30, 2006 filed with the SEC on November 21,
      2006.(2)
              Filed
      as an exhibit to the registrant’s Current Report on Form 8-K filed
      with the SEC on November 22, 2006(3)
              Filed
      as an exhibit to the registrants Report on Form 10-KSB for the period
      ending December 31, 2006 filed with the SEC on May 18,
      2007.(4)
              Filed
      as an exhibit to the registrants Report on Form 10-QSB for the period
      ending June 30, 2007 filed with the SEC on August 13,
  2007.(5)
              Filed
      as an exhibit to the registrant’s Current Report on Form 8-K filed
      with the SEC on November 19, 2007.(6)
              Filed
      as an exhibit to the registrant’s Current Report on Form 8-K filed
      with the SEC on April 25, 2008.(7)
              Filed
      as an exhibit to the registrants Report on Form 10-KSB for the period
      ending December 31, 2007 filed with the SEC on March 28,
      2008.
 
  
  
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  SIGNATURE
  In
accordance with the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
  EARTH
BIOFUELS, INC.
  /s/  Dennis G.
      McLaughlin, III
 Dennis G.
McLaughlin, III
 Chief
Executive Officer
 (Principal
Executive Officer)
  Date:  May
20, 2008
  /s/ Darren
L. Miles
 Darren L.
Miles
 Chief
Financial Officer
 (Principal
Financial and Accounting Officer)
  Date: May
20, 2008
 
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