**UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

 

----

 

**Form 10-QSB**

 

----

 

**ý****  QUARTERLY REPORT PURSUANT TO SECTION 13 OR15(d)**

**OF THE SECURITIES EXCHANGE ACT OF1934**

 

**For theQuarterly Period Ended March 31, 2006**

 

**or**

 

**o****  TRANSITION REPORT PURSUANT TO SECTION 13OR 15(d)**

**OF THE SECURITIES EXCHANGE ACT OF1934**

** **

**CommissionFile Number 333-110249**

 

----

 

**Earth Biofuels, Inc.**

(Exact name of registrant asspecified in its charter)

 

| **Delaware**                                                      | ** ** | **71-0915825**                        |
|-------------------------------------------------------------------|------------|---------------------------------------|
| (State or other  jurisdiction of incorporation or   organization) |       | (I.R.S. Employer  Identification No.) |

 

**3001 KnoxStreet, Suite 403**

**Dallas, TX75205**

(Address of principalexecutive offices, including zip code)

 

**(214)389-9800**

(Registrant’s telephonenumber, including area code)

 

----

 

Indicate by check mark whether the registrant(1) has filed all reports required to be filed by Section 13 or15(d) of the Securities Exchange Act of 1934 during the preceding 12months (or for such shorter period that the registrant was required to file suchreports), and (2) has been subject to such filing requirements for thepast 90 days.

Yes ý    No o

 

Indicate by check mark whether the registrant is anaccelerated filer (as defined in Rule 12b-2 of the Exchange Act).  Yes  o   No ý

 

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

 

As of May 17, 2006 there were 192,883,608 shares ofthe registrant’s common stock outstanding.

 

 

----

 

**EARTHBIOFUELS, INC.**

**CONSOLIDATEDBALANCE SHEETS**

**(UNAUDITED)**

 
| ** **                                                                                                                                                        | ** ** | **March 31,  2006** | ** ** | **December 31,  2005** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------------|------------|-----------------------------|------------|
| **ASSETS**                                                                                                                                                        |       |                     |       |                        |       |
| Current Assets                                                                                                                                                    |       |                     |       |                        |       |
| Cash and cash equivalents                                                                                                                                         |       | $                        | —     |                        | $          | 82,093 |   |
| Trade accounts receivable, net                                                                                                                                    |       | 294,092                  |       | 253,376                     |       |
| Accounts receivable – tax credits                                                                                                                            |       | 296,996                  |       | 374,381                     |       |
| Prepaid expenses & other current assets                                                                                                                       |       | 325,879                  |       | 40,401                      |       |
| Inventory                                                                                                                                                         |       | 208,603                  |       | 131,391                     |       |
| Total Current Assets                                                                                                                                              |       | 1,125,570                |       | 881,642                     |       |
| Property and equipment, net                                                                                                                                       |       | 9,967,621                |       | 455,419                     |       |
| Goodwill                                                                                                                                                          |       | 3,981,280                |       | 3,981,280                   |       |
| Other assets                                                                                                                                                      |       | 2,612                    |       | 261,384                     |       |
| Total Assets                                                                                                                                                      |       | $                        | 15,077,083 |                        | $          | 5,579,725 |   |
| **LIABILITIES  AND STOCKHOLDERS’ EQUITY (DEFICIT)**                                                                                                          |       |                     |       |                        |       |
| Current Liabilities                                                                                                                                               |       |                     |       |                        |       |
| Accounts payable and accrued liabilities                                                                                                                          |       | $                        | 1,397,416  |                        | $          | 763,215 |   |
| Shares payable                                                                                                                                                    |       | —                   |       | 4,210,248                   |       |
| Payables to related parties                                                                                                                                       |       | 1,820,756                |       | 1,442,569                   |       |
| Property, sales and payroll taxes payable                                                                                                                         |       | 139,495                  |       | 12,643                      |       |
| Payable from asset acquisition                                                                                                                                    |       | 1,100,054                |       | —                      |       |
| Short term convertible debt, net of debt  discount of $610,000                                                                                                    |       | 390,000                  |       | —                      |       |
| Other current liabilities                                                                                                                                         |       | —                   |       | 98,021                      |       |
| Total Current Liabilities                                                                                                                                         |       | 4,847,721                |       | 6,526,696                   |       |
|                                                                                                                                                              |       |                     |       |                        |       |
| Stockholders’ Equity (Deficit)                                                                                                                               |       |                     |       |                        |       |
| Common stock, $.001 par value, 250,000,000  shares authorized, 179,893,270 and 161,591,036 shares issued and outstanding  at March 31, 2006 and December 31, 2005 |       | 179,893                  |       | 161,591                     |       |
| Additional paid-in capital                                                                                                                                        |       | 27,080,774               |       | 9,499,709                   |       |
| Deferred compensation                                                                                                                                             |       | (41,200                  | )          | (98,500                     | )          |
| Accumulated deficit                                                                                                                                               |       | (16,990,105              | )          | (10,509,771                 | )          |
| Total Stockholders’ Equity (Deficit)                                                                                                                         |       | 10,229,362               |       | (946,971                    | )          |
| Total Liabilities and Stockholder’s Equity  (Deficit)                                                                                                        |       | $                        | 15,077,083 |                        | $          | 5,579,725 |   |

 

2

----

 

**EARTHBIOFUELS, INC.**

**CONSOLIDATEDSTATEMENTS OF OPERATIONS**

**(UNAUDITED)**

 
| ** **                                | ** ** | **Three Months  Ended** | ** ** | **Three Months  Ended** | ** ** |
|-------------------------------------------|------------|------------------------------|------------|------------------------------|------------|
| ** **                                | ** ** | **March 31, 2006** | ** ** | **March 31, 2005** | ** ** |
|                                      |       |                         |       |                         |       |
| Sales revenue                             |       | 1,500,338                    |       | 242,004                      |       |
| Energy production credits                 |       | 385,781                      |       | —                       |       |
| Total revenue                             |       | 1,886,119                    |       | 242,004                      |       |
|                                      |       |                         |       |                         |       |
| Cost of sales                             |       | 1,767,257                    |       | 194,987                      |       |
| Gross profit (loss)                       |       | 118,862                      |       | 47,017                       |       |
|                                      |       |                         |       |                         |       |
| Shared based compensation                 |       | 4,615,950                    |       | —                       |       |
| Other selling, general and administrative |       | 1,978,650                    |       | 88,599                       |       |
| Depreciation                              |       | 4,597                        |       | 595                          |       |
|                                      |       |                         |       |                         |       |
| Net Loss                                  |       | $                            | (6,480,335 | )                            | $          | (42,177 | ) |
|                                      |       |                         |       |                         |       |
| Income (loss) per common share:           |       |                         |       |                         |       |
|                                      |       |                         |       |                         |       |
| Basic and diluted:                        |       |                         |       |                         |       |
| Net loss                                  |       | $                            | (0.04      | )                            | $          | (0.00 | ) |
|                                      |       |                         |       |                         |       |
| Weighted average shares:                  |       |                         |       |                         |       |
| Basic and diluted                         |       | 166,668,025                  |       | 146,100,000                  |       |

 

3

----

 

**EARTHBIOFUELS, INC.**

**CONSOLIDATEDSTATEMENTS OF CASH FLOWS**

**(UNAUDITED)**

 
| ** **                                                     | ** ** | **Three Months Ended  March 31, 2006** | ** ** | **Three Months Ended  March 31, 2005** | ** ** |
|----------------------------------------------------------------|------------|------------------------------------------------------------|------------|------------------------------------------------------------|------------|
|                                                           |       |                                                       |       |                                                       |       |
| **Cash Flows from Operating Activities:**                      |       |                                                       |       |                                                       |       |
| Net loss                                                       |       | $                                                          | (6,480,335 | )                                                          | $          | (42,177 | ) |
| Non-cash items included in net loss:                           |       |                                                       |       |                                                       |       |
| Depreciation                                                   |       | 4,597                                                      |       | 595                                                        |       |
| Share based compensation                                       |       | 4,615,950                                                  |       | —                                                     |       |
| Deferred compensation                                          |       | 57,300                                                     |       | —                                                     |       |
| Changes in assets and liabilities:                             |       |                                                       |       |                                                       |       |
| Decrease (increase) in:                                        |       |                                                       |       |                                                       |       |
| Trade accounts receivable                                      |       | (40,716                                                    | )          | (14,764                                                    | )          |
| Accounts receivable – tax credits                         |       | 77,385                                                     |       | —                                                     |       |
| Inventory                                                      |       | (77,212                                                    | )          | 3,911                                                      |       |
| Other assets                                                   |       | (26,706                                                    | )          | —                                                     |       |
| Increase (decrease) in:                                        |       |                                                       |       |                                                       |       |
| Accounts payable and accrued expenses                          |       | 634,203                                                    |       | (9,723                                                     | )          |
| Payables to related parties                                    |       | 839,187                                                    |       | 104,863                                                    |       |
| Property, sales and payroll taxes payable                      |       | 28,831                                                     |       | 2,472                                                      |       |
| Net cash provided by (used in) operating  activities           |       | (367,516                                                   | )          | 45,177                                                     |       |
|                                                           |       |                                                       |       |                                                       |       |
| **Cash Flows From Investing Activities:**                      |       |                                                       |       |                                                       |       |
| Purchase of property, plant and equipment                      |       | (1,259,413                                                 | )          | (5,543                                                     | )          |
|                                                           |       |                                                       |       |                                                       |       |
| **Cash Flows From Financing Activities:**                      |       |                                                       |       |                                                       |       |
| Proceeds from sales of common stock                            |       | 544,836                                                    |       | —                                                     |       |
| Proceeds from short term convertible debt                      |       | 1,000,000                                                  |       | —                                                     |       |
| Net cash provided by financing activities                      |       | 1,544,836                                                  |       | —                                                     |       |
|                                                           |       |                                                       |       |                                                       |       |
| Net increase (decrease) in cash                                |       | (82,093                                                    | )          | 39,634                                                     |       |
|                                                           |       |                                                       |       |                                                       |       |
| Cash and cash equivalents                                      |       |                                                       |       |                                                       |       |
| Beginning of period                                            |       | 82,093                                                     |       | 10,903                                                     |       |
| End of period                                                  |       | $                                                          | —     |                                                       | $          | 50,537 |   |
|                                                           |       |                                                       |       |                                                       |       |
| **Supplemental Cash Flow Disclosures:**                        |       |                                                       |       |                                                       |       |
| Cash paid for income taxes                                     |       | $                                                          | —     |                                                       | $          | — |   |
| Cash paid for interest                                         |       | —                                                     |       | —                                                     |       |
|                                                           |       |                                                       |       |                                                       |       |
| Non-cash activity:                                             |       |                                                       |       |                                                       |       |
| Value of shares issued to acquire  Distribution Drive          |       | $                                                          | 4,210,248  |                                                       | $          |   |   |
| Value of shares issued to acquire assets of  Southern Biofuels |       | 7,157,333                                                  |       | —                                                     |       |
| Debt discount related to beneficial  conversion feature        |       | 610,000                                                    |       | —                                                     |       |
|                                                                |            |                                                            |            |                                                            |            |  |  |  |

 

4

----

 

**EARTHBIOFUELS, INC.**

**NOTES TOCONSOLIDATED FINANCIAL STATEMENTS**

**(UNAUDITED)**

 

**1. BASIS OF PRESENTATION**

 

The unaudited consolidated financial statements ofEarth Biofuels, Inc. (“Earth”) have been prepared in accordance with accountingprinciples generally accepted in the United Stated and the rules of theSecurities and Exchange Commission (“SEC”), and should be read in conjunctionwith the audited financial statements and notes thereto contained in Earth’slatest Annual Report filed with the SEC on Form 10-KSB. In the opinion ofmanagement, all adjustments, consisting of normal recurring adjustments,necessary for a fair presentation of financial position and the results ofoperations for the interim period presented have been reflected herein. Theresults of operations for the interim period are not necessarily indicative ofthe results to be expected for the full year. Notes to the financial statementswhich would substantially duplicate the disclosures contained in the auditedfinancial statements for the most recent fiscal year 2005 as reported in theForm 10-KSB, have been omitted.

 

**2.  GOING CONCERN AND MANAGEMENT PLANS**

 

As shown in the accompanying financial statements,Earth incurred losses from operations and had negative cash flows fromoperations during first quarter 2006. Earth’s continued existence is dependentupon its ability to take advantage of acquisition opportunities, raise capitalthrough private securities offerings, secure collateralized debt financing anduse these sources of capital to grow and enhance its biodiesel production anddistribution operations. Management is focusing on expanding and improving itsbiodiesel production and distribution operations. Through acquisition, organicgrowth and funding via collateralized loans and private placement offerings,Earth plans to increase liquidity necessary to support operating requirements. Therecan be no assurance that any of management’s plans as described above will besuccessfully implemented. These factors raise substantial doubt about Earth’sability to continue as a going concern.

 

**3. ASSET ACQUISITION**

 

On March 31, 2006, Earth entered into an agreementto acquire manufacturing equipment from Southern Bio Fuels, Inc. (“Southern BioFuels”) to be used in the manufacturing of biodiesel at the company’s Durantmanufacturing facility. The agreement provided for consideration in the form of$2,200,000 in cash and 2,933,333 restricted shares of Earth’s common stock. Theshares were valued at market of $7,157,333. As of March 31, 2006, Earth owes$1,100,054 in connection with the asset acquisition, which will be paid in cashonce the equipment is placed in service as per the terms of the agreement.

 

One of the equity owners of Southern Bio Fuels isthe brother of a director of Earth.

 

**4. SHORT TERM CONVERTIBLE DEBT**

 

During the three monthsended March 31, 2006, Earth issued 8% convertible debt agreements for proceeds totaling$1,000,000. The debt matures twelve months from the issue date and isconvertible to Earth common stock at a rate of $0.50 per share. The debt isunsecured. Earth recorded a discount on the debt for the beneficial conversionfeature (“BCF”) in the amount of $610,000. The BCF will be amortized tointerest expense over the terms of the debt agreements.

 

Earth analyzed its short term convertible debtinstruments for derivative accounting under SFAS 133 and EITF 00-19. Earthdetermined the conversion feature met the criteria for classification instockholders’ equity under SFAS 133 and EITF 00-19 due to the agreementcontaining an explicit limit on the number of shares to be delivered uponsettlement. Therefore, derivative accounting is not applicable for theconvertible instruments.

 

5

----

 

**5. EQUITY TRANSACTIONS**

 

During the three months ended March 31, 2006, Earthissued 1,124,101 shares for cash of $544,836. Proceeds from the issuance ofsecurities were used to fund acquisitions and operations. Earth also issued 6,667,800shares owed for the November 2005 acquisition of Distribution Drive. As ofDecember 31, 2005, Earth had a share payable of $461,000 to its majority shareholder.On March 8, 2006, Earth issued 5,532,000 shares in connection with the sharepayable obligation.

 

**6. STOCK-BASED COMPENSATION**

 

On January 1, 2006, Earth adopted SFAS No. 123(R), “Share-BasedPayment” (“SFAS 123(R)”). SFAS 123(R) replaced SFAS No. 123 and supersedes APBOpinion No. 25. SFAS 123(R) requires all share-based payments to employees,including grants of employee stock options, to be recognized in the financialstatements based upon their fair values. The pro forma disclosures previouslypermitted under SFAS No. 123 are no longer an alternative to financialstatement recognition. As of March 31, 2006, the Company had no employee stockoption plans.

 

During the quarter ending March 31, 2006, Earthissued 2,045,000 shares for consulting services. The shares were recorded atfair value totaling $4,615,950.

 

**7. SUBSEQUENT EVENTS**

 

On April 27, 2006, Earth acquired approximatelyeight acres of land in Durant, Oklahoma for $175,000.00 in anticipation of the Company’splans to build an ethanol production facility. The land is immediately adjacentto Earth’s existing biodiesel production facility such that the two facilitieswill be able to share the rail access at the site. Earth has not yet acquiredthe equipment nor obtained the permits necessary for ethanol production at thesite.

 

**Item 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OFFINANCIAL CONDITION AND RESULTS OF OPERATIONS**

 

*Overview*

 

The principal business of Earth is the production,supply and distribution of pure biodiesel fuel (B100) for sale directly towholesalers to be used as a blend stock to make B20, a petroleum diesel-basedalternative fuel. The Company utilizes vegetable oils such as soy and canolaoil as raw material (feedstock) for the production of biodiesel fuel.

 

The Company is also focused on raising capitalthrough private placements of its common stock and securing collateralized debtfinancing essential to providing the capital to expand its business segments.

 

CriticalAccounting Policies

 

The preparation of financial statements inconformity with accounting principles generally accepted in the United Statesrequires management to make estimates and assumptions that affect the amountsreported 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 andfactors. Actual results could differ from these estimates. Critical accountingpolicies are defined as those that are reflective of significant judgments anduncertainties, and potentially could result in materially different resultsunder different assumptions and conditions.

 

6

----

 

*Revenue Recognition*

 

The geographic location of Earth Biofuels, Inc.’scustomer base is primarily in the state of Mississippi and the Dallas, Texasmarket, although management intends to expand operations throughout theSoutheastern and Southwestern United States.**Sales are recorded at net realizable value, net of allowances forreturns, upon shipment of products to customers. Earth records revenue fromfederal incentive programs related to the production of biodiesel when the Companyhas produced and sold the biodiesel and completed all the requirements of theapplicable incentive program.

 

*Business Combinations*

 

Business combinations are accounted for using thepurchase method. Under the purchase method the Company reports the acquiredentities’ assets and liabilities at fair market value. Any excess of the fairmarket value of the consideration given over the fair market value of the netassets acquired is reported as goodwill. If the fair market value of theconsideration given is less than the fair market value of the net assetsacquired, the resulting excess of fair value of acquired net assets over thecost of the acquired entity is allocated, on a pro rata basis, against certainassets acquired in the business combination. If any excess over cost remains afterreducing certain assets to zero, the remaining excess is recognized as anextraordinary gain.

 

**RESULTS OF OPERATIONS FOR THE THREE MONTH PERIOD ENDEDMARCH 31, 2006**

 

Increased activities in operations for the three months ended March 31,2006 compared to March 31, 2005 are largely due to increased operations and theacquisition of Distribution Drive.

 

*Sales*

 

Net sales for fuel and food and beverage were $1,500,338for the quarter ended March 31, 2006. Revenues from federal incentive programsrelated to the production of biodiesel were $385,781 for the quarter endedMarch 31, 2006.

 

# ***Cost of Sales***

# ** **

Cost of sales were $1,767,257for the quarter endedMarch 31, 2006 and consisted ofmaterial costs for biodiesel production and cost of fuel, food and beverages,net of $385,781 in federal tax subsidies.

 

*Selling, General and Administrative Expenses*

 

Selling,general and administrative expenses were $6,599,197 for the quarter ended March31, 2006. These costs reflect $4,615,950 of share based compensation, $477,618of payroll expenses, $367,193 of professional fees, $69,682 of travel expensesand $1,068,754 of other operating expenses. The shares issued as share basedcompensation were valued at market consistent with SFAS 123(R), “Share-BasedPayment”.

 

*The Company’s Liquidity Plan*

 

TheCompany’s need to raise additional equity or debt financing and the Company’sability to generate cash flow from operations sufficient to capitalize onexpansion opportunities as they become available will depend on its future performanceand the Company’s ability to successfully raise capital and implement businessand growth strategies. The Company’s performance will also be affected byprevailing economic conditions. Many of these factors are beyond the Company’scontrol. If future cash flows and capital resources are insufficient to meetthe Company’s debt obligations and commitments, the Company may be forced toreduce or delay activities and capital expenditures, obtain additional equitycapital or debt financing. In the event that the Company is unable to do so,the Company may be left without sufficient liquidity and it may not be able tocontinue operations.

 

# ***Off-Balance Sheet Arrangements***

# ** **

# **At March 31, 2006, the Company had no obligations thatwould qualify to be disclosed as off-balance sheet arrangements.**

 

7

----

 

**Item 3.    Controls and Procedures**

 

An evaluation of the effectiveness of our “disclosurecontrols and procedures” (as such term is defined in Rules 13a-15(e) or 15d-15(e)of the Securities Exchange Act of 1934, as amended (the “Exchange Act”)) wascarried out by us under the supervision and with the participation of theCompany’s President and the Company’s Chief Financial Officer (“CFO”). Basedupon that evaluation, the President and CFO concluded that, as of the end ofthe period covered by this report, our disclosure controls and procedures werenot effective to ensure that information we are required to disclose in reportsthat we file or submit under the Exchange Act is recorded, processed,summarized and reported within the time periods specified in the Securities andExchange Commission rules and forms. Specifically, our independent auditorsidentified deficiencies in our controls related to valuation and recording offixed assets, valuation and recording of share-based compensation, andvaluation and recording of beneficial conversion features associated withconvertible debt. We are continuing our efforts to improve and strengthen ourcontrol processes and procedures to fully remedy these deficiencies. Ourmanagement and directors will continue to work with our auditors and otheroutside advisors to ensure that our controls and procedures are adequate andeffective.

 

There were no significant changes in internal controlsor in other factors that could significantly affect internal controlssubsequent to the date of the most recent evaluation of such, including anycorrective actions with regard to significant deficiencies and materialweaknesses.

 

**PART II – OTHER INFORMATION**

 

**Item 1.****   ****Legal Proceedings –**None

 

**Item 2.   Unregistered Sales of EquitySecurities and Use of Proceeds****.**

 

For the three months ended March 31, 2006, Earthissued 1,124,101 shares for cash of $544,836. Proceeds from the issuance ofsecurities were used to fund acquisitions and operations.

 

For the same period, Earth issued 2,045,000 sharesfor consulting services. The shares were valued at market of $4,615,950.

 

Earth also issued 6,667,800 and 2,933,333 shares forthe purchase of Distribution Drive and the acquisition of Southern Biofuelsassets, respectively. The shares were valued at market of $4,210,248 and$7,157,333, respectively.

 

**Item 3.****   ****Defaults upon SeniorSecurities** – None

 

**Item 4.****   ****Submission of Matters to aVote of Security Holders**–None

 

**Item 5.****   ****Other Information** – None

 

8

----

 

**Item 6.****   ****Exhibits and Reports onForm 8-K**

 

*Reports on Form 8-K*

 
| **Date of Filing** | ** ** | **Subject**                                                                                                                                                                                           |
|------------------------------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| February  17, 2006           |       | Announced the Departure of Directors or Principal  Officers; Election of Directors; Appointment of Principal Officers;  Amendments to Articles of Incorporation or Bylaws; and Change in Fiscal Year. |
| February  21, 2006           |       | Announced  the hiring of Controller of the Company.                                                                                                                                                   |
| March  03, 2006              |       | Completed the Acquisition** **of 100% of the stock of The Wing Sail Company, Inc., dba Distribution  Drive pursuant to the stock purchase agreement.                                             |
|                         |       |                                                                                                                                                                                                  |
| *Exhibit*                    |       |                                                                                                                                                                                                  |
|                         |       |                                                                                                                                                                                                  |
| Exhibit 31.1            |       | Certification  of Chief Executive Officer pursuant to Rule 13a-14(a) under the  Securities Act of 1934.                                                                                     |
| Exhibit 31.2            |       | Certification  of Chief Financial Officer pursuant to Rule 13a-14(a) under the  Securities Act of 1934.                                                                                     |
| Exhibit 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.                                       |
| Exhibit 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.                                       |

 

**SIGNATURES**

 

Pursuantto the requirement of the Securities Exchange Act of 1934, the Registrant hasduly caused this report to be signed on its behalf by the undersigned thereuntoduly authorized this 22nd day of May, 2006.

 
|   | Earth  Biofuels                |
|--------|--------------------------------|
|   |                           |
|   | /s/  Dennis G. McLaughlin, III |   |
|   |                           |
|   | DENNIS  G. MCLAUGHLIN, III     |
|   | Chief  Executive Officer       |

 

9

----