NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

1.

Nature of Activities and Summary of Significant Accounting Policies.

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

The Company’s purpose is to develop, acquire, construct, operate and sell fuel grade ethanol and biodiesel from next-generation technology ethanol and biodiesel production facilities. The Company does not expect to generate significant revenue until its plants are constructed and operational, or operational plants have been acquired. Since inception, the Company has engaged in (i) raising funds through the sale of stock, (ii) purchasing land or options to purchase land for development of ethanol plants in the United States, (iii) selling an ethanol plant site in Wahoo, Nebraska, (iv) receiving permits for ethanol plant sites in Nebraska and Illinois, (v) developing, drafting and submitting three patents on cellulosic ethanol production technology, (vi) constructing a biodiesel manufacturing facility in Kakinada, India through International Biodiesel, Inc. and Universal Biofuels Private, Ltd., a Mauritius corporation, (vii) starting ground work for an ethanol facility in Sutton, Nebraska, (viii) constructing a glycerin refining and vegetable oil pre-treatment facility at the Kakinada plant, and (ix) constructing a cellulosic ethanol commercial demonstration facility in Butte, Montana.

AE Biofuels was originally formed in California on September 12, 2001 as Great Valley Ventures LLC, however, no operating agreement was adopted and no capital was contributed until November 29, 2005. Between September 2001 and November 2005, the Company had no operations and engaged in no activities. From November 2005 through December 2005, the Company commenced development activities with the addition of key advisors, management, and additional founding shareholders. On January 12, 2006, the Company was renamed American Ethanol, LLC. On February 23, 2006, American Ethanol, LLC merged into American Ethanol, Inc., a Nevada corporation.

On June 23, 2006, American Ethanol acquired 88.3% of the outstanding common stock of Marwich II, Ltd. (“Marwich”). Marwich was a shell company with no operations. On December 7, 2007, American Ethanol merged with and into Marwich and (i) each issued and outstanding share of American Ethanol common stock (including common stock issued upon conversion of American Ethanol Series A Preferred Stock, which automatically converted into two common shares for each share of Series A Preferred Stock immediately prior to the closing of the Merger) and Series B Preferred Stock (also convertible into common stock at the holders discretion) converted into common stock and Series B Preferred Stock, respectively, of Marwich, and (ii) each issued and outstanding warrant and/or option exercisable for common stock or Series B preferred stock of American Ethanol was assumed and converted into a warrant and/or option exercisable for common stock or Series B preferred stock of Marwich. Marwich then changed its name to AE Biofuels, Inc.

Basis of Presentation and Consolidation . The consolidated financial statements include the accounts of the Company and its majority -owned subsidiaries. All intercompany balances and transactions have been eliminated in consolidation. The accompanying consolidated balance sheets as of September 30, 2008, the consolidated statements of operations for the three and nine months ended September 30, 2008 and 2007, and the consolidated statements of cash flows for the nine months ended September 30, 2008 and 2007 are unaudited. The consolidated balance sheet as of December 31, 2007 was derived from the 2007 audited consolidated financial statements and notes thereto. The consolidated financial statements in this report should be read in conjunction with the 2007 audited consolidated financial statements and notes thereto included in the Company’s annual report on Form 10-K for the year ended December 31, 2007.  As of September 30, 2008 the Company is a development stage enterprise and presents its statements in accordance with SFAS No. 7, “ Accounting and Reporting by Development Stage Enterprises ”.  The Company expects to commence its principal operations in the fourth quarter of 2008.

5

AE BIOFUELS, INC.

(A Development Stage Company)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

1.

Nature of Activities and Summary of Significant Accounting Policies (contd.).

The accompanying unaudited interim consolidated financial statements as of  September 30, 2008 and 2007 and for the three and nine months ended September 30, 2008 and 2007 have been prepared in accordance with accounting principles generally accepted in the United States (GAAP) pursuant to the rules and regulations of the Securities and Exchange Commission. Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States have been condensed or omitted pursuant to such rules and regulations.

In the opinion of management, the unaudited interim consolidated financial statements for the three and nine months ended September 30, 2008 and 2007 have been prepared on the same basis as the audited consolidated statements as of December 31, 2007 and reflect all adjustments, consisting primarily of normal recurring adjustments, necessary for the fair presentation of its statement of financial position, results of operations and cash flows. The results of operations for the three and nine months ended September 30, 2008 are not necessarily indicative of the operating results for any subsequent quarter, for the full fiscal year or any future periods.

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

Fair Value of Financial Instruments. Our fair value instruments that require remeasurement, primarily marketable securities, are valued by the institution that holds the instruments. Due to the nature of these instruments, which are essentially time deposits, whose original maturity was more than 90 days and could not be classified as cash equivalents. There is little risk of variances between the reported basis by the holding institution and the fair value.  At September 30, 2008, we had one forward inventory purchase contract with a full delivery commitment of $1,492,500 that had been net settled for a fixed amount, and is valued at the fixed amount of the payment due under the terms of the contract.

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

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

Cost of Goods Sold . Cost of goods sold include those costs directly associated with the production of revenues., such as raw material purchases, factory overhead, and other direct production costs.  For the three months ended September 30, 2008, cost of goods sold consists of a lower of cost or market adjustment taken against inventory.

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

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

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

6

AE BIOFUELS, INC.

(A Development Stage Company)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

1.

Nature of Activities and Summary of Significant Accounting Policies (contd.).

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

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

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

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

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

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

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

SFAS 109 provides for recognition of deferred tax assets if the realization of such assets is more likely than not to occur. Otherwise, a valuation allowance is established for the deferred tax assets which may not be realized. As of December 31, 2007, the Company recorded a full valuation allowance against its net deferred tax assets due to operating losses incurred since inception. Realization of deferred tax assets is dependent upon future earnings, if any, the timing and amount of which are uncertain. Accordingly, the net deferred tax assets were fully offset by a valuation allowance.

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

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

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

7

AE BIOFUELS, INC.

(A Development Stage Company)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

1.

Nature of Activities and Summary of Significant Accounting Policies (contd.).

Basic and Diluted Net Loss per Share.   Basic loss per share is computed by dividing loss attributable to common shareholders by the weighted average number of common shares outstanding for the period, net of shares subject to repurchase. Diluted loss per share reflects the dilution of common stock equivalents such as options, convertible preferred stock and warrants to the extent the impact is dilutive. As the Company incurred net losses for the three and nine month periods ended September 30, 2008 and 2007 and on a cumulative basis, potentially dilutive securities have been excluded from the diluted net loss per share computations as their effect would be anti-dilutive.

The following table shows the  weighted-average number of potentially dilutive shares excluded from the diluted net loss per share calculation for the three months ended September 30, 2008 and 2007 and on a cumulative basis:

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

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

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

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

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

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

·

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

·

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

8

AE BIOFUELS, INC.

(A Development Stage Company)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

1.

Nature of Activities and Summary of Significant Accounting Policies (contd.).

·

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

·

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

·

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

Recent Accounting Pronouncements

In September 2006, the FASB issued Statement No. 157, “ Fair Value Measurements ” (“SFAS 157”). SFAS 157 defines fair value, establishes a framework and gives guidance regarding the methods used in measuring fair value, and expands disclosures about fair value measurements.  SFAS 157 is applicable whenever another accounting pronouncement requires or permits assets and liabilities to be measured at fair value.  SFAS 157 does not expand or require any new fair value measures; however the application of this statement may change current practice.  On January 1, 2008, the Company adopted SFAS 157 and the adoption of this statement had no material effect on the Company’s financial statements.  On February 12, 2008, the FASB issued FASB Staff Position (FSP) No. 157-2, “Effective date of FASB Statement No. 157.”  FSP 157-2 delays the effective date of adoption for nonfinancial assets and liabilities to fiscal years beginning after November 15, 2008.  As such, the Company will adopt the provisions of SFAS 157 with respect to non-recurring fair value measurements for non-financial assets and liabilities as of January 1, 2009.

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

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

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

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

9

AE BIOFUELS, INC.

(A Development Stage Company)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

1.

Nature of Activities and Summary of Significant Accounting Policies (contd.).

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

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

2.

Ability to Continue as a Going Concern.

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

The Company has had minimal revenues and has incurred losses from inception through September 30, 2008. The Company has raised approximately $31.8 million dollars to date through the sale of preferred stock (net of placement fees). An additional $8 million of cash was generated through the dissolution of the Sutton Ethanol joint venture.  The Company obtained an additional $11 million in debt from senior secured notes and a term loan. The Company will have to raise significantly more capital or secure a significant amount of debt to complete its business plan and continue as a going concern. Management completed the commissioning of the facility in India on October 1, 2008 and plans to begin operations of this biodiesel facility during the fourth quarter of 2008.

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

The Company today is spending approximately $645,000 per month for its general and administrative and research and development costs. Funds available at September 30, 2008 are sufficient to cover less than one month of our domestic operating costs. During the nine months ended September 30, 2008, we borrowed $650,000 under the credit facility established with a former member of the Company’s board of directors and significant shareholder, in order to meet our funding obligations with respect to our Energy Enzymes subsidiary and meet current obligations. Subsequent to September 30, 2008, we borrowed an additional $ 500,000 under this credit facility.  Due to the risk factors discussed in our annual report on form 10-K and in this quarterly report on form 10-Q, there can be no assurance that we will be successful in raising the additional funds necessary to carry out management’s plans for the future. Management estimates that it will need to obtain additional debt or equity funds for each ethanol and biodiesel facility it builds, plus cash to continue its development efforts.

10

AE BIOFUELS, INC.

(A Development Stage Company)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

3.

Inventory.

Inventory consists of the following:

For the three months ended September 30, 2008, the Company expensed $952,028 in connection with the write-down of inventory to reflect market value below cost.

4.

Property, Plant and Equipment.

Property, plant and equipment consist of the following:

Components of construction in progress include $15,748,177 related to our India biodiesel production facility (expected to be placed in service during the fourth quarter of 2008) and $2,053,949 related to the development of our Sutton property (held for future development of an ethanol facility).

5.

Other Assets.

Other assets consist of the following:

11

AE BIOFUELS, INC.

(A Development Stage Company)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

6.

Intangible Assets.

Intangible assets consist of purchased customer lists (acquired in 2007 in connection with the Biofuels Marketing acquisition discussed in Note 12) which are being amortized over an estimated useful life of 18 months. Intangible assets had a net carrying amount of $83,334 and $233,334 as of September 30, 2008 and December 31, 2007, respectively.

7.

Debt.

Debt consists of the following:

On May 16, 2008, Third Eye Capital ABL Opportunities Fund (“Purchaser”) purchased a 10% senior secured note in the amount of $5 million along with warrants exercisable for 250,000 shares of common stock at an exercise price of $3.00 per share. The Note is secured by first-lien deeds of trust on real property located in Nebraska and Illinois, by a first priority security interest in equipment located in Montana, and a guarantee of $1 million by McAfee Capital LLC (owned by Eric McAfee and his wife). Interest on the Note accrues on the unpaid principal balance and is payable on the first business day of each quarter beginning on July 1, 2008. We may prepay all or any portion of the outstanding principal amount of the Note at any time. The Note matures on May 15, 2009, and at that time the outstanding principal amount of the Note together with all accrued and unpaid interest thereon will become due. At September 30, 2008 the Company was not in compliance with the current ratio covenant for the month of September under the loan agreement and is working with the lender to obtain a waiver of this covenant.    While we expect to obtain a waiver, in the event we are unable to do so, the interest rate under this facility increases by 8% and, at the option of the lender, the indebtedness may become immediately due and payable.  The Company has no cross default provisions in this or any other debt agreement. As a result, our inability to obtain a waiver will have no adverse impact on our other debt obligations.  Nevertheless, the failure to obtain a waiver or the acceleration of this debt obligation as a result of this breach may have an adverse impact on our ability to obtain additional borrowings.   There is no assurance that the Company will be able to obtain alternative funding in the event this debt obligation is accelerated.  Immediate acceleration would have a significant adverse impact on the Company’s near term liquidity.

A discount to the Note was recorded based on the relative fair value of the 250,000 warrants issued with the Note. For purposes of the relative fair value allocation, the warrants were valued using a Black-Scholes valuation with the following assumptions: five year term, volatility of 58.7%, no dividends and a risk free interest rate of 3.66%. The fair value of the Note was estimated using a discounted cash flow analysis. The resulting discount of $822,500, combined with a discount of $500,000 related to cash issuance costs, will be amortized over one year, the term of the Note.  Amortization of this discount for the three and nine months ended September 30, 2008 was $330,625 and $495,937, respectively.

On July 17, 2008, Universal Biofuels Private Limited (“UBPL”), a wholly-owned subsidiary entered into a five year secured term loan with the State Bank of India in the amount of approximately $6 million. The term loan matures in July 2013 and is secured by UBPL’s assets, consisting of the biodiesel plant and land in Kakinada, India.  Repayments begin June 2009 with quarterly payments in the amount of approximately $275,000.  In addition, Suren Ajjarapu, a former officer and member of the Company’s board of directors, entered into a Deed of Overall Guarantee on October 16, 2008. Borrowings under this facility generally bear interest at 12.75% and the rate is subject to adjustment after two years.

D uring the nine month period ended September 30, 2008, Laird Cagan, a former member of the Company’s board of directors, provided project financing to the Energy Enzymes subsidiary.  At September 30, 2008, a total of $1,300,000 was outstanding under this credit facility which accrues interest at 10% interest per annum.  All outstanding principal and accrued interest is due and payable on January 31, 2011.  On September 5, 2008 this credit facility was amended which converted the facility into a revolving line of credit with a credit limit of $2,000,000.  In addition, the maturity date of the credit facility was extended to January 31, 2011, and as a result was re-classified as long-term debt on the balance sheet.

12

AE BIOFUELS, INC.

(A Development Stage Company)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

8.

  Operating Leases.

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

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

9.

Stockholders Equity.

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

Convertible Preferred Stock

Our Articles of Incorporation authorize our board to issue up to 65,000,000 shares of preferred stock, $0.001 par value per share, in one or more classes or series within a class upon authority of the board without further stockholder approval, of which 7,235,402 shares were designated Series B preferred stock. There were 5,533,821 and 6,487,491 shares of Series B preferred stock issued and outstanding as of September 30, 2008 and December 31, 2007, respectively.

Significant terms of the Series B preferred stock are as follows:

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

·

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

·

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

·

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

·

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

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

13

AE BIOFUELS, INC.

(A Development Stage Company)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

9.

Stockholders Equity (contd.).

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

Conversion. Holders of Series B preferred stock have the right, at their option at any time, to convert their shares of Series B preferred stock into common stock at the then effective conversion rate, initially and currently at a one for one rate. The conversion rate is subject to adjustment from time to time in the event of certain dilutive issuances and events, such as stock splits, stock dividends, stock combinations, reclassifications, exchanges and the like. In addition, at such time as a registration statement covering the resale of the shares of common stock issuable upon conversion of the Series B preferred stock has been declared effective by the Securities and Exchange Commission ("SEC"), all outstanding Series B preferred stock shall be automatically converted into common stock at the then effective conversion rate.

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

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

The securities with registration rights described above may be sold under Rule 144, beginning December 15, 2008, at which time the payment obligation shall cease. The Company has elected to pay the Registration Rights Payment in shares of its common stock. The Company expects to issue shares of its common stock for the 12 month period ending December 12, 2008 with an aggregate value of $2,274,402, which were expensed as a Registration Rights Obligation and reflected as a component of Other Income/Expense in the Statement of Operations.

10.

Private Placement of Preferred Stock and Warrants.

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

14

AE BIOFUELS, INC.

(A Development Stage Company)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

10.

Private Placement of Preferred Stock and Warrants. (contd.)

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

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

A former member of the Company’s board of directors and a significant shareholder of the Company is a registered representative of the placement agent. He received 976,721 warrants pursuant to the Series A and B financings (see Note 15).

Warrants

In February 2007, we issued five year warrants exercisable for 5,000 shares at $3.00 per share of the Company’s common stock to a consultant as compensation for services rendered. These warrants are immediately exercisable.

Common Stock Reserved for Issuance

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

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

At September 30, 2008, the weighted average remaining contractual term is 4.64 years. The aggregate intrinsic value of the shares outstanding at September 30, 2008 is $6,872,875. The aggregate intrinsic value represents the total pretax intrinsic value, based on the excess of the Company’s closing stock price of $5.50 as of September 30, 2008 over the option holders’ strike price, which would have been received by the option holders had all option holders exercised their options as of that date. The weighted average grant date fair value of these awards is $3.27.

15

AE BIOFUELS, INC.

(A Development Stage Company)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

10.

Private Placement of Preferred Stock and Warrants (contd.).

Included in the table above are 449,000 options issued to consultants in November 2007 and September 2008. These options had an exercise price of $3.00 and $3.70 and generally vest over three years. At September 30, 2008 the weighted average remaining contractual term was 4.22 years. The Company recorded a (credit)/charge to expense of ($80,839) and $410,772 for the three and nine months ended September 30, 2008, respectively, and $8,541 for the three and nine months ended September 30, 2007 which reflects the fair value valuation and periodic fair value remeasurement of outstanding consultant options under Emerging Issues Task Force, or EITF, No. 96-18, “Accounting for Equity Instruments That are Issued to Other Employees for Acquiring, or in Conjunction with Selling, Goods or Services,” (“EITF 96-18”). The valuation using the Black-Scholes model is based upon the current market value of our common stock and other current assumptions, including the expected term (contractual term for consultant options). The Company records the expense related to consultant options using the accelerated expense pattern prescribed in EITF 96-18.

Options vested and exercisable at September 30, 2008 and December 31, 2007 were 1,267,167 and 817,000, with weighted average exercise prices of $2.56 and $3.06, respectively.

Non-Plan Stock Options

In 2006, the Company issued 290,000 stock options to employees outside of any stock option plan, all of which were forfeited during the nine month period ended September 30, 2008.

11.

Stock Based Compensation.

The Company incurred non-cash, stock compensation charges of $216,739 and $1,777,722 in the three and nine months ended September 30, 2008, respectively and $855,995 and $924,945 in the three and nine months ended September 30, 2007, respectively in connection with options granted to employees and consultants.  Of the non-cash stock compensation charges for the nine months ended September 30, 2008, $800,000 was incurred as a result of the accelerated vesting of restricted stock in connection with the termination of one of our officers, which is treated for accounting purposes as a new award and revalued at the market value of the stock on the day of termination.

Valuation and Expense Information under SFAS 123(R)  

As of  September 30, 2008 and December 31, 2007, there was $3,057,623 and $2,585,196, respectively, of total unrecognized compensation expense under SFAS 123R, net of estimated forfeitures, related to stock options that the Company will amortize over the next four fiscal years.

12.

Acquisitions, Divestitures and Joint Ventures.

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

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

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

16

AE BIOFUELS, INC.

(A Development Stage Company)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

12.

Acquisitions, Divestitures and Joint Ventures (contd.).

Public Company Acquisition . On June 23, 2006, American Ethanol acquired approximately 88.3% of the outstanding common stock of Marwich II, Ltd. from three principal shareholders for $675,000. The purchase price, net of current year expenses ($662,406), was accounted for as a reduction of additional paid-in capital as a step in a reverse merger transaction. In connection with this transaction, three members of American Ethanol's management were named as directors of Marwich. Also on June 23, 2006, American Ethanol entered into an Agreement and Plan of Merger (subsequently amended and restated on July 19, 2007) with Marwich pursuant to which effective December 7, 2007, American Ethanol merged with and into Marwich and (i) each issued and outstanding share of American Ethanol common stock (including common stock issued upon conversion of American Ethanol Series A preferred stock, which automatically converted into common stock immediately prior to the closing of the Merger) and Series B preferred stock was converted into common stock and Series B preferred stock, respectively, of Marwich, and (ii) each issued and outstanding option and warrant exercisable for common stock or Series B preferred stock of American Ethanol was assumed and converted into an option or warrant exercisable for common stock or Series B preferred stock of Marwich. Upon the effectiveness of the Merger, Marwich changed its name to AE Biofuels, Inc. The 3,343,200 shares of Marwich purchased by American Ethanol were retired upon the completion of the Merger.

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

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

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

Technology Company Formation. On February 28, 2007, in consideration for the agreement to fund cellulosic ethanol development efforts, the Company acquired a 51% interest in Energy Enzymes, Inc. The Company has the right to acquire the remaining 49% for 1,000,000 shares of the Company's common stock upon the fulfillment of certain performance milestones. As of September 30, 2008, the Company had funded approximately $807,023 under this agreement.  The performance milestones had not been met as of September 30, 2008.

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

On January 23, 2008, International Biofuels, Ltd agreed to terminate the joint venture with Acalmar Oils and Fats, Ltd. including termination of Acalmar’s right to own or receive any ownership interest in the joint venture. The total cancellation price payable by International Biofuels was $900,000 and is classified in our Statement of Operations as a shareholder agreement cancellation payment.  For the three months ended September 30, 2008, $300,000 was paid to Acalmar by the Company, reducing the remaining balance due to Acalmar to $600,000 at September 30, 2008.

Argentina Project Company . On June 9, 2008, AE Biofuels Americas, Inc., a subsidiary of AE Biofuels, Inc. entered into an agreement to develop a biodiesel plant with a nameplate capacity of 75 million gallons per year located in San Lorenzo, Argentina, subject to certain closing conditions, and signed a preliminary engineering agreement. To date, $204,347 has been funded and expensed under the preliminary engineering agreement.  On August 10, 2008 the Company and DS Development S.A. mutually agreed to cancel the agreement (see Note 18).

17

AE BIOFUELS, INC.

(A Development Stage Company)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

13.

Land Options and Purchases.

The Company and its subsidiary, American Ethanol, Inc., have an option to purchase land in Illinois. The option gives the Company the right to  acquire the land for $934,000.  This option expires in May 2009.

14.

Commitments.

The Company contracted with Desmet Ballestra India Pvt. Ltd. to build a glycerin refinery and pre-treatment plant at our existing biodiesel plant in Kakinada, India. At September 30, 2008 and December 31, 2007, commitments under construction contracts were outstanding for approximately $128,000 and $1,850,000, respectively. Commitments under purchase orders and other short term construction contracts were $321,998 at September 30, 2008.

15.

Related Party Transactions.

During the nine month period ended September 30, 2008, Laird Cagan, a former member of the Company’s board of directors, provided project financing to the Energy Enzymes subsidiary At September 30, 2008, a total of $1,300,000 was outstanding under this credit facility which accrues interest at 10% interest per annum.  All outstanding principal and accrued interest is due and payable on January 31, 2011.  On September 5, 2008 this credit facility was amended which converted the facility into a revolving line of credit with a credit limit of $2,000,000.  In addition, the maturity date of the credit facility was extended to January 31, 2011.

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

The Company and Eric A. McAfee, the Company's Chief Executive Officer and Chairman of the board of directors, are parties to an agreement pursuant to which the Company pays Mr. McAfee a monthly salary of $10,000 per month for services rendered to the Company as its President and CEO. For the three and nine months ended September 30, 2008 and 2007, the Company paid Mr. McAfee $30,000 and $90,000, respectively, pursuant to this agreement.

The Company and CM Consulting are parties to an agreement pursuant to which the Company reimbursed CM Consulting for a minimum of 20 hours per month of time on an aircraft owned by CM Consulting until February 2008. The Company paid an upfront fee of $360,000 starting February 2006 for 24 months of usage. The contract expired in February 2008. The Company expensed $15,000 and $135,000 of this rental fee for the nine months ended September 30, 2008 and 2007, respectively. Eric A. McAfee, a director, officer and significant shareholder of the Company owns 50% of CM Consulting.

The Company and Cagan McAfee Capital Partners are parties to an agreement pursuant to which Cagan McAfee Capital Partners provides administrative and advisory services for a monthly fee of $15,000 plus expense reimbursement to the Company.  For the nine months ended September 30, 2008 and 2007, the Company paid Cagan McAfee Capital Partners $245,174 and $123,856, respectively.  Eric A. McAfee, an officer and member of the Company’s board of director and Laird Cagan, a former of the Company’s board of directors, together own 100% of Cagan McAfee Capital Partners.

TIC - The Industrial Company (TIC) and Delta-T are companies involved in the design and construction of ethanol plants in the United States. In 2006 the Company paid TIC and Delta-T approximately $7.5 million for services related to the design and initial construction work on the Company’s Sutton ethanol plant facility.  In August 2007, the Company and TIC terminated their relationship, and the company wrote off approximately $5.2 million in design work and construction in progress.  On October 6, 2008, the Company and TIC cancelled their Strategic Alliance Agreement and TIC agreed to return 4,000,000 shares of the Company’s common stock for a total payment of $500,000 by the Company.  (See Note 18)

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

18

AE BIOFUELS, INC.

(A Development Stage Company)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

16.

Income Tax.

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

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

We adopted the provisions of FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes - an interpretation of FASB Statement No. 109” (“FIN 48”), on January 1, 2007, and there was no impact to our financial statements. FIN 48 clarifies the accounting for uncertainty in income tax positions. FIN 48 provides that the tax affects from an uncertain tax position can be recognized in our financial statements only if the position is more-likely-than-not of being sustained on audit, based on the technical merits of the position. Tax positions that meet the recognition threshold are reported at the largest amount that is more-likely-than-not to be realized. This determination requires a high degree of judgment and estimation. We periodically analyze and adjust amounts recorded for our uncertain tax positions, as events occur to warrant adjustment, such as when the statutory period for assessing tax on a given tax return or period expires or if tax authorities provide administrative guidance or a decision is rendered in the courts. Most of our unrecognized tax benefits would affect our effective tax rate if recognized. Furthermore, we do not reasonably expect the total amounts of unrecognized tax benefits to significantly increase or decrease within the next 12 months.  Net operating losses at December 31, 2007 and 2006 were $470,464 and $214,885, respectively which expire in 2027.

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

17.

Contingent Liabilities.

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

On April 29, 2008, we filed a Motion to Transfer Venue, seeking a transfer to the Second Judicial District Court of the State of Nevada, located in Washoe County, Nevada. The Motion was granted on or about June 2, 2008 and the case is now pending in Washoe County.  At this time no estimate of a range of loss can be made therefore we have neither accrued for this contingent liability, nor disclosed a range of loss relating to this contingent liability.

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

18.

Subsequent Events.

In October 2008, the Company borrowed an additional $500,000 under the credit facility provided by Laird Cagan, a former director (See Notes 7 and 15).

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

19

Item 2.