Attached files

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EX-4.3 - Parabel Inc.v179026_ex4-3.htm
EX-21 - Parabel Inc.v179026_ex21.htm
EX-4.1 - Parabel Inc.v179026_ex4-1.htm
EX-4.2 - Parabel Inc.v179026_ex4-2.htm
EX-32.1 - Parabel Inc.v179026_ex32-1.htm
EX-31.1 - Parabel Inc.v179026_ex31-1.htm
EX-10.4 - Parabel Inc.v179026_ex10-4.htm
EX-31.2 - Parabel Inc.v179026_ex31-2.htm
EX-10.5 - Parabel Inc.v179026_ex10-5.htm
EX-99.1 - Parabel Inc.v179026_ex99-1.htm
EX-10.3 - Parabel Inc.v179026_ex10-3.htm
EX-10.6 - Parabel Inc.v179026_ex10-6.htm
EX-32.2 - Parabel Inc.v179026_ex32-2.htm
EX-10.2 - Parabel Inc.v179026_ex10-2.htm
 

SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 

 
FORM 10-K
 

 
x
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the fiscal year ended: December 31, 2009
 
or
 
o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934
 
Commission File Number: 0 - 24836
 

 
PetroAlgae Inc.
 
(Exact name of registrant as specified in its charter)
 

 
Delaware
(State or other jurisdiction of incorporation)
33-0301060
(IRS Employer Identification No.)
   
1901 S. Harbor City Blvd., Suite 300
Melbourne, FL
32901
(Address of principal executive offices)
(Zip Code)
 
Registrant’s telephone number, including area code: 321-409-7500
 

 
Securities registered under Section 12(b) of the Exchange Act:
None
 
Securities registered under to Section 12(g) of the Exchange Act:
Common Stock, $.001 Par Value
(Title of Class)
 
 
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. YES ¨ NO x
 
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Exchange Act. YES ¨ NO x
 
Indicate by check mark whether the registrant (1) filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the past 12 months (or for such shorter period that the Registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days. YES x NO ¨
 
Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES x NO ¨
 
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in the definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. ¨
 
Indicate by checkmark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company (as defined in Exchange Act Rule 12b-2).
 
Large Accelerated Filer  ¨
Accelerated Filer ¨
Non-accelerated filer ¨
Smaller reporting company
x
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). YES ¨ NO x
 
The aggregate market value of the voting and non-voting common equity held by non-affiliates computed by reference to the price at which the common equity was sold, or the average bid and asked price of such common equity, as of the last business day of the registrant’s most recently completed second fiscal quarter was approximately $2,005,144 (250,643 shares at $8.00).
 
The number of shares outstanding of the registrant’s common stock as of March 25, 2010 was 106,454,480 shares of common stock, all of one class.
 

 
PETROALGAE INC.
 
ANNUAL REPORT ON FORM 10-K FOR THE FISCAL YEAR ENDED DECEMBER 31, 2009
 
INDEX
 
 
2
     
ITEM 1.
Business
2
ITEM 1A.
Risk Factors
8
ITEM 1B.
Unresolved Staff Comments
14
ITEM 2.
Properties
15
ITEM 3.
Legal Proceedings
16
ITEM 4.
(Removed and Reserved).
17
     
PART II
 
18
     
ITEM 5.
Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
18
ITEM 6.
Selected Financial Data
20
ITEM 7.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
21
ITEM 7A.
Quantitative and Qualitative Disclosures about Market Risk
28
ITEM 8.
Financial Statements and Supplementary Data
29
ITEM 9.
Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
47
ITEM 9A(T). 
Controls and Procedures
48
ITEM 9B.
Other Information
50
     
PART III
 
51
     
ITEM 10.
Directors, Executive Officers and Corporate Governance
51
ITEM 11.
Executive Compensation
54
ITEM 12.
Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
55
ITEM 13.
Certain Relationships and Related Transactions, and Director Independence
56
ITEM 14.
Principal Accounting Fees and Services
57
     
 
59
     
ITEM 15.
Exhibits, Financial Statement Schedules
59
 
-i-

 
PART I
 
ITEM 1.
BUSINESS
 
General
 
PetroAlgae Inc. is a Melbourne, Florida-based Delaware corporation that develops and commercializes new technologies to grow and harvest micro-crops used as feedstock to commercial refineries and other energy producers which results in the production of drop-in fuels. PetroAlgae’s technologies and processes also result in a high valued protein co-product suitable for animal and potentially human consumption.
 
When we use the terms “PetroAlgae,” “the Company,” “we,” “us” and “our,” we mean the combined business of PetroAlgae Inc., a Delaware corporation, and PA LLC, a Delaware limited liability company.
 
Financial information concerning our business for each of 2009 and 2008 is set forth in “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” the consolidated financial statements and the notes thereto, and the supplemental financial information, which are in Part II, Items 7, 7A and 8 of our Annual Report on Form 10-K.
 
Our internet address is www.petroalgae.com and the investor section of our web site is located at https://investor.petroalgae.com/. We make available free of charge, on the investor section of our web site, annual reports on Form 10-K, quarterly reports on Form 10-Q and current reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the U.S. Securities Exchange Act of 1934 (Exchange Act), as well as proxy statements, as soon as reasonably practicable after we electronically file such material with, or furnish it to, the U.S. Securities and Exchange Commission. Also posted on our web site, and available in print upon request of any shareholder to our Investor Relations Department, are our certificate of incorporation and by-laws and our Code of Business Conduct and Ethics governing our directors, officers and employees. Within the time period required by the SEC, we will post on our web site any amendment to the Code of Business Conduct and Ethics and any waiver applicable to any executive officer, director or senior financial officer (as defined in the Code). Our Investor Relations Department can be contacted at PetroAlgae Inc., 1901 S. Harbor City Blvd., Suite 300, Melbourne, FL 32901, telephone: 321-409-7272, email: investorrelations@petroalgae.com.
 
Cautionary Statement Pursuant to the U.S. Private Securities Litigation Reform Act of 1995
 
We have included or incorporated by reference in this Annual Report on Form 10-K, and from time to time our management may make, statements that may constitute “forward-looking statements” within the meaning of the safe harbor provisions of the U.S. Private Securities Litigation Reform Act of 1995. Forward-looking statements are not historical facts but instead represent only our beliefs regarding future events, many of which, by their nature, are inherently uncertain and outside our control. These statements include statements other than historical information or statements of current condition and may relate to our future plans and objectives and results, among other things, as well as statements about trends in or growth opportunities for our business, in Part II, Item 7 of this Annual Report on Form 10-K. By identifying these statements for you in this manner, we are alerting you to the possibility that our actual results and financial condition may differ, possibly materially, from the anticipated results and financial condition indicated in these forward-looking statements. Important factors that could cause our actual results and financial condition to differ from those indicated in the forward-looking statements include, among others, those discussed under “Risk Factors” in Part I, Item 1A of this Annual Report on Form 10-K.
 
History
 
PetroAlgae LLC, now called PA LLC, was founded in 2006 in Melbourne, FL as a private company focused on developing enabling technologies for the renewable energy market. In August of 2008, PetroTech Holdings Corp. (“PetroTech Holdings”) acquired all of the equity in PA LLC held by XL TechGroup, Inc. in exchange for the release of certain accumulated debt obligations.
 
-2-

 
In December 2008, PetroTech Holdings (i) acquired Dover Glen Inc. ("Dover Glen"), a shell company listed on the OTC Bulletin Board, (ii) assigned its entire interest in PA LLC to Dover Glen, and (iii) changed Dover Glen’s name to PetroAlgae Inc. As a result of the acquisition and assignment, the business of PA LLC became  the sole line of business of PetroAlgae.
 
PetroAlgae (as its predecessor Dover Glen) was originally incorporated in the state of California on April 15, 1988, and it changed its domicile to Delaware on August 12, 2008.
 
PetroTech Holdings is owned by Valens U.S. SPV I, LLC, a Delaware limited liability company (“Valens U.S.”), Valens Offshore SPV I, Ltd., a Cayman Islands limited company (“Valens SPV I”), Valens Offshore SPV II, Corp., a Delaware corporation (“Valens SPV II”), Laurus Master Fund, Ltd. (In Liquidation), a Cayman Islands limited company (the “Fund”), Calliope Capital Corporation, a Delaware corporation (“CCC”) and PSource Structured Debt Limited, a Guernsey company (“PSource”). The Fund, CCC and PSource are each managed by Laurus Capital Management, LLC, a Delaware limited liability company (“LCM”). Valens U.S., Valens SPV I and Valens SPV II are each managed by Valens Capital Management, LLC (“VCM”). Eugene Grin and David Grin, through other entities, are the controlling principals of LCM and VCM and share sole voting and investment power over all securities of the Company held by PetroTech Holdings. Eugene Grin and David Grin disclaim beneficial ownership of the securities of the Company held by PetroTech Holdings, except to the extent of such person’s pecuniary interest in PetroTech Holdings, if any.
 
During the course of 2009, the Company issued and sold PetroAlgae common stock and warrants to purchase common stock in a series of private placement transactions, including:
 
 
·
308,813 shares of common stock to Valens U.S. for the purchase price of $8.00 per share, and 5 year warrants to purchase 308,813 shares of PetroAlgae’s common stock at an exercise price of $15.00 per share;
 
 
·
253,687 shares of common stock to Valens SPV I for the purchase price of $8.00 per share, and 5 year warrants to purchase 253,687 shares of PetroAlgae’s common stock at an exercise price of $15.00 per share;
 
 
·
375,000 shares of common stock to Green Alternative Energy USA, LLC for the purchase price of $8.00 per share, and a 5 year warrant to purchase 375,000 shares of PetroAlgae’s common stock at an exercise price of $15.00 per share;
 
 
·
500,000 shares of its common stock to UBS AG for the purchase price of $8.00 per share, and a 5 year warrant to purchase 500,000 shares of PetroAlgae’s common stock at an exercise price of$15.00 per share;
 
 
·
357,143 shares of common stock to Green Science Energy LLC in return for thirty percent (30%) of the outstanding equity interests, on a fully diluted basis, in Green Science Energy LLC, and a 5 year warrant to purchase 357,143 shares of PetroAlgae’s common stock at an exercise price of $15.00 per share, along with an option, which expires on June 30, 2010, to purchase: (i) 250,000 shares of PetroAlgae’s common stock at an exercise price of $8.00 per share, and (ii) a warrant to purchase 250,000 shares of PetroAlgae’s common stock at an exercise price of $15.00 per share.
 
The proceeds from these private placements are used for working capital purposes.
 
– 3 –

 
The diagram below sets forth a simplified presentation of our corporate structure, as of December 31, 2009, immediately following the transactions described above.
 

 
PetroAlgae Inc.
 
Company Overview
 
PetroAlgae develops new technologies to economically grow, harvest and process micro-crops. The Company’s primary business model is to license this technology to large customers who will commercially produce this biomass, which in turn is separated into two co-products 1) renewable fuel feedstock and 2) protein for animal feed and potentially a human supplement.  The renewable fuel product is intended to be used as a direct feedstock to energy producers, including existing refineries. In the case of commercial refineries, this is expected to result in drop-in fuels such as diesel and jet fuel. When used in existing fermentation facilities, it is expected to directly result in ethanol production. When used as a feedstock for other energy producers, particularly power generators, it is a renewable input source for co-firing with fossil fuels.
 
PetroAlgae believes that use of PetroAlgae’s proprietary technology will allow the user to achieve a greater level of productivity than can be realized with other standard biomass growing techniques, and believes that this increased growth optimization is critical to the ability to produce products that can profitably be grown at commercial commodity scale without requiring subsidies.
 
In 2009, the Company completed a working demonstration facility in Florida showing the Company’s technology, processes and yield, with two reactors of commercial scale (approximately one hector each).  The growth reactors on this site are designed to be modular to support rapid deployment with a relatively high predictive cost and productivity.  The processing segment of this facility demonstrates the functionality of the required equipment used to process the harvested biomass into the products that the Company’s customers could derive from their licensed systems.  For certain segments of this facility PetroAlgae has obtained independent audits and third-party verification for product composition, product applications and use, and facility yields. The Company expects that many more studies and audits will be conducted to further commercialization efforts.
 
– 4 –

 
For this reason, the Company has attracted a sizable number of prospective customers who have the capability to license the PetroAlgae technology in return for licensee fees and royalties.
 
Market Background
 
There is a pressing worldwide demand for alternative fuel solutions which is both large and immediate. Predicted future shortages of petroleum oil, and in particular, of residuum, the heavy fraction of crude, and continued pricing uncertainty in petroleum oil supply have led to significant growth in the need for biomass feedstock. Global consumption of petroleum diesel fuel (as one example) exceeds 200 billion gallons annually and continues to grow at a rate that exceeds improvements in production. The gap between supply and demand is widening and drove prices during 2008 to historically high levels. Beyond the economic issues associated with petroleum, there are also significant environmental challenges: petroleum fuels are non-renewable, produce many pollutants and release large quantities of carbon dioxide into the atmosphere when burned.
 
PetroAlgae is developing a commercial, scalable solution to meet this need through the commercial-scale production of biomass which can be used as feedstock in existing refineries to produce drop-in fuel such as diesel and jet fuel.  The fuels are called “drop-in” because they are functionally identical to the petroleum based versions they supplement, and hence, drop-in to the existing infrastructure (pipeline, tankers, etc.). PetroAlgae’s system is designed to provide quality feedstocks at prices which compete directly with petroleum residuum, with a production system that is operational in a much shorter time frame than other natural or synthetic methods of biomass production. The Company’s production processes are intended to be sustainable and resource-efficient. When these development processes are optimized, significantly less land would be required than most biofuel feedstocks. Since arable land is not required, farm land and rain forests do not need to be negatively impacted.
 
PetroAlgae’s technology also produces a high quality protein as a co-product which is suitable as an ingredient in animal feed and potentially human food. Currently, the availability of protein (especially in developing countries) that meets cost and nutrition requirements is lacking. A parallel problem in the food market is the growing concern of pesticides from conventionally grown protein sources that remain in feed to animals are then transferred to human food products. The annual market for animal feed is estimated by PetroAlgae to be approximately $15-20 billion dollars and is projected to grow at a compounded annual growth rate of 28% (as estimated by FAOSTAT).
 
Business Development
 
PetroAlgae’s business model is primarily based on licensing and/or joint ventures with partners who will share both the risk and the reward. As the proprietor of the technologies and processes, PetroAlgae assumes the development risk and optimizes its production processes. Licensing and joint venture partners will assume the costs of capital equipment at their sites. Profits will then be shared between parties through payments to PetroAlgae in the form of milestone payments during construction, licensing fees, and royalties thereafter. We believe partners are interested in this model for the following reasons:
 
 
·
First, we believe we have the highest likelihood of being the first to achieve commercial success in the marketplace due to the technical progress made to date.
 
 
·
Second, we believe we are the most likely to be producing biomass at an economically viable rate as evidenced by the production results already realized.
 
 
·
Third, we intend to provide deployment processes to partners as part of the licensing agreements which further reduces deployment risk for our partners.
 
With this business model, revenues and profit sharing generated by PetroAlgae would consist of a combination of upfront payments, licensing fees, milestone payments and royalties, and in some cases, sharing of profits. Royalties would be earned by PetroAlgae from the sale of biocrude and protein from the licensee to the marketplace.
 
– 5 –

 
Our commercialization strategy focuses on maximizing licensing opportunities worldwide based on the licensee’s need for a solution and ability to implement PetroAlgae’s technology. This includes discussions with hundreds of potential licensees spanning 40 countries whose combined needs for large-scale biomass production are significant.
 
Since inception, we have been subject to tax by both federal and state taxing authorities. Until the respective statutes of limitations expire, we are subject to income tax audits in the jurisdictions in which we operate. We are no longer subject to U.S. federal tax examinations for fiscal years prior to 2005, and we are not subject to audits prior to the 2005 fiscal year for the state jurisdiction.
 
While sales cycles for large licensing deals are traditionally long, the market’s growing acceptance of our technology continues to increase as reflected by the successful signing of a number of non-binding Memorandums of Understanding (“MOU”) from among many qualified business discussions.  Under the MOUs, PetroAlgae and the potential licensee agree to negotiate a final license contract.  However, key contract terms set forth in the MOU may change pending final negotiations and the negotiations may not always result in a final contract.
 
In March 2009, PetroAlgae entered into a Master Licensing Agreement with GTB Power Enterprise Ltd. to construct and operate at least ten separate 5,000 hectares (12,355 acres) license units for the production of micro-crop biomass in China.  Recently the Company entered into a MOU with CECIC Chongqing Industry Co., Ltd (CECIC-CQ), an operating subsidiary of the China Energy Conservation Investment Corporation (CECIC), the state owned company which has completed over 3,000 energy conservation projects in China.   This MOU contemplates that the Master License Agreement for China held by GTB Power Enterprise Ltd. would be transferred to CECIC, or that CECIC would otherwise become PetroAlgae’s exclusive licensee in China in conjunction with the termination of the license with GTB Power Enterprise Ltd.  Our intent, in support of the foregoing, is to accelerate PetroAlgae’s penetration of China’s renewable energy market.
 
In December 2009, PetroAlgae signed an MOU intended to result in the license of the Company’s technology to a large conglomerate in Indonesia. This prospect’s various businesses cover a range of activities including palm oil, property development, leisure and agriculture. The MOU contemplates that this group would initially build a partial license unit to demonstrate the commercial viability of producing renewable fuels in Indonesia with the remaining portion of the full license unit 5,000 hectares to follow.
 
In November 2009, PetroAlgae entered into an MOU with Indian Oil Corporation Limited (“IOCL”), a Fortune 500 company and one of the largest commercial enterprises in India, to potentially license PetroAlgae’s technology. Under the terms of the MOU, IOCL would build a pilot facility to demonstrate the commercial viability of producing renewable fuels from micro-crops in India. Upon achieving success, the pilot facility would be expected to lead to the deployment of a licensed unit for large-scale production of renewable fuels by IOCL.
 
Technology and Intellectual Property
 
PetroAlgae has made significant progress in 2009 with respect to its technology.  The Company’s biomass has been, and continues to be, tested for suitability as a coker feedstock for existing petroleum refineries.  Independent pilot-scale testing indicates that the biomass can be practically processed in the coker, and that the resulting fuel yields are sufficient to economically compete with residuum (the current feedstock used in fuel production). 
 
In December 2009, PetroAlgae entered into an MOU which contemplates a strategic partnership with Foster Wheeler USA Corporation, a global leader in energy engineering solutions, to develop and co-market end-to-end market solutions for the large-scale production of green renewable gasoline, diesel, and jet fuel in existing petroleum refineries.  Foster Wheeler USA Corporation is also providing PetroAlgae access to commercial cokers for future conversion testing.
 
– 6 –

 
In complement to the development in the coker application, recent and ongoing combustion tests indicate that the biomass could be an effective renewable drop-in offset in coal-fired power plants and boilers.
 
With regard to PetroAlgae’s protein co-product, several significant advances have also occurred during the course of the year. First, third party laboratory testing has confirmed a favorable amino acid profile as compared with soy protein, the current industry standard.  The amino acid profile is an important price driver for the sale of protein. Second, recent animal feed trials of PetroAlgae’s protein in poultry demonstrate that digestibility is comparable to concentrated soy protein.  In addition, in November 2009, the Company’s protein was successfully cleared by the Indonesian Ministry of Agriculture as an approved raw material to be used and/or imported for use as an ingredient in animal feed.
 
In anticipation of this progress, PetroAlgae has implemented an aggressive strategy to secure its intellectual property.  This strategy comprises pursuing patent protection, intentionally guarding trade secrets and implementing remotely-controlled security devices.  The Company’s technology and processes include, but are not limited to optimized nutritional schemes, light management, selective harvesting, and distinct extraction processes. In addition to the intellectual property strategy, we have pursued trademarks designed to protect our marketing and branding efforts. To accomplish its technical success, PetroAlgae bolsters its own development efforts by utilizing third-party technology contributors where appropriate.
 
Raw Materials
 
The company uses primarily 4 categories of raw materials in its pilot demonstration facility, micro-crop species, fertilizer, water, and naturally available elements such as sunlight and CO2.  The micro-crops are natural and indigenous to the Florida region. The Company grows the crops on site from small cultures to large quantities used to inoculate the Company’s commercial-scale bioreactors.  Water is sourced locally and recycled.  Fertilizer is readily available and optimized with other readily available micronutrients that are used commonly in agriculture.  Similar processes and use of raw materials will be applied with each customer, applicable to their specific geographic location.
 
Competition
 
As the world searches for viable petroleum replacements, biofuels have attracted significant interest. At first glance, biofuels in general appear to have very desirable characteristics such as being renewable, sustainable and environmentally friendly.  However, many current biofuel feedstocks do not meet these criteria. Although many crops are renewable, many also happen to be staples of the food supply. Thus, there is now serious competition for both the food and fuel industries. Further compounding the problem is the fact that yields for other plant-based crops are very low, whereas demand for fuel is very high. Using traditional feedstocks, there is not enough available land to satisfy the projected mandated demand. Furthermore, efforts to create additional crop land have had a very damaging effect on the environment. For example, in certain countries, tropical rainforests are being burned so that palm plantations can be expanded.
 
The micro-crop based solution from PetroAlgae has potential to successfully address all of these issues. Not surprisingly, there are many new entrants in the algae and micro-crop market, some of whom have started to build demonstration facilities and sign preliminary agreements with potential customers. Of the approximately 200 algae/micro-crop companies (worldwide), the overwhelming majority are focused on the production of biodiesel/ethanol specifically, rather than drop-in fuels that can utilize existing refining and pipeline infrastructure.  A small subset of these companies indicates an understanding of the drop-in-fuel approach as well as the advantage in providing a new protein source rather than depleting the current food-supply.  Moreover, no competitors, to our knowledge, have demonstrated economic feasibility at commercial scale without depending on government subsidies.
 
Employees
 
PetroAlgae has been successful in recruiting experienced, cross-disciplined professionals to develop the company to date. The Company employed 113 full-time individuals as of December 31, 2009. During 2010, PetroAlgae anticipates continued growth and is planning to appropriately build out its human infrastructure necessary to accomplish the Company’s goals as it is successful in obtaining customer license projects.  This includes, but is not limited to, sustaining aggressive research and development and continuing the business efforts of developing and supporting potential and secured licensees.
 
– 7 –

 
ITEM 1A.
RISK FACTORS
 
We face a variety of risks that are substantial and inherent in our business, including market, liquidity, credit, operational, legal and regulatory risks. The following are some of the more important factors that could affect our business and should be considered carefully. In addition, these statements constitute our cautionary statements under the Private Securities Litigation Reform Act of 1995.
 
Risks Related to Our Business
 
We may be unable to solve technical and engineering challenges that would make the production of micro-crops systems non-scalable at economically attractive metrics.
 
Although we have successfully built a pilot scale demonstration facility, and have extracted small field scale quantities of biocrude and protein for technical validation, the fully automated commercial design and engineering of a larger production system is still under design and cost-analysis.  The risk exists that the completion of this process design and engineering may face delays, failures, or unexpected costs and that we may not be able to successfully design a scalable, cost-effective system for the growth and harvesting of micro-crops. Even in the event that we are able to design and engineer a complete micro-crop production system, the risk exists that once a licensee begins to scale up and replicate such a system, unforeseen factors and issues may arise which makes any such system uneconomical, thus causing additional delays or outright failure.
 
We face significant challenges in successfully and rapidly scaling-up a pilot facility.
 
Additional capital expenditures are required for the micro-crop production facility. We will need to successfully scale-up the pilot facility to produce larger quantities and measure production yields. The risk exists that failure to successfully scale-up the demonstration facility will result in new technical hurdles and/or delayed commercialization efforts.
 
We, or our potential licensees, may be unable to deploy our system at scale.
 
To date, neither PetroAlgae nor its existing licensee has constructed a facility utilizing PetroAlgae’s proprietary system of growing and harvesting micro-crops on the commercial scale currently anticipated (i.e. 5000 hectares per unit).  Therefore, it has yet to be proven whether PetroAlgae’s system may be deployed on a full commercial scale or operate in a commercially viable manner.  Additionally, it is unknown whether key performance metrics, such as (by way of example) growth and production rates, may be maintained at a full scale commercial level. While PetroAlgae intends to be actively involved in the construction of the facilities by PetroAlgae’s licensees, and only license its technology to potential licensees which it believes can effectively build and operate facilities utilizing its system, such licensees may ultimately lack the expertise or the resources, or otherwise be unable, to do so.
 
We may be unable to acquire and/or retain licensees.
 
PetroAlgae’s main source of revenue will be in the form of licensing fees and royalties from its future licensees. Therefore, obtaining new licensees is critical for PetroAlgae’s continued growth and operation. There is a risk that PetroAlgae will be unable to acquire and/or retain licensees due to (by way of example) the proposed licensing fees, royalties, capital expenditures or technical feasibility of the PetroAlgae micro-crop system.  For example, the growth from the PetroAlgae micro-crop production system and the relevant processes and methodologies being considered for operating the system may not yield a result that is commercially attractive to potential licensees (on a single unit cost compared to competitive products or otherwise), or to potential licensees in certain targeted markets. Our micro-crop production system requires large fixed capital costs, which could render the system cost prohibitive for potential licensees, or potential licensees in certain target markets. Failure to secure licensees in a timely manner could have a material adverse effect on, or cause us to cease, our continued operations.
 
– 8 –

 
Our licensing methodology may not be accepted by potential licensees.
 
Our revenue projections are based on a model for licensing agreements which may not be accepted by our potential licensees.  Specifically, without limitation, potential licensees may be unwilling to pay the projected licensing fees prior to or during construction of the PetroAlgae system and/or full commercial deployment of such system. While one licensee has agreed to do so, it is unknown whether future licensees would be so willing, or even whether the existing licensee will be able to fulfill its payment obligations. Therefore, even if we are successful at attracting new licensees for our system, we may not realize revenue from such licensees in the form or time frame we currently anticipate. Even if licensees execute licensing agreements in the form currently anticipated, there is no guarantee that such licensees will make payments in the time frame to which they may agree. If potential licensees are unwilling or unable to pay as anticipated, the projected timing of our revenues and incoming cash flows could have a material adverse effect on, or cause us to cease, our continued operations.
 
Licensees who are or have been retained may be unable to perform their obligations to PetroAlgae.
 
PetroAlgae’s main source of revenue will be in the form of licensing fees and royalties from its future licensees. Although PetroAlgae has signed its first licensing agreement, PetroAlgae has yet to realize revenue from such licensee beyond the initial payment as a master licensee.  If PetroAlgae does not begin to realize revenues from licensee, or obtain new licensees, it may have a material adverse effect on our revenues, our operations, or may cause us to cease operations altogether.
 
The market may not accept the products produced by our micro-crop production system.
 
The biomass produced by our micro-crop production system produces two primary products, biocrude (feedstock) and protein.  These products will be sold by licensees into existing markets and it is expected that oil prices and protein prices will fluctuate. If they were to drop significantly, this may have an effect on the licensee’s expected profitability or their ability to secure end-customers. These products may also require industry and/or regulatory testing in the country in which they are produced and/or sold.  This may have an effect on the licensee’s ability to secure end customers and potentially, PetroAlgae’s licensing fees and royalties. It has yet to be proven that potential buyers for specific products produced by our system, including without limitation refineries and feed companies, would ultimately purchase these products produced by licensees of the PetroAlgae system.  Failure to establish such a market or any significant reduction in a licensee’s profitability may result in failure to pay PetroAlgae the projected licensing fees and royalties. Any of these may have a material adverse effect on our revenues and results of operations, or cause us to cease operations altogether.
 
We are dependent upon funding from our principal shareholder.
 
To date, we have been dependent upon funding from PetroTech Holdings and its affiliates. If available capital is expended, PetroTech Holdings and its affiliates may be unable to continue to fund the Company as PetroTech Holdings and its affiliates (including without limitation those funds currently managed by Valens Capital Management, LLC), may not have the necessary resources available.  Moreover, PetroTech Holdings and its affiliates may simply be unwilling to continue to provide funding to the Company given the amount of funds contributed to date.  In such case, the Company may need to enter into agreements under less favorable terms, or borrow funds at higher interest rates and under less favorable terms and conditions than historically obtained from PetroTech Holdings and its affiliates.  There is no certainty as to whether any new funding source would even be available. If funding is not available when needed, or is available only on unfavorable terms, we may be unable to implement our development plan, enhance our existing business, complete acquisitions or otherwise take advantage of business opportunities or respond to competitive pressures, any of which could have a material adverse effect on our production, revenues and results of operations, or cause us to cease operations altogether.
 
We may be unable to fully enforce our intellectual property in certain countries.
 
We are partially dependent on the enforceability of our intellectual property rights. We expect to expand the use of our technology into countries that may not provide adequate legal remedies in the event of a violation of the Company’s technology. Although the Company has taken measures to secure the appropriate patents and methods to protect trade secrets, we may not be able to fully execute our business plan and/or may face significant competition if we fail to adequately protect our processing technology. Lack of enforceability may lead to significantly lower licensing fees which could have a material adverse effect on our operations.
 
– 9 –

 
We may not be able to recruit and retain the necessary specialist and experienced individuals.
 
PetroAlgae currently relies on key individuals in the management and operation of its business.  In order to continue the research and design of the PetroAlgae production system and move to larger commercial scaling and deployment, it will be necessary for us to recruit a significant number of additional qualified individuals including experienced management and specific subject-matter experts. Additionally, technical support personnel will be needed to support the licensees when we begin to commercially scale worldwide. Any inability to retain key employees or obtain the appropriate resources through hiring, outsourcing or through other contractors could delay or impair our ability to achieve successful results.
 
We have a history of losses and there is no guarantee we will achieve positive cash flow.
 
PetroAlgae has a history of operating losses since inception. The Company expects losses to continue and does not expect positive cash flow from operations in the near term. There is no guarantee that the Company will achieve cash flow positive operations prior to expending its available capital.
 
We may not be able to rapidly switch our industry-focus.
 
“Biofuel” is a general term and comprises a wide variety of technologies that could be considered “green” technologies. For the foreseeable future, we expect to be completely focused specifically on the production and marketing of micro-crops that produce a feedstock for the fuel industry and proteins for the animal and human feed markets. Accordingly, an industry shift away from green feedstocks or the emergence of new competing products may reduce the demand for our products. The risk remains that we may be unable to shift our business focus to other technologies/products rapidly to respond to any drastic shifts in the industry.
 
If a competitor were to achieve a technological breakthrough, our operations and business could be negatively impacted.
 
There currently exist a number of businesses that are pursuing the use of algae, bacteria and other micro-crops and other methods for creating biomass and/or alternative fuels. Should a competitor achieve an R&D, technological or biological breakthrough where production costs are significantly reduced, or if the costs of similar competing products were to fall substantially, we may have difficulty attracting licensees. Additionally, competition from other technologies considered “green technologies” could lessen the demand for our products. Furthermore, competitors may have access to larger resources (capital or otherwise), that propel their progress in the market place, resulting in a negative impact on PetroAlgae’s business. Any of these competitive forces may inhibit our ability to attract and/or retain licensees and there is no guarantee that we could sustain our expected licensing fees or royalties on an on-going basis. This could have a material adverse effect on, or cause us to cease, our operations.
 
– 10 –

 
Minority shareholder interest in PA LLC (which is the operating entity of PetroAlgae Inc.) could materially affect the operation of the Company or investment in the Company.
 
Our operations are currently conducted through PA LLC. We own an approximate 81.3% ownership interest in the membership interests of PA LLC. Other than membership interests issued as part of our employee compensation plans, Arizona Science & Technology Enterprises, LLC ("AZTE") owns the remaining membership interests in PA LLC. The operating agreement of PA LLC provides AZTE with anti-dilution protection and other minority investor rights (including consent rights over certain corporate actions, such as mergers between PA LLC and any other entity if PetroAlgae Inc. would not own a majority of the voting power of the resulting entity) which could have the effect of impairing our ability to operate the business if we do not secure the cooperation of AZTE. If this were to happen, any investment in PetroAlgae Inc. could materially suffer.
 
We may be sued or become a party to litigation
 
While we have no knowledge of any threatened litigation matters, we may be subject to lawsuits from time to time arising in the ordinary course of our business. We may be forced to incur costs and expenses in connection with defending ourselves with respect to such litigation and the payment of any settlement or judgment in connection therewith if there is an unfavorable outcome. The expense of defending litigation may be significant. The amount of time to resolve lawsuits is unpredictable and defending ourselves may divert management’s attention from the day-to-day operations of our business, which could adversely affect our business, results of operations and cash flows. In addition, an unfavorable outcome in any such litigation could have a material adverse effect on our business, results of operations and cash flows.
 
None of the directors of the Company are independent directors.
 
All of the members of the board of directors of the Company have a direct or indirect material financial relationship with the Company and are also currently either employed or engaged by the Company, PetroTech Holdings, or affiliates thereof. These relationships may interfere with the ability of the directors to exercise independent judgment with respect to the Company.
 
Risks Related to Our Common Stock
 
The market price of our common stock is likely to be highly volatile and subject to wide fluctuations.
 
The market price of our common stock and the market prices for securities of biotechnology companies in general, are expected to be highly volatile. The following factors, in addition to the other risk factors described, and the potentially low volume of trades in our common stock, may have a significant impact on the market price of our common stock, some of which are beyond our control: announcements of technological innovations and discoveries by us or our competitors; developments concerning any research and development, manufacturing, and marketing collaborations; new products or services that we or our competitors offer; actual or anticipated variations in operating results and expenses; the initiation, conduct and/or outcome of intellectual property and/or litigation matters; conditions or trends in our industry; regulatory developments in the United States and other countries; changes in the economic performance and/or market valuations of other biofuel companies; our announcement, or competitors’ announcements, of significant acquisitions, strategic partnerships, joint ventures or capital commitments; additions or departures of key personnel; dilution caused by our issuance of additional shares of common stock and other forms of equity securities, which we expect to make in connection with future capital financings to fund operations and growth, to attract and retain valuable personnel and in connection with future strategic partnerships with other companies; changes in expectations as to our business, prospects, financial condition, and results of operations; significant sales of our common stock, including sales by selling stockholders and by future investors in any future offerings we may make to raise additional capital; changes in the accounting methods used in or otherwise affecting our industry; changes in the valuation of similarly situated companies, both in our industry and in other industries; fluctuations in interest rates and the availability of capital in the capital markets; and global unrest, terrorist activities, and economic and other external factors.
 
– 11 –

 
The stock market in general has recently experienced relatively large price and volume fluctuations. In particular, market prices of securities of biofuel companies have experienced fluctuations that often have been unrelated or disproportionate to the operating results of these companies. Continued market fluctuations could result in extreme volatility in the price of the common stock, which could cause a decline in the value of the common stock. Price volatility may be worse if the trading volume of the common stock is low.
 
These and other factors are largely beyond our control, and the impact of these risks, singly or in the aggregate, may result in material adverse changes to the market price of our common stock and our results of operations and financial condition.
 
Future sales of common stock or the issuance of securities senior to the common stock or convertible into, or exchangeable or exercisable for, common stock could materially adversely affect the trading price of the common stock, and our ability to raise funds in new equity offerings.
 
Future sales of substantial amounts of our common stock or other equity-related securities in the public market or privately, or the perception that such sales could occur, could adversely affect prevailing trading prices of our common stock and could impair our ability to raise capital through future offerings of equity or other equity-related securities. We can make no prediction as to the effect, if any, that future sales of shares of common stock or equity-related securities, or the availability of shares of common stock for future sale, will have on the trading price of our common stock.
 
It is not anticipated that there will be an active public market for the common stock in the near term and shareholders may have to hold common stock for an indefinite period of time.
 
Although our common stock is eligible for trading on the OTCBB, there currently is not an active public or other trading market for the common stock, and we cannot assure that any market will develop or be sustained. It is not anticipated that there will be an active public market for the common stock in the near term and shareholders may have to hold their common stock for an indefinite period of time. As of December 31, 2009, PetroTech Holdings was the record owner of 100,000,000 shares of our common stock, which represented approximately 91.75% of the total voting power of the Company on a fully-diluted basis. Because our common stock is expected to be thinly traded, shareholders cannot expect to be able to liquidate their investment in case of an emergency or if they otherwise desire to do so. It may be difficult to for shareholders to resell a large number of your shares of common stock in a short period of time or at or above their purchase price.
 
Because PetroAlgae became public by means of an assignment into a public shell, it may not be able to attract the attention of major brokerage firms.
 
There may be risks associated with PetroAlgae becoming public through an assignment into a public shell. Securities analysts of major brokerage firms may not provide coverage of the company since there is no incentive for brokerage firms to recommend the purchase of our common stock. No assurance can be given that brokerage firms will, in the future, want to conduct any secondary offerings on our behalf.
 
Because of the concentration of voting power in our Company, the ability of a shareholder to influence the management of the Company will be extremely limited.
 
Because of the concentration of voting power in our Company, the ability of a shareholder to influence the management of the Company may be extremely limited. As of December 31, 2009, total securities of the Company held by PetroTech Holding, Valens SPV I and Valens U.S. represent approximately 95.7% of the total voting power of the Company on a fully-diluted basis.  As a result, the ability of a shareholder to influence the management of the Company may be extremely limited.
 
– 12 –

 
There are no automated systems for negotiating trades on the OTCBB and it is possible for the price of a stock to go up or down significantly during a lapse of time between placing a market order and its execution, which may affect trades in our securities.
 
Because there are no automated systems for negotiating trades on the OTCBB, they are conducted via telephone. In times of heavy market volume, the limitations of this process may result in a significant increase in the time it takes to execute investor orders. Therefore, when investors place market orders, an order to buy or sell a specific number of shares at the current market price, it is possible for the price of a stock to go up or down significantly during the lapse of time between placing a market order and its execution.
 
Our stock may be considered a “penny stock” if it trades below $5.00 per share.
 
As of December 31, 2009, our common stock trades in excess of $5.00 per share, but there can be no assurance that this price will be maintained in the future. If the trading price of our common stock falls below $5.00 per share, trading in our common stock will be subject to the requirements of Rule 15g-9 under the Securities Exchange Act of 1934. Under this rule, broker-dealers who recommend low-priced securities to persons other than established customers and accredited investors must satisfy special sales practice requirements. The broker-dealer must make an individualized written suitability determination for the purchaser and receive the purchaser’s written consent prior to the transaction.
 
SEC regulations also require additional disclosure in connection with any trades involving a “penny stock,” including the delivery, prior to any penny stock transaction, of a disclosure schedule explaining the penny stock market and its associated risks. In addition, broker-dealers must disclose commissions payable to both the broker-dealer and the registered representative and current quotations for the securities they offer. The additional burdens imposed upon broker-dealers by such requirements may discourage broker-dealers from recommending transactions in our securities, which could severely limit the liquidity of our securities and consequently adversely affect the market price for our securities. In addition, few broker-dealers are likely to undertake these compliance activities. Other risks associated with trading in penny stocks could also be price fluctuations and the lack of a liquid market.
 
We do not anticipate payment of dividends, and investors will be wholly dependent upon the market for the common stock to realize economic benefit from their investment.
 
Holders of our common stock will only be entitled to receive those dividends that are declared by our Board of Directors out of retained earnings. We do not expect to have retained earnings available for declaration of dividends in the foreseeable future. There is no assurance that such retained earnings will ever materialize to permit payment of dividends to shareholders. Our Board of Directors will determine future dividend policy based upon our results of operations, financial condition, capital requirements, reserve needs and other circumstances.
 
A portion of our cash flow must be used to service our debt obligations, and we are vulnerable to interest rate fluctuations.
 
Fixed rate borrowings may have their fair market value adversely impacted from changes in interest rates. Floating rate borrowings will lead to additional interest expense if interest rates increase. PetroAlgae enters into loan arrangements when needed. At December 31, 2009, the principal balance on the Company’s outstanding long-term notes was $35.5 million, of which $17.8 million was outstanding at a floating rate of 2% over the prime interest rate and $17.7 million was outstanding at a fixed rate of 12%.  Our borrowings are subject to interest rate risk.  Changes in economic conditions could result in higher interest rates, thereby increasing our interest expense and reducing our funds available to make payments of interest and principal on the notes and for capital investment, operations or other purposes.
 
– 13 –

 
 
ITEM 1B.
UNRESOLVED STAFF COMMENTS
 
Not applicable.
 
– 14 –

 
ITEM 2.
PROPERTIES
 
Melbourne Corporate Headquarters
 
Our corporate headquarters are located in Melbourne, Florida. The headquarters house the executive and administrative offices, as well as the finance, business development, operations and information technology departments. It also includes meeting space and PetroAlgae’s computer network and communications infrastructure. This is a sublease agreement that can be terminated with 30 day written notice.
 
Kennedy Space Center Space Life Sciences Lab
 
PetroAlgae leases approximately 1000 square feet of laboratory and controlled-environment space in the Kennedy Space Center Life Sciences Laboratory. The facility has broad analysis capabilities for chemistry, molecular biology, microscopy and microbiology. The controlled environmental chambers allow PetroAlgae to control and manipulate environmental parameters such as climate, temperature, day/night cycles and seasonal cycles to simulate growing conditions for research purposes as well as to understand other climates throughout the world. PetroAlgae benefits from access to NASA engineering, scientific and analytical expertise available through the Kennedy Space Center Life Sciences Laboratory. This is an annual agreement that can be terminated with 90 day written notice. The current lease expires Sept. 30, 2010.
 
Gateway Research Lab Facility
 
PetroAlgae has built a state-of-the-art laboratory in Melbourne, Florida designed for chemical analyses, culture storage, backup inoculum growth, bench top research experiments and fast turnaround analysis of field samples. In addition, the lab has complete analysis capabilities. This is a three year lease agreement which expires Sept. 30, 2010.
 
Fellsmere Field-Scale R&D Facility
 
PetroAlgae has constructed its primary field-scale development facility for the PetroAlgae production process in Fellsmere, Florida (approximately 40 miles from Melbourne). The facility provides demonstration-scale live processing of all portions of the PetroAlgae process as well as indoor and outdoor empirical testing, and laboratory analysis. It also houses the personnel that develop, run and maintain the facility. This is an annual agreement with a five year renewal option. The renewal/expiration date is July 1, 2010.
 
– 15 –

 
ITEM 3.
LEGAL PROCEEDINGS
 
There are no material pending legal proceedings to which PetroAlgae is a party or any of its property is the subject.
 
– 16 –

 
ITEM 4.
(REMOVED AND RESERVED).
 
– 17 –

 
PART II
 
ITEM 5.
MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
 
Our common stock is quoted on the OTC Bulletin Board under the symbol “PALG.” As of March 20, 2010, we had 670 stockholders of record of our common stock.
 
The following table sets forth, for the quarters indicated, the high and low sales prices per share of the Company’s common stock.
 
   
Sales Price
 
   
High
   
Low
 
Fiscal 2008:
           
             
Third Quarter(1)
  $ 1.01     $ 0.005  
                 
Fourth Quarter
  $ 7.00     $ 0.25  
                 
Fiscal 2009:
               
                 
First Quarter
  $ 10.00     $ 2.00  
                 
Second Quarter
  $ 11.00     $ 2.65  
                 
Third Quarter
  $ 40.00     $ 8.00  
                 
Fourth Quarter
  $ 24.95     $ 15.00  
  

(1) Our common stock was initially quoted on the OTCBB (under the symbol “VOXQ” of a predecessor company) on July 25, 2008.
 
On March 29, 2010, the last reported sales price for the Company’s common stock on the OTC Bulletin Board was $22.50 per share.
 
Dividends
 
The holders of shares of our common stock are entitled to dividends out of funds legally available when and as declared by our board of directors. We have never declared or paid cash dividends. Our board of directors does not anticipate declaring a dividend in the foreseeable future.
 
– 18 –

 
Equity Compensation Plan
 
The following table summarizes information as of December 31, 2009, relating to the Company’s equity compensation plan pursuant to which grants of options, restricted stock, or other rights to acquire shares may be granted from time to time.
 
Plan Category
 
Number of securities to
be issued upon
exercise price of
outstanding options,
warrants and rights (a)
   
Weighted-average
exercise price of
outstanding options,
warrants and rights (b)
   
Number of securities
remaining available
for future issuance
under equity
compensation plans
(excluding securities
reflected in column
(a) (c)
 
Equity Compensation plans approved by security holders (1)
    1,117,500     $ 8.48       2,882,500  
Equity Compensation plans not approved by security holders
                 
Total
    1,117,500     $ 8.48       2,882,500  

(1) Represents the Petroalgae Inc. 2009 Equity Compensation Plan.
 
Transfer Agent and Registrar
 
The transfer agent and registrar for our common stock is Island Stock Transfer, 100 Second Avenue, South, Suite 104N, St. Petersburg, Florida 33701, telephone (727) 289-0010, facsimile (727) 289-0069.
 
Issuer Repurchases
 
There were no issuer repurchases by the registrant or any affiliate purchaser during the fiscal year ended December 31, 2009.
 
– 19 –

 
ITEM 6.
SELECTED FINANCIAL DATA
 
Not applicable.
 
– 20 –

 
ITEM 7.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
 
The following discussion contains forward-looking statements that involve numerous risks and uncertainties, such as statements of our plans, objectives, expectations, and intentions. Our actual results could differ materially from those anticipated in the forward-looking statements. Factors that could cause or contribute to these differences include those discussed in this report under “Risk Factors,” as well as those discussed elsewhere in this report. You should read the following discussion and analysis in conjunction with the Company’s financial statements and related notes, each included elsewhere in this report.
 
Overview
 
PetroAlgae is a development stage company which is demonstrating, and commercializing for license, new technologies to grow and harvest micro-crops that produce renewable feedstocks for the petroleum industry and protein for the feed/food industries. This is intended to result in fuels that are functionally interchangeable to petroleum based and other transportation fuels. The corporate strategy is to select the most suitable microorganism for each specific location (indigenous to the region) and application, and then apply PetroAlgae’s distinct proprietary processes to scale its growth rate (productivity) from that of a microorganism to that of a high output-producing micro-crop. Micro-crops include algae, diatoms, micro-angiosperms, cyanobacters and other small fuel and food-producing organisms with extremely rapid growth potential.
 
Through third-party testing, PetroAlgae has received encouraging, positive results for the feedstock when used in test-cokers and when co-fired with coal directly as a fuel source.  These results have led to key collaborations with industry expert FosterWheeler.We look forward to continued development with Foster Wheeler and anticipate future collaborations with other key industry entities.
 
Along with the feedstock for the petroleum industry, a complementary co-product produced from these micro-crops, is a high-quality protein. The proteins has been, and continues to be tested as an ingredient in animal feed with encouraging, positive results in composition, purity and suitability as an animal feed ingredient.  In fact, the Company has received its first clearance (in Indonesia), to use the protein product for animal feed. We anticipate more clearances to follow and will be seeking top-tier strategic alliances in this market.
 
The Company completed its pilot demonstration system in Florida. This site serves as a pilot, with commercial-scale bioreactors that demonstrate end-to-end processing from biomass growth, harvesting, dewatering, and through the processing and drying of both protein and biomass feedstock from which transportation fuels could then be produced. Utilizing commercial-scale bioreactors, this site generates significant quantities of biomass, along with representative products under measured production disciplines. These materials are used for testing and customer samples, which management expects will provide analytical results to further support the value proposition to our potential license partners.
 
As the Company is successful in developing these technologies, the Company will continue to sell licenses for these technologies to partners in specific geographic regions, for a specified area of production. The sales cycle for these units can take many months while the license partners evaluate the effectiveness and economics of applying this technology to their region. The Company will assist in the deployment of this technology to licensees with modular bioreactor systems that can be built and operated cost-effectively on a very large commercial scale. Sizes of these licensed units will vary, but is expected to be approximately 5,000 hectares (12,355 acres) per “unit”.
 
The Company previously announced, in March 2009, its first license agreement with GTB Power Enterprise Ltd. for multiple system deployments in China. In December 2009, PetroAlgae entered into a strategic MOU with CECIC Chongqing Industry Co., Ltd (CECIC-CQ), an operating subsidiary of the China Energy Conservation Investment Corporation (CECIC).  This MOU contemplates that the Master License Agreement for China held by GTB Power Enterprise Ltd. would be transferred to CECIC, or that CECIC would otherwise become PetroAlgae’s exclusive licensee in China in conjunction with the termination of the license agreement with GTB Power Enterprise Ltd.. Our intent, in support of the foregoing, is to accelerate PetroAlgae’s penetration of China’s renewable energy market.
 
– 21 –

 

At the end of 2009 we entered into a Master License Agreement with Green Science Energy LLC for the use of our proprietary technology to produce biofuels in Egypt. This agreement generated $4 million in cash flow for PetroAlgae.
 
In the coming year, it is the goal of management to continue to sign multiple MOUs from the current business development pipeline and convert a portion of these into signed contracts. As contracts are signed, it is expected that initial pilot deployments will immediately follow.
 
PetroAlgae has incurred losses since inception of operations on June 22, 2006 and has an accumulated deficit of $58,860,269 as of December 31, 2009. PetroAlgae’s losses have resulted principally from its continued research and development expenses and construction of a multi-acre pilot demonstration system.
 
As a development stage company, we expect continued progress commercializing our proprietary technologies and that in 2010 we will continue to realize early license fees from customers. While we strive to maintain proper cost and spending controls, our expenditures through the fourth quarter of 2009 reflect the operation of the demonstration pilot system and increases in marketing and business development expenses as the Company continues to prepare for customer deployment.  It is management’s expectation that operating expenses will increase modestly in 2010 to accommodate growing activity in business development, commercial deployment and establishing infrastructure.
 
Results of Operations
 
In December 2009, PetroAlgae received its initial receipt of customer licensee fees, however the recognition of these fees as revenues for the Company are expected to begin in 2010. In general, the Company expects to record and recognize revenue when persuasive evidence of an arrangement exists, services have been rendered or product delivery has occurred.
 
Twelve Months Ended December 31, 2009 Compared to Twelve Months Ended December 31, 2008
 
Total Costs and Expenses increased $20.0 million (or 118%) primarily due to an increase in personnel costs, consulting costs, and an increase in activity of research and development as the Company continues to grow its operations.
 
Research and Development Expenses. Total research and development expenses increased $ 10.2 million (or 94%) to $21 million for the twelve months ended December 31, 2009, from $10.9 million in the comparable period in 2008. The development costs include the research and experimentation of the various system components and for 2009 the design and construction of the commercial scaled pilot system for customer demonstration. During the period from inception to August 1, 2008, a portion of the Company’s research and development activities were provided by XL TechGroup for support services and recorded as related party expenses separate from direct and third party expenses. The portion of related party research and development expenses were NIL and $468,000 for the periods ending December 31, 2009 and 2008, respectively.
 
General and Administrative Expenses. Total general and administrative expenses increased $4.5 million (or 94%) to $9.3 million for the twelve months ended December 31, 2009 from $4.8 million in the comparable period in 2008. General and administration expenses include the Company’s business development, information technology, and intellectual property management. During the period from inception to August 1, 2008, a portion of the Company’s general and administration activities were provided by XL TechGroup for support services and recorded as related party expenses separate from direct and third party expenses. The portion of related party general and administration expenses were NIL and $1.7 million for the periods ending December 31, 2009 and 2008, respectively.

 
– 22 –

 

Depreciation. Depreciation expense increased $870,000 (or 323%) to $1.14 million for the twelve months ended December 31, 2009 from $269,000 for the comparable period in 2008. The increase was due to the addition of more laboratory equipment, computer equipment, furniture, and leasehold improvements equipment during the twelve months of 2009 compared with the comparable period of 2008.
 
Interest Expense. Interest expense on PetroAlgae’s debt outstanding under its note with PetroAlgae Inc (PetroTech Holdings Corp. assumed the note from XL TechGroup in August 2008, and PetroAlgae Inc assumed the note from PetroTech Holdings Corp in December 2008) increased to $2.6 million (or 117%) for the twelve months ended December 31, 2009 from $1.2 million for the comparable period in 2008.
 
Liquidity and Capital Resources
 
At December 31, 2009 PetroAlgae had $4.7 million in cash and cash equivalents.
 
Net cash used in operating activities was $25 million and $11.8 million in 2009 and 2008, respectively. This was primarily attributed to expenditures used to fund PetroAlgae’s research and product development activities and building its operational and business development efforts.
 
Net cash used in investing activities, purchase of capital assets was $2.2 million and $.8 million for the years ended December 31, 2009 and 2008, respectively. The fluctuations from period to period are due to the continued growth and expansion, primarily in the construction of its demonstration facility.  
 
Net cash provided by financing activities was $21.5 million in 2009, and $22.9 million in 2008 which consisted of advances from our principal lender and the sale of common shares for cash.
 
PetroAlgae’s contractual payment obligations as of December 31, 2009 are as follows:
 
   
Total
   
Less than
1 year
   
1-3 years
   
3-5 years
   
More than
5 years
 
Operating lease for facilities
  $ 135,552     $ 135,552     $              
                                         
Total
  $ 135,552     $ 135,552     $              
 
PetroAlgae has primarily financed its operations through loans or the sale of equity securities from its principal shareholder that have resulted in aggregate cumulative proceeds of approximately $35.5 million in debt and $14.5 million in equity, respectively.
 
We expect to continue to incur modest losses in 2010. The amount and timing of our future losses are highly uncertain. Our ability to achieve and thereafter sustain profitability will be dependent upon, among other things, entering into partner license agreements, and receiving milestone payments from such partner license agreements.
 
We will require substantial additional capital in order to continue our development and product commercialization. While we believe that the proceeds from the recent investments, combined with current capital resources and anticipated cash flows from licensing activities, may not be sufficient to meet our capital and operating requirements for the near term, we cannot assure you that we will not require additional necessary financing. Our funding requirements may significantly increase at any time due to technological advances or competition from other companies. Our future capital requirements will also depend on numerous other factors, including scientific progress in our research and development programs, successful completion of our demonstration system, our ability to attract advance licensing fees from customers, additional personnel costs, and the costs in filing and prosecuting patent applications and enforcing patent claims. We cannot assure you that adequate funding will be available to us or, if available, that it will be available on acceptable terms. Any shortfall in funding could result in our having to curtail our research and development efforts, and cause us substantial difficulty in continuing to operate as a going concern.

 
– 23 –

 

PetroAlgae Inc. has never paid or declared dividends on its capital stock.
 
Critical Accounting Policies and Management Estimates
 
The SEC defines critical accounting policies as those that are, in management’s view, important to the portrayal of our financial condition and results of operations and demanding of management’s judgment. Our discussion and analysis of financial condition and results of operation are based on PetroAlgae’ consolidated financial statements, which have been prepared in, accordance with U.S. generally accepted accounting principles, or GAAP. The preparation of these financial statements requires PetroAlgae to make estimates on experience and on various assumptions that we believe are reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from those estimates.
 
PetroAlgae’s critical accounting polices include:
 
Revenue Recognition
 
In general, the Company records revenue when persuasive evidence of an arrangement exists, services have been rendered or product delivery has occurred, the sales price to the customer is fixed or determinable, and collectability is reasonably assured. The following policies reflect specific criteria for the various revenues streams of the Company:
 
Revenue is recognized at the time the product is delivered. Provision for sales returns will be estimated based on the Company’s historical return experience. Revenue will be presented net of returns.
 
Cash and Cash Equivalents and Cash Concentrations
 
The Company considers all highly liquid investments with an original maturity of three months or less to be cash equivalents. The Company at December 31, 2009, has approximately $4,600,000 on deposit at a single financial institution.
 
Fair Value of Financial Instruments
 
Fair value estimates discussed herein are based upon certain market assumptions and pertinent information available to management as of December 31, 2009 and 2008. The respective carrying value of certain on-balance-sheet financial instruments, approximate their fair values. These financial instruments include cash, accounts payable, accrued expenses, notes payable and due to affiliates. Fair values were assumed to approximate carrying values for these financial instruments because they are short term in nature and their carrying amounts approximate fair values or they are receivable or payable on demand.
 
The carrying value of the Company’s note payable approximated its fair value based on the current market conditions for similar debt instruments.
 
Property and Equipment
 
Property and equipment is recorded at cost. Expenditures for major improvements and additions are added to property and equipment, while replacements, maintenance and repairs which do not extend the useful lives are expensed.

 
– 24 –

 

Long Lived Assets
 
The carrying value of long-lived assets is reviewed on a regular basis for the existence of facts and circumstances that suggest impairment. Should there be an impairment the Company measures the amount of the impairment based on the amount that the carrying value of the impaired asset exceeds the discounted cash flows expected to result from the use and eventual disposal from the impaired assets. There were no impairments in 2009 or 2008.
 
Income Taxes
 
The Company follows ASC 740 Income Taxes for recording the provision for income taxes. Deferred tax assets and liabilities are computed based upon the difference between the financial statement and income tax basis of assets and liabilities using the enacted marginal tax rate applicable when the related asset or liability is expected to be realized or settled. Deferred income tax expenses or benefits are based on the changes in the asset or liability each period. If available evidence suggests that it is more likely than not that some portion or all of the deferred tax assets will not be realized, a valuation allowance is required to reduce the deferred tax assets to the amount that is more likely than not to be realized. Future changes in such valuation allowance are included in the provision for deferred income taxes in the period of change.
 
PA LLC is organized as a limited liability company under the state law of Delaware. As a limited liability company that has elected to be taxed as a partnership, the Company’s earnings pass through to the members and are taxed at the member level. Accordingly, no income tax provision has been included in these financial statements for the operations related to PA LLC.
 
Equity-Based Compensation

The Company accounts for stock based compensation in accordance with ASC 718 Stock Compensation. This Statement requires that the cost resulting from all share-based transactions be recorded in the financial statements. The Statement establishes fair value as the measurement objective in accounting for share-basedpayment arrangements and requires all entities to apply a fair-value-based measurement in accounting for share-based payment transactions with employees. The Statement also establishes fair value as the measurement objective for transactions in which an entity acquires goods or services from non-employees in share based payment transactions.
 
Recent Accounting Pronouncements
 
Adoption of New Accounting Standards
 
Accounting Standards Codification
 
In June 2009, the FASB issued Statement of Financial Accounting Standards (“SFAS”) No. 168, The FASB Accounting Standards Codification and the Hierarchy of Generally Accepted Accounting Principles (the “Codification”). This standard replaces SFAS No. 162, The Hierarchy of Generally Accepted Accounting Principles, and establishes only two levels of U.S. generally accepted accounting principles (“GAAP”), authoritative and nonauthoritative. The FASB ASC has become the source of authoritative, nongovernmental GAAP, except for rules and interpretive releases of the SEC, which are sources of authoritative GAAP for SEC registrants. All other nongrandfathered, non-SEC accounting literature not included in the Codification will become nonauthoritative. This standard is effective for financial statements for interim or annual reporting periods ending after September 15, 2009. The adoption of the Codification changed the Company’s references to GAAP accounting standards but did not impact the Company’s results of operations, financial position or liquidity.
 
Participating Securities Granted in Share-Based Transactions
 
Effective January 1, 2009, the Company adopted a new accounting standard included in ASC 260, Earnings Per Share (formerly FASB Staff Position (“FSP”) Emerging Issues Task Force (“EITF”) 03-6-1, Determining Whether Instruments Granted in Share-Based Payment Transactions Are Participating Securities).  The new guidance clarifies that non-vested share-based payment awards that entitle their holders to receive nonforfeitable dividends or dividend equivalents before vesting should be considered participating securities and included in basic earnings per share. The Company’s adoption of the new accounting standard did not have a material effect on previously issued or current earnings per share.

 
– 25 –

 

Business Combinations and Noncontrolling Interests
 
Effective January 1, 2009, the Company adopted a new accounting standard included in ASC 805, Business Combinations (formerly SFAS No. 141(R), Business Combinations).  The new standard applies to all transactions or other events in which an entity obtains control of one or more businesses. Additionally, the new standard requires the acquiring entity in a business combination to recognize all (and only) the assets acquired and liabilities assumed in the transaction; establishes the acquisition-date fair value as the measurement date for all assets acquired and liabilities assumed; and requires the acquirer to disclose additional information needed to evaluate and understand the nature and financial effect of the business combination. The Company’s adoption of the new accounting standard did not have a material effect on the Company’s consolidated financial statements.
 
Effective January 1, 2009, the Company adopted a new accounting standard included in ASC 810, Consolidations (formerly SFAS 160, Noncontrolling Interests in Consolidated Financial Statements).  The new accounting standard establishes accounting and reporting standards for the noncontrolling interest (or minority interests) in a subsidiary and for the deconsolidation of a subsidiary by requiring all noncontrolling interests in subsidiaries be reported in the same way, as equity in the consolidated financial statements. As such, this guidance has eliminated the diversity in accounting for transactions between an entity and noncontrolling interests by requiring they be treated as equity transactions. The Company’s adoption of this new accounting standard did not have a material effect on the Company’s consolidated financial statements.
 
Fair Value Measurement and Disclosure
 
Effective January 1, 2009, the Company adopted a new accounting standard included in ASC 820, Fair Value Measurements and Disclosures (“ASC 820”) (formerly FASB FSP No 157-2, Effective Date of FASB Statement No. 157), which delayed the effective date for disclosing all non-financial assets and non-financial liabilities, except for items that are recognized or disclosed at fair value on a recurring basis (at least annually). This standard did not have a material impact on the Company’s consolidated financial statements.
 
In April 2009, the FASB issued new guidance for determining when a transaction is not orderly and for estimating fair value when there has been a significant decrease in the volume and level of activity for an asset or liability. The new guidance, which is now part of ASC 820 (formerly FSP 157-4,  Determining Fair Value When the Volume and Level of Activity for the Asset or Liability Have Significantly Decreased and Identifying Transactions That Are Not Orderly ), requires disclosure of the inputs and valuation techniques used, as well as any changes in valuation techniques and inputs used during the period, to measure fair value in interim and annual periods. In addition, the presentation of the fair value hierarchy is required to be presented by major security type as described in ASC 320, Investments — Debt and Equity Securities . The provisions of the new standard were effective for interim periods ending after June 15, 2009. The adoption of the new standard on April 1, 2009 did not have a material on the Company’s consolidated financial statements.
 
In April 2009, the Company adopted a new accounting standard included in ASC 820, (formerly FSP 107-1 and Accounting Principles Board (“APB”) 28-1, Interim Disclosures about Fair Value of Financial Instruments).  The new standard requires disclosures of the fair value of financial instruments for interim reporting periods of publicly traded companies in addition to the annual disclosure required at year-end. The provisions of the new standard were effective for the interim periods ending after June 15, 2009. The Company’s adoption of this new accounting standard did not have a material effect on the Company’s consolidated financial statements.
 
In August 2009, the FASB issued new guidance relating to the accounting for the fair value measurement of liabilities. The new guidance, which is now part of ASC 820, provides clarification that in certain circumstances in which a quoted price in an active market for the identical liability is not available, a company is required to measure fair value using one or more of the following valuation techniques: the quoted price of the identical liability when traded as an asset, the quoted prices for similar liabilities or similar liabilities when traded as assets, or another valuation technique that is consistent with the principles of fair value measurements. The new guidance clarifies that a company is not required to include an adjustment for restrictions that prevent the transfer of the liability and if an adjustment is applied to the quoted price used in a valuation technique, the result is a Level 2 or 3 fair value measurement. The new guidance is effective for interim and annual periods beginning after August 27, 2009. The Company’s adoption of the new guidance did not have a material effect on the Company’s consolidated financial statements.

 
– 26 –

 

Derivative Instruments and Hedging Activities
 
Effective January 1, 2009, the Company adopted a new accounting standard included in ASC 815, Derivatives and Hedging (SFAS No. 161, Disclosures about Derivative Instruments and Hedging Activities, an amendment of SFAS No.133). The new accounting standard requires enhanced disclosures about an entity’s derivative and hedging activities and is effective for fiscal years and interim periods beginning after November 15, 2008. Since the new accounting standard only required additional disclosure, the adoption did not impact the Company’s consolidated financial statements.
 
Other-Than-Temporary Impairments
 
In April 2009, the FASB issued new guidance for the accounting for other-than-temporary impairments. Under the new guidance, which is part of ASC 320, Investments — Debt and Equity Securities (formerly FSP 115-2 and 124-2, Recognition and Presentation of Other-Than-Temporary Impairments), and other-than-temporary impairment is recognized when an entity has the intent to sell a debt security or when it is more likely than not that an entity will be required to sell the debt security before its anticipated recovery in value.  The new guidance does not amend existing recognition and measurement guidance related to other-than-temporary impairments of equity securities and is effective for interim and annual reporting periods ending after June 15, 2009. The Company’s adoption of the new guidance did not have a material effect on the Company’s consolidated financial statements.
 
Subsequent Events
 
In May 2009, the FASB issued new guidance for subsequent events. The new guidance, which is part of ASC 855, Subsequent Events  (formerly SFAS No. 165,  Subsequent Events)  is intended to establish general standards of accounting for and disclosure of events that occur after the balance sheet date but before financial statements are issued or are available to be issued. Specifically, this guidance sets forth the period after the balance sheet date during which management of a reporting entity should evaluate events or transactions that may occur for potential recognition or disclosure in the financial statements, the circumstances under which an entity should recognize events or transactions occurring after the balance sheet date in its financial statements, and the disclosures that an entity should make about events or transactions that occurred after the balance sheet date. The new guidance is effective for fiscal years and interim periods ended after June 15, 2009 and will be applied prospectively. The Company’s adoption of the new guidance did not have a material effect on the Company’s consolidated financial statements. The Company evaluated subsequent events through the date the accompanying financial statements were issued, which was March 30, 2010.
 
Accounting Standards Not Yet Effective
 
Accounting for the Transfers of Financial Assets
 
In June 2009, the FASB issued new guidance relating to the accounting for transfers of financial assets. The new guidance, which was issued as SFAS No. 166, Accounting for Transfers of Financial Assets,  an amendment to SFAS No.  140, was adopted into Codification in December 2009 through the issuance of Accounting Standards Updated (“ASU”) 2009-16. The new standard eliminates the concept of a “qualifying special-purpose entity,” changes the requirements for derecognizing financial assets, and requires additional disclosures in order to enhance information reported to users of financial statements by providing greater transparency about transfers of financial assets, including securitization transactions, and an entity’s continuing involvement in and exposure to the risks related to transferred financial assets. The new guidance is effective for fiscal years beginning after November 15, 2009. The Company will adopt the new guidance in 2010 and is evaluating the impact it will have to the Company’s consolidated financial statements.
 
Accounting for Variable Interest Entities
 
In June 2009, the FASB issued revised guidance on the accounting for variable interest entities. The revised guidance, which was issued as SFAS No. 167, Amending FASB Interpretation No. 46(R), was adopted into Codification in December 2009 through the issuance of ASU 2009-17. The revised guidance amends FASB Interpretation No. 46(R), Consolidation of Variable Interest Entities, in determining whether an enterprise has a controlling financial interest in a variable interest entity. This determination identifies the primary beneficiary of a variable interest entity as the enterprise that has both the power to direct the activities of a variable interest entity that most significantly impacts the entity’s economic performance, and the obligation to absorb losses or the right to receive benefits of the entity that could potentially be significant to the variable interest entity. The revised guidance requires ongoing reassessments of whether an enterprise is the primary beneficiary and eliminates the quantitative approach previously required for determining the primary beneficiary. The Company does not expect that the provisions of the new guidance will have a material effect on its consolidated financial statements.

Revenue Recognition
 
In October 2009, the FASB issued ASU 2009-13, Multiple-Deliverable Revenue Arrangements. The new standard changes the requirements for establishing separate units of accounting in a multiple element arrangement and requires the allocation of arrangement consideration to each deliverable based on the relative selling price. The selling price for each deliverable is based on vendor-specific objective evidence (“VSOE”) if available, third-party evidence if VSOE is not available, or estimated selling price if neither VSOE or third-party evidence is available. ASU 2009-13 is effective for revenue arrangements entered into in fiscal years beginning on or after June 15, 2010. The Company does not expect that the provisions of the new guidance will have a material effect on its consolidated financial statements.
 
 
– 27 –

 
 
ITEM 7A.           QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
 
Interest Rate Risk
 
Our exposure to interest rate risk is related to our borrowings. Fixed rate borrowings may have their fair market value adversely impacted from changes in interest rates. Floating rate borrowings will lead to additional interest expense if interest rates increase.
 
PetroAlgae enters into loan arrangements when needed. At December 31, 2009, the principal balance on the Company’s outstanding long-term  note  was $35.5 million, of which $17.8  million was outstanding at a floating rate of 2% over the prime interest rate and $17.7 million was outstanding at a fixed rate of 12%.
 
Our borrowings are subject to interest rate risk. Changes in the prime interest rate will have an affect on interest rate expense. The trend in the prime interest rate has recently been depressed with no indications of a meaningful reversal. Our financial instrument holdings have been analyzed to determine their sensitivity to interest rate change. In this sensitivity analysis, we used a two hundred and fifty basis point parallel shift in the interest rate curve for all maturities and for all instruments; all other factors were held constant. However, if there were a two hundred and fifty basis point increase in interest rates, the expected adverse impact to our financial statements would be immaterial.
 
Exchange Rate Risk
 
We are currently not subject to foreign exchange risk as a result of exposures to changes in currency exchange rates.
 
Commodity Price Risk
 
The result of deploying our technology, once commercialized, will be the creation of feedstock for the fuel and animal feed markets which may directly or indirectly compete with existing commodities. Biodiesel fuel is a commodity whose price is determined based on in part the price of petroleum diesel, world demand, supply and other factors, all of which are beyond our control. We expect that petroleum prices will continue to fluctuate in the future. Significant fluctuations in these commodity prices could impact the economic profitability of our products and services. However, given that we are still at the development stage, we are currently not subject to commodity price risk.

 
– 28 –

 

ITEM 8.
FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
 
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
 
Shareholders and Board of Directors
 
We have audited the accompanying consolidated balance sheets of PetroAlgae Inc. (a Development Stage Company) as of December 31, 2009 and 2008, and the related consolidated statements of operations, stockholders’ (deficit) equity and cash flows for the years ended December 31, 2009, and 2008, and the period from inception (September 22, 2006) to December 31, 2009. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.
 
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States of America). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
 
In our opinion the financial statements referred to above present fairly, in all material respects, the financial position of PetroAlgae Inc. (a Development Stage Company) as of December 31, 2009 and 2008, and the results of operations for the years ended December 31, 2009, and 2008, and the period from inception (September 22, 2006) to December 31, 2009, in conformity with accounting principles generally accepted in the United States of America.
 
The accompanying financial statements have been prepared assuming that the Company will continue as a going concern.  As discussed in Note 1 to the financial statements, the Company has incurred significant losses from operations and has a working capital deficit and no revenue generating operations. These factors raise substantial doubt about the Company’s ability to continue as a going concern. Management’s plans in regard to this matter are also discussed in Note 1. The financial statements do not include any adjustments that might result from the outcome of this uncertainty.

Kingery & Crouse PA
 
/s/ Kingery & Crouse PA
Certified Public Accountants
Tampa, Florida
March 30, 2010

 
– 29 –

 

PetroAlgae Inc.
(A Development Stage Company)
Consolidated Balance Sheets
 
   
December 31,
   
December 31,
 
   
2009
   
2008
 
ASSETS
           
Current assets:
           
Cash
  $ 4,679,302     $ 10,416,823  
Prepaid expenses
    129,333       110,277  
Total current assets
    4,808,635       10,527,100  
Property and equipment
    3,653,225       1,390,712  
Accumulated depreciation
    (1,416,350 )     (324,507 )
Net property and equipment
    2,236,875       1,066,205  
Long-term deposits
    5,200       5,000  
Total assets
  $ 7,050,710     $ 11,598,305  
                 
Liabilities and Stockholders' (Deficit)
               
Current liabilities:
               
Accounts payable
  $ 536,328     $ 1,043,285  
Accrued expenses
    1,617,191       1,786,341  
Accrued expenses - related party
    2,144,840       349,779  
Note payable - related party
    -       7,639,601  
Stock price quaranty
    7,500,000       -  
Deferred revenue
    2,800,000       -  
Total current liabilities
    14,598,359       10,819,006  
Note payable - related party
    35,489,096       16,921,243  
Other long term liabilities
    758,917       758,917  
Total liabilities
    50,846,372       28,499,166  
                 
Stockholders (deficit):
               
Preferred stock - $.001 par value, 25,000,000 shares authorized, no shares issued or outstanding
    -       -  
Series B - 10,000,000 shares authorized
               
Undesignated - 15,000,000 shares authorized
               
Common stock - $.001 par value, 300,000,000 shares authorized 106,229,356 and 104,274,189 shares issued and outstanding
    106,229       104,274  
Paid in capital
    22,133,497       13,466,546  
Deferred compensation
    (1,531,250 )     (3,106,250 )
Deficit accumulated during the development stage
    (58,860,269 )     (27,365,431 )
      (38,151,793 )     (16,900,861 )
Noncontrolling interest
    (5,643,869 )     -  
Total stockholders' (deficit) equity
    (43,795,662 )     (16,900,861 )
                 
Total liabilities and stockholders' (deficit) equity
  $ 7,050,710     $ 11,598,305  

See the accompanying notes to the financial statements.

 
– 30 –

 

PetroAlgae Inc.
(A Development Stage Company)
Consolidated Statements of Operations
 
               
For the
 
               
Period From
 
               
September 22,
 
               
2006
 
               
(Inception)
 
   
Year Ended
   
Year Ended
   
Through
 
   
December 31,
   
December 31,
   
December 31,
 
   
2009
   
2008
   
2009
 
                   
Revenue
  $ -     $ -     $ -  
                         
Costs and expenses:
                       
General and administrative
    9,293,799       3,083,555       12,780,565  
General and administrative - related party
    -       1,699,047       3,023,739  
Research and development
    21,052,390       10,399,670       38,833,254  
Research and development - related party
    -       467,607       1,130,975  
Purchased research and development
    3,018,144       -       3,018,144  
Interest expense - related party
    2,636,642       1,248,039       4,328,153  
Depreciation expense
    1,137,733       268,691       1,462,240  
Total costs and expenses
    37,138,708       17,166,609       64,577,070  
Net loss before non controlling interest
    (37,138,708 )     (17,166,609 )     (64,577,070 )
                         
Non-controlling interest
    5,643,869       40,211       5,716,800  
                         
Net loss
  $ (31,494,839 )   $ (17,126,398 )   $ (58,860,270 )
                         
Basic and diluted common shares outstanding
    104,840,703       100,362,021          
Basic and diluted loss per share
  $ (0.30 )   $ (0.17 )        

See the accompanying notes to the financial statements.

 
– 31 –

 
 
PetroAlgae Inc.
(A Development Stage Company)
Consolidated Statement of Changes in Stockholders' (Deficit)
Period From Inception (September 22, 2006) to December 31, 2009

                                 
Deficit
       
                                 
Accumulated
       
                                 
During the
       
   
Common Stock
         
Paid in
   
Deferred
   
Non Controlling
   
Development
       
   
Shares
   
Amount
   
Capital
   
Compensation
   
Interest
   
Stage
   
Total
 
Shares issued at inception for cash
    100,000,000     $ 100,000     $ 388,532     $ -     $ -     $ -     $ 488,532  
Net loss
    -       -       -       -       -       (1,410,724 )     (1,410,724 )
Balance - December 31, 2006
    100,000,000       100,000       388,532       -       -       (1,410,724 )     (922,192 )
                                                         
Net loss
    -       -       -       -       -       (8,828,309 )     (8,828,309 )
Balance - December 31, 2007
    100,000,000       100,000       388,532       -       -       (10,239,033 )     (9,750,501 )
                                                         
Recapitalization
    99,586       99       (67,811 )     -       -       -       (67,712 )
Shares issued for cash at $3.15 per share
    3,174,603       3,175       9,996,825       -       -       -       10,000,000  
Shares issued for deferred services at $3.15 per share
    1,000,000       1,000       3,149,000       (3,150,000 )     -               -  
Amortization of deferred services
    -       -       -       43,750       -       -       43,750  
Net loss
    -       -       -               -       (17,126,398 )     (17,126,398 )
Balance - December 31, 2008
    104,274,189       104,274       13,466,546       (3,106,250 )     -       (27,365,431 )     (16,900,861 )
                                                         
Shares issued for services at $6.62 per share
    151,057       151       999,849       -       -       -       1,000,000  
Shares issued for cash at $8.00 per share
    1,437,500       1,438       11,498,562       -       -       -       11,500,000  
Shares issued for services at $8.00 per share
    9,467       9       51,397       -       -       -       51,406  
Shares issued for purchased research and development at $8.00 per share
    357,143       357       2,856,787       -       -       -       2,857,144  
Amortization of deferred services
    -       -       -       1,575,000       -       -       1,575,000  
Fair value of options and warrants issued
    -       -       760,356       -       -       -       760,356  
Derivative liability
    -       -       (7,500,000 )     -       -       -       (7,500,000 )
Loss attributable to non controlling interest
    -       -       -       -       (5,643,869 )     -       (5,643,869 )
Net loss
    -       -       -       -       -       (31,494,838 )     (31,494,838 )
Balance - December 31, 2009
    106,229,356     $ 106,229     $ 22,133,497     $ (1,531,250 )   $ (5,643,869 )   $ (58,860,269 )   $ (43,795,662 )

See the accompanying notes to the financial statements.

 
– 32 –

 

PetroAlgae Inc.
(A Development Stage Company)
Consolidated Statements of Cash Flows
 
               
For the
 
               
Period From
 
               
September 22,
 
               
2006
 
               
(Inception)
 
   
Year Ended
   
Year Ended
   
Through
 
   
December 31,
   
December 31,
   
December 31,
 
   
2009
   
2008
   
2009
 
Cash flows from operating activities:
                 
Net loss
  $ (31,494,838 )   $ (17,126,398 )   $ (58,860,269 )
Adjustments to reconcile net loss to net cash used in operating activities:
                       
Loss attributable to non controlling interest
    (5,643,869 )     -       (5,643,869 )
Amortization of license agreement
    -       -       758,917  
Common shares issued for services
    3,225,762       43,750       3,269,512  
Common shares issued for purchased research and development
    3,018,144       -       3,018,144  
Expenses paid and interest added to note payable - related party
    2,723,313       2,558,191       9,089,556  
Depreciation
    1,137,733       268,691       1,462,240  
Net liabilities related to recapitalization
    -       (67,712 )     (67,712 )
(Increase) in prepaid expenses
    (19,056 )     (103,933 )     (129,333 )
Increase (decrease) in deposits
    (10,902 )     2,700       (15,902 )
Increase (decrease) in accounts payable
    (575,297 )     712,384       467,988  
Increase (decrease) in accrued liabilities
    (158,448 )     1,863,064       1,977,672  
Increase in deferred revenue
    2,800,000       -       2,800,000  
Net cash (used in) operating activities
    (24,997,458 )     (11,849,263 )     (41,873,056 )
                         
Cash flows from investing activities:
                       
Acquisition of property and equipment
    (2,240,063 )     (812,660 )     (3,630,775 )
Net cash (used in) investing activities
    (2,240,063 )     (812,660 )     (3,630,775 )
                         
Cash flows from financing activities:
                       
Proceeds from notes payable - related party
    10,000,000       12,894,601       28,194,601  
Common shares issued for cash
    11,500,000       10,000,000       21,988,532  
Net cash provided by financing activities
    21,500,000       22,894,601       50,183,133  
Net increase in cash
    (5,737,521 )     10,232,678       4,679,302  
Cash - beginning of period
    10,416,823       184,145       -  
Cash - end of period
  $ 4,679,302     $ 10,416,823     $ 4,679,302  
                         
Cash paid for:
                       
Interest
  $ -     $ -     $ -  
Income taxes
  $ -     $ -     $ -  
                         
Non cash investing and financing activities:
                       
Reclassification of equity to derivative liability
  $ 7,500,000     $ -     $ 7,500,000  
Common shares issued for deferred services
  $ -     $ 3,150,000     $ 3,150,000  

See the accompanying notes to the financial statements.

 
– 33 –

 

PetroAlgae Inc.
 
(A Development Stage Company)
Notes to Consolidated Financial Statements
December 31, 2009 and 2008

Note 1   BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
 
Organization
 
On December 16, 2008, Corporate Services International, a Delaware corporation, sold 9,000,000 shares of Series B preferred stock of the Dover Glen, Inc. and 10,000,000 shares of common stock of Dover Glen, Inc. to PetroTech Holdings Corp., a Delaware corporation (“PetroTech Holdings”), for $350,000 in a private placement transaction.
 
On December 16, 2008, PetroTech Holdings submitted a conversion notice to the Dover Glen, Inc. for its 9,000,000 shares of Series B preferred stock. Each share of Series B preferred stock of the Company converted into 10 shares of common stock of the Company.
 
As a result of the acquisition of shares and subsequent conversion, PetroTech Holdings was the owner of 100,000,000 shares of common stock of the Dover Glen, Inc. which, as of December 16, 2008, represented 99.9% of the total issued and outstanding common stock of the Dover Glen, Inc.
 
On December 19, 2008, PetroTech Holdings assigned its entire interest in PetroAlgae LLC (“PA LLC”), representing approximately 81.3% of the membership interests on a fully diluted basis of PA LLC, to  Dover Glen, Inc. for no consideration. This assignment had the effect of causing Dover Glen, Inc. to cease being a shell company. As a result of the assignment, the business of PA LLC has become the sole line of business of Dover Glen, Inc. Also, on December 19, 2008, the Dover Glen, Inc. changed its name to “PetroAlgae Inc.
 
 
PA LLC was created on September 22, 2006, in the state of Delaware to develop a commercial, scalable solution comprising a proprietary library of algae that combines the characteristics of rapid growth rate and high oil content. The algae are cultivated in modular bioreactors that can be operated cost-effectively at commercial scale with harvesting occurring on a continuous basis.
 
The Company is currently in the development stage.
 
Basis of Presentation
 
The Company's financial statements are presented 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 significant losses from operations aggregating $58,860,269 since inception. In addition, the Company had a working capital deficit at December 31, 2009, of $9,800,426 and has no significant revenue generating operations.
 
The Company's ability to continue as a going concern is contingent upon its ability to secure additional financing, increase ownership equity and attain profitable operations. In addition, the Company's ability to continue as a going concern must be considered in light of the problems, expenses and complications frequently encountered in a competitive business environment.

 
– 34 –

 

The Company is pursuing financing for its operations and seeking additional investments. In addition, the Company is seeking to establish a revenue base. Failure to secure such financing or to raise additional equity capital and to establish a revenue base may result in the Company depleting its available funds and not being able pay its obligations.
 
The financial statements do not include any adjustments to reflect the possible future effects on the recoverability and classification of assets or the amounts and classification of liabilities that may result from the possible inability of the Company to continue as a going concern.
 
Principles of Consolidation
 
The consolidated financial statements presented herein include the accounts of the Company and its consolidated subsidiary PA, LLC of which the Company owns approximately 82% on a fully diluted basis.
 
All intercompany transactions and balances have been eliminated in consolidation.
 
Reclassifications
 
Certain amounts presented in the 2008 financial statements have been reclassified to conform to current year presentation.
 
Use of Estimates
 
The accompanying financial statements are prepared in accordance with accounting principles generally accepted in the United States of America which require management to make estimates and assumptions. These estimates and assumptions affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expense. Actual results may differ from these estimates.
 
Revenue Recognition
 
In general, the Company records revenue when persuasive evidence of an arrangement exists, services have been rendered or product delivery has occurred, the sales price to the customer is fixed or determinable, and collectability is reasonably assured. The following policies reflect specific criteria for the various revenues streams of the Company:
 
Revenue is recognized at the time the product is delivered. Provision for sales returns will be estimated based on the Company's historical return experience. Revenue will be presented net of returns.
 
Cash and Cash Equivalents and Cash Concentrations
 
The Company considers all highly liquid investments with an original maturity of three months or less to be cash equivalents. The Company at December 31, 2009, has approximately $4,600,000 on deposit at a single financial institution.
 
Fair Value of Financial Instruments
 
Fair value estimates discussed herein are based upon certain market assumptions and pertinent information available to management as of December 31, 2009 and 2008. The respective carrying value of certain on-balance-sheet financial instruments, approximate their fair values. These financial instruments include cash, accounts payable, accrued expenses and notes payable. Fair values were assumed to approximate carrying values for these financial instruments because they are short term in nature and their carrying amounts approximate fair values or they are receivable or payable on demand.

 
– 35 –

 

The carrying value of the Company’s note payable approximated its fair value based on the current market conditions for similar debt instruments.
 
Property and Equipment
 
Property and equipment is recorded at cost. Expenditures for major improvements and additions are added to property and equipment, while replacements, maintenance and repairs which do not extend the useful lives are expensed.
 
Long Lived Assets
 
The carrying value of long-lived assets is reviewed on a regular basis for the existence of facts and circumstances that suggest impairment. Should there be an impairment the Company measures the amount of the impairment based on the amount that the carrying value of the impaired asset exceeds the discounted cash flows expected to result from the use and eventual disposal from the impaired assets. There were no impairments in 2009 or 2008.
 
Income Taxes
 
The Company follows ASC 740 Income Taxes for recording the provision for income taxes. Deferred tax assets and liabilities are computed based upon the difference between the financial statement and income tax basis of assets and liabilities using the enacted marginal tax rate applicable when the related asset or liability is expected to be realized or settled. Deferred income tax expenses or benefits are based on the changes in the asset or liability each period. If available evidence suggests that it is more likely than not that some portion or all of the deferred tax assets will not be realized, a valuation allowance is required to reduce the deferred tax assets to the amount that is more likely than not to be realized. Future changes in such valuation allowance are included in the provision for deferred income taxes in the period of change.
 
Beginning January 1, 2007, we adopted ASC 740-10-05 Accounting for Uncertainty in Income Taxes. The Interpretation prescribes a recognition threshold and a measurement attribute for the financial statement recognition and measurement of tax positions taken or expected to be taken in a tax return. For those benefits to be recognized, a tax position must be more-likely-than-not to be sustained upon examination by taxing authorities. The amount recognized is measured as the largest amount of benefit that is greater than 50 percent likely of being realized upon ultimate settlement.
 
PA LLC is organized as a limited liability company under the state law of Delaware. As a limited liability company that has elected to be taxed as a partnership, the Company’s earnings pass through to the members and are taxed at the member level. Accordingly, no income tax provision has been included in these financial statements for the operations related to PA LLC.
 
Loss Per Share
 
Basic earnings (loss) per share are calculated by dividing net income (loss) by the weighted average number of common shares outstanding for the period. Diluted earnings (loss) per share is calculated by dividing net income (loss) by the weighted average number of common shares and dilutive common stock equivalents outstanding. During periods in which the Company incurs losses common stock equivalents, if any, are not considered, as their effect would be anti dilutive.
 
Equity-Based Compensation
 
The Company accounts for stock based compensation in accordance with ASC 718 Stock Compensation. This Statement requires that the cost resulting from all share-based transactions be recorded in the financial statements. The Statement establishes fair value as the measurement objective in accounting for share-based payment arrangements and requires all entities to apply a fair-value-based measurement in accounting for share-based payment transactions with employees. The Statement also establishes fair value as the measurement objective for transactions in which an entity acquires goods or services from non-employees in share-based payment transactions.
 
Recently Issued Accounting Pronouncements
 
Adoption of New Accounting Standards
 
Accounting Standards Codification

 
– 36 –

 

In June 2009, the FASB issued Statement of Financial Accounting Standards (“SFAS”) No. 168, The FASB Accounting Standards Codification and the Hierarchy of Generally Accepted Accounting Principles  (the “Codification”). This standard replaces SFAS No. 162, The Hierarchy of Generally Accepted Accounting Principles, and establishes only two levels of U.S. generally accepted accounting principles (“GAAP”), authoritative and nonauthoritative. The FASB ASC has become the source of authoritative, nongovernmental GAAP, except for rules and interpretive releases of the SEC, which are sources of authoritative GAAP for SEC registrants. All other nongrandfathered, non-SEC accounting literature not included in the Codification will become nonauthoritative. This standard is effective for financial statements for interim or annual reporting periods ending after September 15, 2009. The adoption of the Codification changed the Company’s references to GAAP accounting standards but did not impact the Company’s results of operations, financial position or liquidity.
 
Participating Securities Granted in Share-Based Transactions
 
Effective January 1, 2009, the Company adopted a new accounting standard included in ASC 260, Earnings Per Share (formerly FASB Staff Position (“FSP”) Emerging Issues Task Force (“EITF”) 03-6-1, Determining Whether Instruments Granted in Share-Based Payment Transactions Are Participating Securities).  The new guidance clarifies that non-vested share-based payment awards that entitle their holders to receive nonforfeitable dividends or dividend equivalents before vesting should be considered participating securities and included in basic earnings per share. The Company’s adoption of the new accounting standard did not have a material effect on previously issued or current earnings per share.
 
Business Combinations and Noncontrolling Interests
 
Effective January 1, 2009, the Company adopted a new accounting standard included in ASC 805, Business Combinations (formerly SFAS No. 141(R), Business Combinations).  The new standard applies to all transactions or other events in which an entity obtains control of one or more businesses. Additionally, the new standard requires the acquiring entity in a business combination to recognize all (and only) the assets acquired and liabilities assumed in the transaction; establishes the acquisition-date fair value as the measurement date for all assets acquired and liabilities assumed; and requires the acquirer to disclose additional information needed to evaluate and understand the nature and financial effect of the business combination. The Company’s adoption of the new accounting standard did not have a material effect on the Company’s consolidated financial statements.
 
 Effective January 1, 2009, the Company adopted a new accounting standard included in ASC 810, Consolidations (formerly SFAS 160, Noncontrolling Interests in Consolidated Financial Statements).  The new accounting standard establishes accounting and reporting standards for the noncontrolling interest (or minority interests) in a subsidiary and for the deconsolidation of a subsidiary by requiring all noncontrolling interests in subsidiaries be reported in the same way, as equity in the consolidated financial statements. As such, this guidance has eliminated the diversity in accounting for transactions between an entity and noncontrolling interests by requiring they be treated as equity transactions. The Company’s adoption of this new accounting standard did not have a material effect on the Company’s consolidated financial statements.
 
Fair Value Measurement and Disclosure
 
Effective January 1, 2009, the Company adopted a new accounting standard included in ASC 820, Fair Value Measurements and Disclosures (“ASC 820”) (formerly FASB FSP No 157-2, Effective Date of FASB Statement No. 157), which delayed the effective date for disclosing all non-financial assets and non-financial liabilities, except for items that are recognized or disclosed at fair value on a recurring basis (at least annually). This standard did not have a material impact on the Company’s consolidated financial statements.
 
In April 2009, the FASB issued new guidance for determining when a transaction is not orderly and for estimating fair value when there has been a significant decrease in the volume and level of activity for an asset or liability. The new guidance, which is now part of ASC 820 (formerly FSP 157-4,  Determining Fair Value When the Volume and Level of Activity for the Asset or Liability Have Significantly Decreased and Identifying Transactions That Are Not Orderly ), requires disclosure of the inputs and valuation techniques used, as well as any changes in valuation techniques and inputs used during the period, to measure fair value in interim and annual periods. In addition, the presentation of the fair value hierarchy is required to be presented by major security type as described in ASC 320, Investments — Debt and Equity Securities . The provisions of the new standard were effective for interim periods ending after June 15, 2009. The adoption of the new standard on April 1, 2009 did not have a material on the Company’s consolidated financial statements.

 
– 37 –

 

In April 2009, the Company adopted a new accounting standard included in ASC 820, (formerly FSP 107-1 and Accounting Principles Board (“APB”) 28-1, Interim Disclosures about Fair Value of Financial Instruments).  The new standard requires disclosures of the fair value of financial instruments for interim reporting periods of publicly traded companies in addition to the annual disclosure required at year-end. The provisions of the new standard were effective for the interim periods ending after June 15, 2009. The Company’s adoption of this new accounting standard did not have a material effect on the Company’s consolidated financial statements.
 
In August 2009, the FASB issued new guidance relating to the accounting for the fair value measurement of liabilities. The new guidance, which is now part of ASC 820, provides clarification that in certain circumstances in which a quoted price in an active market for the identical liability is not available, a company is required to measure fair value using one or more of the following valuation techniques: the quoted price of the identical liability when traded as an asset, the quoted prices for similar liabilities or similar liabilities when traded as assets, or another valuation technique that is consistent with the principles of fair value measurements. The new guidance clarifies that a company is not required to include an adjustment for restrictions that prevent the transfer of the liability and if an adjustment is applied to the quoted price used in a valuation technique, the result is a Level 2 or 3 fair value measurement. The new guidance is effective for interim and annual periods beginning after August 27, 2009. The Company’s adoption of the new guidance did not have a material effect on the Company’s consolidated financial statements.
 
Derivative Instruments and Hedging Activities
 
Effective January 1, 2009, the Company adopted a new accounting standard included in ASC 815, Derivatives and Hedging (SFAS No. 161, Disclosures about Derivative Instruments and Hedging Activities, an amendment of SFAS No.133). The new accounting standard requires enhanced disclosures about an entity’s derivative and hedging activities and is effective for fiscal years and interim periods beginning after November 15, 2008. Since the new accounting standard only required additional disclosure, the adoption did not impact the Company’s consolidated financial statements.
 
Other-Than-Temporary Impairments
 
In April 2009, the FASB issued new guidance for the accounting for other-than-temporary impairments. Under the new guidance, which is part of ASC 320, Investments — Debt and Equity Securities (formerly FSP 115-2 and 124-2, Recognition and Presentation of Other-Than-Temporary Impairments), and other-than-temporary impairment is recognized when an entity has the intent to sell a debt security or when it is more likely than not that an entity will be required to sell the debt security before its anticipated recovery in value.  The new guidance does not amend existing recognition and measurement guidance related to other-than-temporary impairments of equity securities and is effective for interim and annual reporting periods ending after June 15, 2009. The Company’s adoption of the new guidance did not have a material effect on the Company’s consolidated financial statements.
 
 Subsequent Events
 
In May 2009, the FASB issued new guidance for subsequent events. The new guidance, which is part of ASC 855, Subsequent Events  (formerly SFAS No. 165,  Subsequent Events)  is intended to establish general standards of accounting for and disclosure of events that occur after the balance sheet date but before financial statements are issued or are available to be issued. Specifically, this guidance sets forth the period after the balance sheet date during which management of a reporting entity should evaluate events or transactions that may occur for potential recognition or disclosure in the financial statements, the circumstances under which an entity should recognize events or transactions occurring after the balance sheet date in its financial statements, and the disclosures that an entity should make about events or transactions that occurred after the balance sheet date. The new guidance is effective for fiscal years and interim periods ended after June 15, 2009 and will be applied prospectively. The Company’s adoption of the new guidance did not have a material effect on the Company’s consolidated financial statements.

 
– 38 –

 

Accounting Standards Not Yet Effective
 
Accounting for the Transfers of Financial Assets
 
In June 2009, the FASB issued new guidance relating to the accounting for transfers of financial assets. The new guidance, which was issued as SFAS No. 166, Accounting for Transfers of Financial Assets,  an amendment to SFAS No.  140, was adopted into Codification in December 2009 through the issuance of Accounting Standards Updated (“ASU”) 2009-16. The new standard eliminates the concept of a “qualifying special-purpose entity,” changes the requirements for derecognizing financial assets, and requires additional disclosures in order to enhance information reported to users of financial statements by providing greater transparency about transfers of financial assets, including securitization transactions, and an entity’s continuing involvement in and exposure to the risks related to transferred financial assets. The new guidance is effective for fiscal years beginning after November 15, 2009. The Company will adopt the new guidance in 2010 and is evaluating the impact it will have to the Company’s consolidated financial statements.
 
Accounting for Variable Interest Entities
 
In June 2009, the FASB issued revised guidance on the accounting for variable interest entities. The revised guidance, which was issued as SFAS No. 167, Amending FASB Interpretation No. 46(R), was adopted into Codification in December 2009 through the issuance of ASU 2009-17. The revised guidance amends FASB Interpretation No. 46(R), Consolidation of Variable Interest Entities, in determining whether an enterprise has a controlling financial interest in a variable interest entity. This determination identifies the primary beneficiary of a variable interest entity as the enterprise that has both the power to direct the activities of a variable interest entity that most significantly impacts the entity’s economic performance, and the obligation to absorb losses or the right to receive benefits of the entity that could potentially be significant to the variable interest entity. The revised guidance requires ongoing reassessments of whether an enterprise is the primary beneficiary and eliminates the quantitative approach previously required for determining the primary beneficiary. The Company does not expect that the provisions of the new guidance will have a material effect on its consolidated financial statements.
 
Revenue Recognition
 
In October 2009, the FASB issued ASU 2009-13, Multiple-Deliverable Revenue Arrangements. The new standard changes the requirements for establishing separate units of accounting in a multiple element arrangement and requires the allocation of arrangement consideration to each deliverable based on the relative selling price. The selling price for each deliverable is based on vendor-specific objective evidence (“VSOE”) if available, third-party evidence if VSOE is not available, or estimated selling price if neither VSOE or third-party evidence is available. ASU 2009-13 is effective for revenue arrangements entered into in fiscal years beginning on or after June 15, 2010. The Company does not expect that the provisions of the new guidance will have a material effect on its consolidated financial statements.
 
Note 2   Property and Equipment
 
Property and equipment and related accumulated depreciation and amortization consist of:
 
   
31-Dec
 
Estimated
 
   
2009
   
2008
 
useful lives*
 
Leasehold improvements
  $ 613,864     $ 365,160  
5-10 years
 
Furniture and fixtures
    81,716       22,567  
3-7 years
 
Automobiles
    62,641       32,344  
2-5 years
 
Computer and office equipment
    230,068       127,019  
1-7 years
 
Engineering equipment
    2,276,908       607,050  
2-7 years
 
Software and networking
    388,029       236,572  
1-5 years
 
Total cost basis
  $ 3,653,226     $ 1,390,712      
                     
Less accumulated depreciation and amortization
    (1,416,350     (324,507    
    $ 2,236,876     $ 1,066,205      
 

* All depreciation is calculated using the straight line method
 
 
– 39 –

 

Depreciation expense was $1,137,733, $268,691 and $1,462,240 for the years ended December 31, 2009 and 2008 and the period from inception to December 31, 2009.
 
Note 3   Notes Payable – Related Party
 
On July 24, 2009, the Company entered into agreements with its principle lender to restructure all of the Company’s loans. The Company, PA LLC, PetroTech Holdings Corp., and LV Administrative Services, Inc., as administrative and collateral agent for PetroTech Holdings Corp., fully executed an Omnibus Amendment, Joinder and Reaffirmation Agreement, which amended (i) the demand notes issued by PA LLC to PetroTech Holdings Corp. dated August 21, 2008, September 3, 2008, September 18, 2008 and September 25, 2008 in the aggregate principal amount of $7,222,089, (ii) the convertible demand notes issued by PA LLC to PetroTech Holdings Corp. dated April 24, 2009 and May 11, 2009 in the aggregate principal amount of $10,000,000, (iii) the demand note issued by PA LLC to Valens US SPV I, LLC in the principal amount of $417,512 dated August 8, 2008, ((iv) the promissory note dated June 12, 2008 issued by PA LLC in favor of XL Techgroup, Inc. and assigned to PetroTech Holdings Corp. in the principal amount of $25,000,000 and (v) a master security agreement dated August 21, 2008 by PA LLC in favor of LV Administrative Services, Inc. on behalf of PetroTech Holdings Corp. The Company also delivered an equity pledge agreement and a guaranty in connection with the Omnibus Amendment, Joinder and Reaffirmation Agreement. Principally, the maturity of the loans was changed to three years from this date.

 
– 40 –

 

Notes payable consist of the following at December 31, 2009 and 2008:
 
   
2009
   
2008
 
Note Payable to Valens US
  $ 417,512     $ 417,512  
·      Collateral – all assets of the Company
               
·      Interest accrues monthly, at 12% per annum
               
·      Note is due on July 24, 2012
               
                 
Notes Payable to PetroTech Holdings Corp.
               
·      Collateral – all assets of the Company
               
·      Interest accrues monthly, at 12% per annum
               
·      Notes are due on July 24, 2012
    7,222,089       7,222,089  
                 
Notes Payable to PetroTech Holdings Corp.
               
·      Collateral – all assets of the Company
               
·      Interest accrues monthly, at 12% per annum
               
·      Notes are due on July 24, 2012
    10,000,000       -  
                 
Up to $25,000,000 collateralized note dated January 1, 2007
               
·      collateral – all assets of the Company
               
·      Interest payable monthly, and is drawn into note on a monthly basis at Prime + 2%
(5.25% at December 31, 2009)
               
·      Funding provided as needed.
               
·      Note is due on July 24, 2012
    17,849,495       16,921,243  
                 
Total
    35,489,096       24,560,844  
Less current portion
    -       7,639,601  
Long-term portion
  $ 35,489,096     $ 16,921,243  
 
The note agreements are collectively secured by all of the Company’s assets.
 
A portion of the notes payable at December 31, 2007, were held by XL TechGroup, Inc. During 2007 and 2008 the Company received funding from XL TechGroup, Inc. in the form of a note with the interest rate at prime + 2%, with the interest drawing into the note after each month. During 2007 and 2008, cash advances totaled $5,300,000 and $5,255,000, and non cash advances totaled $3,607,793 and $2,758,450. In August 2008, the note held by XL TechGroup, Inc. was acquired by PetroTech Holdings Corp, The balance of this note at December 31, 2009 and 2008, was $17,849,495 and $16,921,243. The balance of the notes are also held by PetroTech Holdings Corp. or Valens US. These entities are affiliates of the Company.
 
Interest charged to operations on these notes was $2,636,642, $1,248,039 and $4,328,153 during the years ended December 31, 2009 and 2008 and the period from inception to December 31, 2009.
 
Note 4   Leases
 
The Company has non-cancellable operating leases for office space that expire through 2010. In addition, XL TechGroup, Inc. currently sub leases office space to PetroAlgae Inc. on a month to month basis, at a current rate of $41,321 per month.
 
Rental expense for all operating leases during 2009 and 2008 was $749,890 and $436,592.

 
– 41 –

 

Future minimum lease payments under non-cancellable operating leases (with initial or remaining lease terms in excess of one year) as of December 31, 2009 are:
Year ending December 31, 2010
  $ 24,011  
 
Note 5   Stockholders’ (Deficit) Equity
 
The Company’s equity consists of the following:
 
300,000,000 shares of $.001 par value common stock
 
25,000,000 shares of $.001 par value preferred stock of which 15,000,000 shares are undesignated and 10,000,000 shares are designated as series B. Each share of series B preferred stock is entitled to 10 votes on all matters voted on and is convertible into 10 shares of common stock at the option of the holder.
 
At Inception the Company issued 100,000,000 shares of common stock in exchange for cash of $488,532.
 
During December 2008 the Company issued 3,174,603 shares of common stock for cash of $3.15 per share aggregating $10,000,000 pursuant to a private placement.
 
During December 2008 the Company issued 1,000,000 shares of common stock for consulting services to be performed through December 2010. The shares were valued at $3.15 per share aggregating $3,150,000 based on the sale of common stock described above which approximated fair market value on the date it was agreed the shares would be issued. The $3,150,000 was recorded as deferred compensation and $1,575,000 and $43,750 was amortized during 2009 and 2008.
 
On January 15, 2009, PetroAlgae Inc.(the “Company”) entered into a Stock Purchase Agreement with Engineering Automation and Design Inc., a Nebraska corporation (“EAD”), pursuant to which the Company issued 151,057 shares of common stock, par value $0.001 per share, of the Company as partial consideration, in advance, for certain services relating to the design and engineering, and construction of facilities for the growth and harvesting of algae for the production of algae oil provided by a wholly-owned subsidiary of EAD to the Company’s subsidiary, PA LLC. The fair value of the shares was approximately $6.62 per share based on the trading price of the Company's common shares or $1,000,000 in the aggregate.
 
During August through October 2009 the Company sold 1,437,500 units consisting of one share of common stock and a warrant to purchase a share of common stock at $15.00 for a period of 5 years for $8.00 per unit ($5.43 per common share and $2.57 per warrant) or $11,500,000 as follows:
 
562,500 units to an affiliate
875,000 units to third parties
 
The units sold to the third parties included an additional 875,000 warrants exercisable at $8.00 per share for a period of 6 months and 875,000 warrants exercisable at $15.00 per share for a period of 6 months. These additional warrants expired on January 9, 2010.

 
– 42 –

 

The 562,500 units sold to the affiliate and 375,000 of the units sold to a third party contained share price and warrant exercise price guarantees. The purchase price of the common stock and the exercise price of the warrants will be adjusted in the event that the Company issues common stock or warrants at a price below $8.00 for common shares or a $15.00 exercise price for warrants for a period of six months from the purchase date. Because of these potential adjustments, the shares issued and the warrants are accounted for as liabilities in accordance with ASC guidance. The cash proceeds received of $7,500,000 were allocated between the common stock and the warrants and the fair values of the common stock and warrants of $5,090,625 ($5.43 per share) and $2,409,375 ($2.57 per warrant), respectively, were recorded as liabilities. For the warrants,, the Company estimated the fair value using the Black-Scholes valuation model, based on the estimated fair value of the common stock on the valuation date, an expected dividend yield of 0%, a risk-free interest rate based on constant maturity rates published by the U.S. Federal Reserve applicable to the remaining term of the instruments, an expected life equal to the remaining term of the instruments and an implicit volatility of 82%. Because of the limited historical trading period of the Company’s common stock, the limited number of shares held by non-affiliates and the very small trading volume of its common stock, the fair value of the common stock was estimated at $5.43 per share based on the conversion price of the $10,000,000 note described in Note 3 and the implicit volatility of 82% was determined based on the aggregate cash proceeds received. The Company is required to re-measure the fair value of these liabilities at each reporting period. At the expiration of the six month price guarantee period, it is expected that the common stock and warrants will no longer be required to be accounted for as liablities and will be reclassified to equity.
 
During December 2009 the Company issued 357,143 units consisting of one share of common stock and a warrant to purchase a share of common stock at $15.00 for a period of 5 years in exchange for a 30% interest in Green Sciences Energy, LLC, a subsidiary of Congoo, LLC. The units were valued at $8.00 per unit or $2,857,144 which was the value at which the Company sold common shares and warrants during the period immediately preceding this issuances discussed above. In addition the Company issued an additional 250,000 warrants exercisable at $8.00 per share for a period of 6 months and 250,000 warrants exercisable at $15.00 per share for a period of 6 months. These additional warrants expire on June 30, 2010. The Company has used the Black-Scholes option pricing model using the following assumptions to value these 500,000 additional options:
 
Volatility 82%, Dividend rate 0%, risk free interest rate 0.18%
 
The fair value of the options of $161,000 and the fair value of the units of $2,857,144 has been charged to operations as purchased research and development.
 
During December 2009 the Company issued 9,467 shares of common stock valued at $51,406 for services. The shares were valued at $5.43 per share which was the fair value of the shares sold as described above.
 
Noncontrolling Interest and PA LLC Equity Incentive Plan
 
During 2007 the Company issued 5% of the Class A voting units (1,000,000 units) of PA LLC valued at $25,713 as partial consideration for a license to AzTE. AzTE has been granted anti-dilution and is entitled to 5% of the fully diluted capitalization of PA LLC. Pursuant to the non dilution clause, the Company will be required to issue AzTE an additional 172,149 units as of December  31, 2009.
 
PA LLC has an equity compensation plan which allows employees and consultants awards of Class B units and is limited to 14% of the total outstanding units.
 
PA LLC granted 3,142,071 units to various employees through unit grant agreements. The unit grants generally vest over four years of continual service. The fair value of these grants was determined by the Company as $95,402 at the grant date, and related charges of $7,385 and $12,544 were included in operating expenses at December 31, 2009, and 2008. The fair value of the unit grants was determined using the transaction that took place in 2006 where XL TechGroup, Inc. contributed $488,532 into PA LLC, and in return, received 19,000,000 units of PA LLC ($.03 per unit). As of December 31, 2009, the total unrecognized compensation cost for non-vested unit grants granted under the Plan was $48.795 which will be amortized over the remaining vesting periods. In addition to the amortization of the fair value of units, the Company also recognizes an operational expense of $.01 per unit granted to employees. This has resulted in an additional expense of $29.345 through December 31. 2009
 
As of December 31, 2009, non-controlling interest parties collectively owned approximately 18% of PA LLC, and have absorbed their respective portion of the loss of PA LLC. The amount of loss absorbed is $5,643,869 for the year ended December 31, 2009. Prior to January 1, 2009, minority interests absorbed $72,931 of the Company’s net losses.

 
– 43 –

 

Stock Options
 
On June 17, 2009, the Company adopted the 2009 Equity Compensation Plan. The plan is intended to provide employees, consultants and others the opportunity to receive incentive stock options. The plan is administered by the Board of Directors and is limited to 4,000,000 shares of the Company’s common stock. The exercise price shall be equal to or greater than the fair value of the underlying common stock on the date the option is granted and its term shall not exceed ten years. Awards shall not vest in full prior to the third anniversary of the award date.
 
On June 17 and July 16, 2009 the Company granted an aggregate of 1,072,500 and 45,000 options to purchase common shares at an exercise price of $8.50 and $8.00, respectively, per share. The options vest over a period of 4 years and expire 10 years from the grant date. The fair value of the options aggregated $4,818,000 and was calculated using the following assumptions – term 10 years, risk free interest rate 3.31% volatility 82%, and dividend yield 0%. The fair value will be charged to operations over the vesting period commencing on July 1, 2009. During the year ended December 31, 2009, $600,000 was charged to operations related to these options.
 
A summary of stock option activity is as follows:
 
   
Number
of
shares
   
Weighted
average
exercise
price
   
Weighted
average
fair
value
 
Balance at December 31, 2008
                 
Granted June 17, 2009
    1,072,500     $ 8.50     $ 4.18  
Granted July 16, 2009
    45,000     $ 8.00     $ 4.21  
Exercised/Forfeited
        $     $  
Balance at December 31, 2009
    1,117,500     $ 8.50     $ 4.18  
   
The following table summarizes information about fixed-price stock options at December 31, 2009:
 
   
Outstanding
 
Exercise
Prices
 
Weighted
Average
Number
Outstanding
 
Weighted
Average
Contractual
Life
  
Weighted
Average
Exercise
Price
 
$8-8.50
 
1,117,500
 
10 years
  
$
8.48
 
 
None of the outstanding options are exercisable at December 31, 2009.
 
As of December 31, 2009, the aggregate intrinsic value of all stock options outstanding and expected to vest was $0.00 and the aggregate intrinsic value of currently exercisable stock options was approximately $0.00.  The Intrinsic value of each option share is the difference between the fair market value of the common stock of $8.00 and the exercise price of such option share to the extent it is “in-the-money”.  Aggregate Intrinsic value represents the value that would have been received by the holders of in-the-money options had they exercised their options on the last trading day of the year and sold the underlying shares at the closing stock price on such day.  The intrinsic value calculation is based on the price at which the Company has been selling common shares during 2009.  There were no in-the-money options outstanding and exercisable as of December 31, 2009.
 
The total intrinsic value of options exercised during the years ended December 31, 2009 and 2008, was $0.00 and $0.00, respectively.  Intrinsic value of exercised shares is the total value of such shares on the date of exercise less the cash received from the option holder to exercise the options.  The total cash proceeds received from the exercise of stock options was $0.00 and $0.00 for the years ended December 31, 2009 and 2008, respectively.
 
The total fair value of options granted during the years ended December 31, 2009 and 2008 was $4,818,000 and $0.00, respectively.  The total fair value of option shares vested during the years ended December 31, 2009 and 2008 was $0.00 and $0.00.

 
– 44 –

 

Note 6   Licenses for Intellectual Property
 
During 2007, a minority member of PA LLC contributed licensed intellectual property to PA LLC. In exchange for the licensed intellectual property, the member accepted an ownership interest of 1,000,000 Class A Units (see Note 5), $1,550,000 in cash, $500,000 in cash upon the initial commercial sale of licensed products, a future stream of royalty payments of 3.5% (subject to certain minimums) of net sales derived from the licensed products and 7% of certain other sales, collectively fair valued at $2,334,629 on the transaction date. The Company is unable to determine at this time if it will be able to commercially utilize the intellectual property and has recorded research and development expense during the year ended December 31, 2007,for the entire fair value of $2,334,629. As a result of this transaction, the Company recorded a long-term liability and realized research and development expense aggregating $758,917 related to the present value of the estimated minimum future payments, which is included in the fair value above.
 
Since inception, we have been subject to tax by both federal and state taxing authorities. Until the respective statutes of limitations expire, we are subject to income tax audits in the jurisdictions in which we operate. We are no longer subject to U.S. federal tax examinations for fiscal years prior to 2005, and we are not subject to audits prior to the 2005 fiscal year for the state jurisdiction. The Company has received an initial payment of $2,800,000 during December 2009 and recorded the payment as deferred revenue. The balance was received during January 2010.
 
Note 7   Retirement Plan
 
Employees of PA LLC can take advantage of the 401k retirement plan where if they contribute a percentage of their gross pay toward a 401k plan, PA LLC will match the contribution. The contribution is matched up to 4%. Matching contributions were $220,263 and $97,228 during 2009 and 2008.
 
Note 8   Income Taxes
 
The Company accounts for income taxes under SFAS 109, which requires use of the liability method. SFAS 109 provides that deferred tax assets and liabilities are recorded based on the differences between the tax bases of assets and liabilities and their carrying amounts for financial reporting purposes, referred to as temporary differences. Deferred tax assets and liabilities at the end of each period are determined using the currently enacted tax rates applied to taxable income in the periods in which the deferred tax assets and liabilities are expected to be settled or realized.
 
The provision for income taxes differs from the amount computed by applying the statutory federal income tax rate to income before provision for income taxes for the years ended December 31, 2009 and 2008. The sources and tax effects of the differences are as follows:

 
– 45 –

 
 
Income tax provision at the federal statutory rate
    34 %
Effect of operating losses
    (34 )%
      0 %
 
As of December 31, 2009, the Company has a net operating loss carry forward of approximately $32,000,000. This loss will be available to offset future taxable income. If not used, this carry forward will expire through 2029. The deferred tax asset of approximately $11,000,000 relating to the operating loss carry forward has been fully reserved at December 31, 2009. The increase in the valuation allowance related to the deferred tax asset was approximately $6,000,000 during 2009. The principal difference between the accumulated deficit for income tax purposes and the accumulated deficit for financial reporting purposes results from the losses of PA LLC whose tax returns are not consolidated with those of Petro Algae, Inc.
 
Since inception, we have been subject to tax by both federal and state taxing authorities. Until the respective statutes of limitations expire, we are subject to income tax audits in the jurisdictions in which we operate. We are no longer subject to U.S. federal tax examinations for fiscal years prior to 2005, and we are not subject to audits prior to the 2005 fiscal year for the state jurisdiction.
 
Since inception, we have been subject to tax by both federal and state taxing authorities. Until the respective statutes of limitations expire, we are subject to income tax audits in the jurisdictions in which we operate. We are no longer subject to U.S. federal tax examinations for fiscal years prior to 2005, and we are not subject to audits prior to the 2005 fiscal year for the state jurisdiction.
 
Note 9   Related Party Transactions
 
During 2008 and the period from inception to December 31, 2009, the Company paid XL TechGroup, Inc. an aggregate of $1,699,047 and $3,023,739 as reimbursement for general and administrative expenses and $467,607 and $1,130,975 as reimbursement for research and development expenses.
 
The Company currently sub leases office space from XL TechGroup, Inc. on a month to month basis at a rate of $41,321 per month.
 
Note 10   Subsequent Events
 
From February 6, 2010 to March 1, 2010, the Company sold 331,250 units consisting of one share of common stock and a warrant to purchase a share of common stock at $15.00 for a period of 5 years for $8.00 per unit ($5.43 per common share and $2.57 per warrant) or $2,650,000 as follows:
 
312,500 units to affiliates
  18,750 units to third parties
 
The 312,500 units sold to the affiliate contained share price and warrant exercise price guarantees. The purchase price of the common stock and the exercise price of the warrants will be adjusted in the event that the Company issues common stock or warrants at a price below $8.00 for common shares or a $15.00 exercise price for warrants for a period of six months from the purchase date. Because of these potential adjustments, the shares issued and the warrants will be accounted for as derivative instrument liabilities in accordance with ASC guidance. The cash proceeds received of $2,500,000 will be allocated between the common stock and the warrants and the fair values of the common stock and warrants of $1,696,875 ($5.43 per share) and $803,125 ($2.57 per warrant), respectively, will be recorded as derivative instrument liabilities. For the warrants,, the Company estimated the fair value using the Black-Scholes valuation model, based on the estimated fair value of the common stock on the valuation date, an expected dividend yield of 0%, a risk-free interest rate based on constant maturity rates published by the U.S. Federal Reserve applicable to the remaining term of the instruments, an expected life equal to the remaining term of the instruments and an implicit volatility of 82%. Because of the limited historical trading period of the Company’s common stock, the limited number of shares held by non-affiliates and the very small trading volume of its common stock, the fair value of the common stock was estimated at $5.43 per share based on the conversion price of the $10,000,000 note described in Note 3 and the implicit volatility of 82% was determined based on the aggregate cash proceeds received. The Company is required to re-measure the fair value of these derivative instrument liabilities at each reporting period. At the expiration of the six month price guarantee period, it is expected that the common stock and warrants will no longer be required to be accounted for as derivative instruments and will be reclassified to equity.
 
During February 2010, 106,126 common shares which had previously been issued for services were returned the Company and retired.

 
– 46 –

 

ITEM 9.
CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
 
None.
 
 
– 47 –

 

ITEM 9A(T). 
CONTROLS AND PROCEDURES
 
Disclosure Controls and Procedures
 
Under the supervision and with the participation of our management, including our principal executive officer and principal financial officer, we conducted an evaluation of our disclosure controls and procedures, as such term is defined under Rule 13a-15(e) and Rule 15d-15(e) promulgated under the Securities Exchange Act of 1934, as amended (Exchange Act). Based on this evaluation, our principal executive officer and principal financial officer concluded that our disclosure controls and procedures were effective as of the end of the period covered by this report to ensure that information required to be disclosed by us in the reports we file or submit under the Exchange Act is recorded, processed, summarized, and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms and that our disclosure and controls are designed to ensure that information required to be disclosed by us in the reports that we file or submit under the Exchange Act is accumulated and communicated to our management, including our principal executive officer and principal financial officer, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure.
 
Internal Control over Financial Reporting
 
Management’s Annual Report on Internal Control Over Financial Reporting
 
Management of the Company is responsible for establishing and maintaining adequate internal control over financial reporting. The Company’s internal control over financial reporting is a process designed under the supervision of the Company’s principal executive officer and principal financial officer to provide reasonable assurance regarding the (i) effectiveness and efficiency of operations, (ii) reliability of financial reporting and the preparation of the Company’s financial statements for external reporting purposes in accordance with U.S. generally accepted accounting principles, and (iii) compliance with applicable laws and regulations.
 
As of the end of the Company’s 2009 fiscal year, management conducted an assessment of the effectiveness of the Company’s internal control over financial reporting based on the framework established in “Internal Control over Financial Reporting — Guidance for Smaller Public Companies” issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Based on this assessment, management has determined that the Company’s internal control over financial reporting as of December 31, 2009 was effective, although management did identify certain significant deficiencies.
 
The SEC has defined “significant deficiency” as a deficiency, or a combination of deficiencies, in internal control over financial reporting that is less severe than a material weakness, yet important enough to merit attention by those responsible for oversight of the registrant’s financial reporting. In this regard, we continue to have a small number of accounting and financial personnel with fairly limited redundancies which redundancies could be considered necessary to adequately support our financial reporting requirements. This deficiency is due to our small size and limited operating history. During fiscal 2010, as we continue to implement our business plan, we expect to increase our accounting resources to augment our financial reporting requirements.
 
We understand that remediation of deficiencies in internal controls is a continuing work in progress due to the issuance of new standards and promulgations. However, remediation of any known deficiency is among our highest priorities. Our management will periodically assess the progress and sufficiency of our ongoing initiatives and make adjustments as and when necessary. As of the date of this report, our management believes that the implementation of our business plan and the concomitant increase in our accounting and financial resources will remediate any deficiency in internal control over financial reporting.
 
Notwithstanding the aforementioned deficiency, our management performed additional analyses, reconciliations and other procedures and has concluded that the Company’s consolidated financial statements for the periods covered by and included in this annual report are fairly stated in all material respects in accordance with generally accepted accounting principles in the U.S. for each of the periods presented herein.

 
– 48 –

 

This annual report does not include an attestation report of the Company’s registered public accounting firm regarding internal control over financial reporting. Management’s report was not subject to attestation by the Company’s registered public accounting firm pursuant to temporary rules of the Securities and Exchange Commission that permit the Company to provide only management’s report in this annual report.
 
Changes in Internal Controls
 
During our most recent fiscal quarter, there has not been any change in our internal control over financial reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
 
Inherent Limitations Over Internal Controls
 
The Company’s internal control over financial reporting is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. The Company’s internal control over financial reporting includes those policies and procedures that:
 
 
(i)
pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the Company’s assets;
 
 
(ii)
provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that the Company’s receipts and expenditures are being made only in accordance with authorizations of the Company’s management and directors; and
 
 
(iii)
provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the Company’s assets that could have a material effect on the financial statements.
 
Management, including the Company’s principal executive officer and principal financial officer, does not expect that the Company’s internal controls will prevent or detect all errors and all fraud. A control system, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of internal controls can provide absolute assurance that all control issues and instances of fraud, if any, have been detected. Also, any evaluation of the effectiveness of controls in future periods is subject to the risk that those internal controls may become inadequate because of changes in business conditions, or that the degree of compliance with the policies or procedures may deteriorate.

 
– 49 –

 
 
ITEM 9B.
OTHER INFORMATION
 
None.

 
– 50 –

 

PART III
 
ITEM 10.
DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
 
Directors and Executive Officers
 
The following identifies each of the directors and executive officers of PetroAlgae Inc.
 
Name
 
Age
 
Positions
John S. Scott
 
59
 
Director, Chairman of the Board
         
Isaac D. Szpilzinger
 
62
 
Director
         
Sayan Navaratnam
 
35
 
Director
         
David Szostak
 
55
 
President, Secretary and Treasurer
 
Set forth below is biographical information with respect to each of the aforementioned individuals.
 
John S. Scott, Ph.D. has been the Chairman of the Board of Directors of the Company since December 16, 2008. Dr. Scott founded XL TechGroup, Inc. in 2002 and has been a Director of XL TechGroup, Inc. and its Chief Executive Officer since that date. Dr. Scott is an entrepreneur and inventor who has founded and successfully grown eleven technology companies within the past 25 years. Dr. Scott has authored business theories surrounding the development of successful technology enterprises, and lectures to business schools throughout the United States. Previously, he was a professor at the universities of Maryland and Arizona, and a visiting professor at the University of North Carolina. Dr. Scott has also been a consultant to the United States and various European governments, and was a national research council fellow at NASA. He earned a B.Sc in physics and astrophysics at Michigan State University and a Ph.D in the astrophysics/physics dual program from the University of Arizona’s Steward Observatory.
 
Isaac D. Szpilzinger has been a Director of the Company since December 16, 2008. He is an attorney in solo private practice licensed in the state of New York. From 1987 until 2006, Mr. Szpilzinger practiced with the law firm of Herzfeld & Rubin, P.C. where he was named a partner in 1994. He began his legal career in 1985 with a clerkship in the New York State Supreme Court, Appellate Division, Second Judicial Department. Mr. Szpilzinger holds a B.S. in Chemistry, cum laude, from Brooklyn College, and an M.A. in Chemistry and an Advanced Certificate in Educational Administration and Supervision from Brooklyn College. He also holds a Juris Doctor degree, cum laude, from New York Law School.
 
Sayan Navaratnam has been a Director of the Company since December 16, 2008. Since March 1, 2009, Mr. Navaratnam has been a Senior Managing Director of Laurus Capital Management, LLC and a Senior Managing Director of Valens Capital Management, LLC, entities affiliated with our principal shareholder. Since 2004, he has been the Chairman of Creative Vistas, Inc. (CVAS). From 2000 to 2003, Mr. Navaratnam was the Chief Operating Officer of ASPRO Technologies Ltd. From 1997 to 2000, he was the Chief Executive Officer of Satellite Communications Inc., and its research arm Satellite Advanced Technologies. Mr. Navaratnam currently serves on the board of a number of privately-held and publically held companies including AC Technical Systems, Iview Digital Video Solutions, Cygnal Technologies, White Radio, and Thinkpath. Mr. Navaratnam graduated from the University of Toronto with an Honours Double Specialist degree in economics and political science.

 
– 51 –

 

David Szostak has been President, Secretary and Treasurer of the Company since December 16, 2008 and the Chief Financial Officer of PA LLC since its inception in 2006. A certified public accountant, he is currently the Chief Financial Officer and a Director of XL TechGroup, Inc. Mr. Szostak began his career in Chicago, Illinois working as an auditor (CPA) for a large size accountancy firm (Laventhol and Howarth) and later other smaller accounting firms. In 1987, he was Corporate Controller at Extel, Inc., a global manufacturer of electronic communication equipment for industry and governments. When Extel acquired Hetra Computer, Inc., a manufacturer of government specialty computers, in 1990, Mr. Szostak relocated to Florida and accepted the position of Vice President and CFO of Hetra. In 1993, when XL Vision, the predecessor company to XL TechGroup, acquired Hetra, Mr. Szostak continued in the same position with XL Vision. He earned his Bachelor of Science in finance at Southern Illinois University, with graduate studies at DePaul University in Chicago.
 
The following identifies the directors and significant employees of PA LLC.
 
Name
 
Age
 
Positions
John S. Scott
 
59
 
Director, Chairman of the Board
         
Isaac D. Szpilzinger
 
62
 
Director
         
Sayan Navaratnam
 
35
 
Director
         
Ottmar Dippold
 
67
 
Chief Executive Officer
         
David Szostak
 
55
 
Chief Financial Officer
         
Jim McCreary
 
51
 
Chief Operating Officer
 
Ottmar Dippold became the CEO of PA LLC in March 2008. Mr. Dippold joined Space Systems Laboratory in 1967 where he served as team leader for the design of next generation optical systems for the US Air Force and NASA. He was the founder, Chairman, CEO and President of Opto-Mecanik, Inc., a designer and manufacturer of infrared optical and laser-based systems and served in this capacity for 27 years. Mr. Dippold also served as Chairman of Applied Photonics, a provider of laser-based solutions to the semiconductor and flat panel display industries. Mr. Dippold received a degree in optical engineering from the Deroy Optical Institute, Munich, Germany.
 
Jim McCreary is currently PA LLC’s Chief Operating Officer. He joined in 2006. Before joining PetroAlgae, he was the founding CEO, CFO, or CTO of over a dozen different new venture companies, most recently in software (ValueLogix), mobile communications (ThisInstant) and medical devices (VirtualScopics, RTek Medical Systems). Mr. McCreary has a Bachelor of Arts with Honors in Economics from Yale and an MBA with Distinction from the Harvard Business School.
 
Board of Directors and Officers
 
Each director is elected until the next annual meeting of the registrant and until his or her successor is duly elected and qualified. Officers are elected by, and serve at the discretion of, the board of directors. The board of directors may also appoint additional directors up to the maximum number permitted under our by-laws. A director so chosen or appointed will hold office until the next annual meeting of stockholders.
 
Each executive officer serves at the discretion of the board of directors and holds office until his or her successor is elected or until his or her earlier resignation or removal in accordance with our certificate of incorporation and by-laws.
 
Committees of the Board of Directors
 
We do not have standing audit, nominating or compensation committees, or committees performing similar functions. Our board of directors believes that it is not necessary to have standing audit, nominating or compensation committees at this time because the functions of such committees are adequately performed by our board of directors.

 
– 52 –

 
 
Code of Business Conduct and Ethics
 
The Company has adopted a Code of Business Conduct and Ethics for all directors, officers and employees. The Code of Business Conduct and Ethics is available under the investor section of the Company’s website at www.petroalgae.com. A copy of the Code of Business Conduct and Ethics may also be obtained at no charge by written request to the attention of the Investor Relations Department at PetroAlgae Inc., 1901 S. Harbor City Blvd., Suite 300, Melbourne, FL 32901, telephone: 321-409-7272, email: investorrelations@petroalgae.com.

 
– 53 –

 
 
ITEM 11.
EXECUTIVE COMPENSATION
 
The following tables set forth information concerning all cash compensation awarded to, earned by or paid to all individuals serving as PA LLC’s principal executive officers during the last three completed fiscal years, and all non-cash compensation awarded to those same individuals as of December 31, 2009.
 
Summary Compensation Table
 
Name and Principal Position
 
Year
 
Salary
   
Bonus
   
Company
Stock
Awards
   
Total
Compensation
 
                             
Ottmar Dippold,
 
2007
 
$210,000
   
   
   
$210,000
 
Chief Executive Officer
 
2008
 
$233,077
   
$68,900
   
   
$301,977
 
   
2009
 
$258,615
   
   
   
$258,615
 
                             
Jim McCreary,
 
2007
 
$200,000
   
   
   
$200,000
 
Chief Operating Officer
 
2008
 
$200,000
   
$53,000
   
   
$253,000