UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Form 10-K

þ		ANNUAL REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

o		TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

Commission file number 333-145939

CleanTech Biofuels, Inc.

(Exact Name of Registrant as Specified in Its charter)

Delaware		33-0754902
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)
7386 Pershing Ave., University City, Missouri		63130
(Address of principal executive offices)		(Zip Code)

(Registrant’s telephone number): (314) 802-8670

Securities registered under Section 12(b) of the Exchange Act: None

Securities registered under Section 12(g) of the Exchange Act: None

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

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

Indicate by check mark whether 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 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 þ No o

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (232.405) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes o No o

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

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

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

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

The aggregate market value of the voting and non-voting common equity held by non-affiliates as of June 30, 2010 (the last business day of our most recently completed second quarter) — $1,754,914

As of March 22, 2011, the number of shares outstanding of the Company’s common stock was 69,077,151.

DOCUMENTS INCORPORATED BY REFERENCE

 

 

CLEANTECH BIOFUELS, INC.
TABLE OF CONTENTS

		PAGE
PART I
ITEM 1 Business			3
ITEM 1A Risk Factors			11
ITEM 1B Unresolved Staff Comments			18
ITEM 2 Properties			18
ITEM 3 Legal Proceedings			18
ITEM 4 (Removed and Reserved)			18
PART II
ITEM 5 Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities			19
ITEM 6 Selected Financial Data			20
ITEM 7 Management’s Discussion and Analysis of Financial Condition and Results of Operations			20
ITEM 7A Quantitative and Qualitative Disclosures About Market Risk			29
ITEM 8 Financial Statements and Supplemental Data			30
ITEM 9 Changes in and Disagreements with Accountants on Accounting and Financial Disclosure			52
ITEM 9A Controls and Procedures			52
ITEM 9B Other Information			53
PART III
ITEM 10 Directors, Executive Officers and Corporate Governance			53
ITEM 11 Executive Compensation			56
ITEM 12 Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters			60
ITEM 13 Certain Relationships and Related Transactions and Director Independence			61
ITEM 14 Principal Accountant Fees and Services			62
PART IV.
ITEM 15 Exhibits and Financial Statement Schedules			62
Signatures			65
Index to Exhibits			66
Exhibit 21.1
Exhibit 31.1
Exhibit 31.2
Exhibit 32.1
Exhibit 32.2

Statement Regarding Forward-Looking Information

From time to time, we make written or oral statements that are “forward-looking,” including statements contained in this report and other filings with the Securities and Exchange Commission (“SEC”) and in our reports to stockholders. The Private Securities Litigation Reform Act of 1995 and Section 21E of the Securities Exchange Act of 1934, as amended, provide a safe harbor for such forward-looking statements. All statements, other than statements of historical facts, included herein regarding our strategy, future operations, financial position, future revenues, projected costs, prospects, plans, objectives and other future events and circumstances are forward-looking statements. In some cases, you can identify forward-looking statements by terminology such as “anticipates,” “believes,” “estimates,” “expects,” “intends,” “may,” “plans,” “projects,” “would,” “should” and similar expressions or negative expressions of these terms. Such statements are only predictions and, accordingly, are subject to substantial risks, uncertainties and assumptions.

Actual results or events could differ materially from the plans, intentions and expectations disclosed in the forward-looking statements we make. We caution you that any forward-looking statement reflects only our belief at the time the statement is made. Although we believe that the expectations reflected in our forward-looking statements are reasonable, we cannot guarantee our future results, levels of activity, performance or achievements. Refer to our Risk Factors section of this report for a full description of factors we believe could cause actual results or events to differ materially from the forward-looking statements that we make. These factors include:

	•		our ability to raise additional capital on favorable terms,
	•		our ability to continue operating and to implement our business plan,
	•		the commercial viability of our technologies,
	•		our ability to maintain and enforce our exclusive rights to our technologies,
	•		the demand for and production costs of various energy products made from our biomass,
	•		competition from other alternative energy technologies, and
	•		other risks and uncertainties detailed from time to time in our filings with the SEC.

Although we believe the expectations reflected in our forward-looking statements are based upon reasonable assumptions, it is not possible to foresee or identify all factors that could have a material and negative impact on our future performance. The forward-looking statements in this report are made on the basis of management’s assumptions and analyses, as of the time the statements are made, in light of their experience and perception of historical conditions, expected future developments and other factors believed to be appropriate under the circumstances.

PART I

ITEM 1.		Business

The following discussion of our Company Overview and Plan of Operation should be read in conjunction with the financial statements and related notes to the financial statements included elsewhere in this report. This discussion contains forward-looking statements that relate to future events or our future financial performance. These statements involve known and unknown risks, uncertainties and other factors that may cause our actual results, levels of activity or performance to be materially different from any future results, levels of activity or performance. These risks and other factors include, among others, those listed under “Statement Regarding Forward-Looking Information.”

Company Overview

We are a development stage company focused on being a provider of: (i) cellulosic biomass derived from municipal solid waste, also known as MSW, as a feedstock for producing energy and other chemical products and (ii) recyclables (metals, plastics, glass) from the MSW.

We were originally incorporated in 1996 as Long Road Entertainment, Inc., and were formed to operate as a holding company for businesses in the theater, motion picture and entertainment industries. We ceased conducting that business in 2005 and were dormant until the fall of 2006, at which time our founder and then controlling stockholder decided to pursue the sale of the company. In anticipation of that sale, we changed our name to Alternative Ethanol Technologies, Inc.

On March 27, 2007, we entered into an Agreement and Plan of Merger and Reorganization in which we agreed to acquire SRS Energy, Inc., a Delaware corporation, that is the holder of our technology licenses. Pursuant to the merger agreement, SRS Acquisition Sub, our wholly-owned subsidiary, merged into SRS Energy with SRS Energy as the surviving corporation. We consummated the merger on May 31, 2007 resulting in SRS Energy becoming our wholly-owned subsidiary. Effective August 2, 2007, we changed our name to CleanTech Biofuels, Inc.

SRS Energy was originally formed as a wholly-owned subsidiary of Supercritical Recovery Systems, Inc., a Delaware corporation, in July 2004. At that time, Supercritical Recovery Systems, Inc. was a licensee of various technologies for the processing of waste materials into usable products. Prior to our acquisition of SRS Energy, Supercritical Recovery Systems, Inc. distributed approximately 80% of its ownership of SRS Energy to the stockholders of Supercritical Recovery Systems, Inc. Since our acquisition of SRS Energy, Supercritical Recovery Systems, Inc. has ceased its business activities with respect to licensing other technologies.

In September 2008, we acquired the exclusive rights, in the United States and Canada, to use the Biomass Recovery System developed by Anthony Noll. We refer to this technology as our Biomass Recovery Process. Our rights to use the Biomass Recovery Process technology permit us to use the biomass we derive from MSW to produce all energy products. In addition, in October 2008, we acquired the patent for the pressurized steam classification (“PSC”) technology from World Waste Technologies (“WWT”), who previously had purchased the patent from the University of Alabama Huntsville. As a result we became the licensor of the PSC technology to Bio-Products International, Inc. (“Bio-Products”) under its Master License Agreement. Prior to then, Bio-Products was the sublicensor of the PSC technology to us.

Since early 2008, we had been in litigation against Bio-Products regarding our use of the PSC technology as a sublicensee. In March 2009, we entered into a Settlement Agreement with Bio-Products settling all claims. Pursuant to the Settlement Agreement, in addition to a customary mutual release, Bio-Products entered into a covenant not to sue whereby Bio-Products and its related parties agreed to permit us to use the Biomass Recovery Process technology worldwide, for any product that we desire and with no royalty due to Bio-Products. We also terminated the License Agreement pursuant to which we were the sublicensee of Bio-Products and have no further obligations thereunder. We continue to be the licensor to Bio-Products under the Master License Agreement and we continue to own the patent for the PSC technology. As a result of the Settlement Agreement, we are now capable of using the Biomass Recovery Process technology to produce any energy product that we desire and are no longer limited to production of fuel grade ethanol in the United States.

We have no operating history as a producer of biomass feedstocks or any energy products and have not constructed any operating plants to date. We have not earned any revenues to date and our current capital and other existing resources are not sufficient to fund the implementation of our business plan or our required working capital. We will require substantial additional capital to implement our business plan and we may be unable to immediately obtain the capital required to continue operating.

Plan of Operation

Our focus is to secure sufficient capital to fund our current working capital requirements and the construction of a commercial plant as described further in this section. We currently do not have sufficient capital to continue operations. All of our developments/projects require a significant amount of capital that we currently do not have. While we continue to aggressively pursue capital, we have not had recent success securing meaningful amounts of financing. As a result, we can provide no assurance that we will secure any capital in the immediate time frame required and the failure to do so will likely result in an inability to continue operations.

Our company was initially conceived as a fully-integrated producer of cellulosic ethanol from MSW. Based on our investigation and acquisition of new technologies and research and development of our existing technologies in 2008, we re-focused our business to the commercialization of our Biomass Recovery Process technology for cleaning and separating MSW into its component parts and initiated a plan to consolidate the ownership and/or rights to use intellectual property around this technology. The technology is currently in use by another operator in a commercial setting in Australia. As a result, we believe this technology is ready for commercial implementation in the United States and elsewhere. In furtherance of our new focus, we are currently in the process of raising capital to design and build a commercial biomass recovery plant to provide biomass feedstock for customer evaluation and trial purchases. Initially, the biomass feedstock output will be sold or provided to electric utilities, power and steam producers, and biofuel research firms for evaluation. In addition to this capital raise for plant development, the Company is also working towards licensing and/or developing potential commercial projects as they present themselves. All of our developments plan to focus on cleaning and separating MSW into its component parts in order to obtain: (i) a homogenous feedstock of cellulosic biomass for producing energy and other chemical products and (ii) recyclable products (metals, plastics).

As a result of our focus on converting MSW into a biomass feedstock for energy or chemical products, we determined that we no longer would use the Brelsford and HFTA technologies. In the fourth quarter of 2008, Brelsford Engineering, Inc. terminated our license to the Brelsford technology for non-payment of certain fees. We decided not to use the technology going forward in our operations and wrote off the remaining asset as of December 31, 2008. The impairment loss of $97,500 is included in research and development expense on the statement of operations for the year ended December 31, 2008. Additionally, we terminated our agreement with HFTA, Inc. during the fourth quarter of 2009 as we determined to not use the HFTA technology going forward in our operations. We wrote off the related asset of approximately $693,000 as an impairment loss and the loss is included in research and development expense on the statement of operations for the year ended December 31, 2009.

Biomass Feedstock Production

The Company plans to design and build a commercial biomass recovery plant to provide biomass feedstock for customer evaluation and trial purchases. Initially, the biomass feedstock output will be sold or provided to electric utilities, power and steam producers, and biofuel and chemical research firms for evaluation. In addition to research and development, the Company is also working towards licensing and/or developing potential commercial projects.

We completed construction of a small test vessel in Kentucky and, beginning in April 2009, this vessel has processed approximately 12 tons of MSW into approximately 4-5 tons of biomass. We have provided the biomass produced during this testing phase to a number of fuel producers who are evaluating whether they can use our biomass as a feedstock for their technologies. In July 2010, we entered into an agreement with Fiberight to install this test vessel at Fiberight’s cellulosic ethanol pilot plant in Lawrenceville, Virginia. We anticipate our vessel to be installed and operational during the second quarter 2011. Once upgraded and installed, the vessel is expected to produce cellulosic biomass feedstock for Fiberight’s Targeted Fuel Extraction process. We expect such production should further validate our licensed Biomass Recovery Process, which we believe could then be used for on-site cellulosic biomass feedstock production for alternative energy producers. Additionally, we will have access to biomass produced at the Lawrenceville plant for delivery to other companies interested in testing it as feedstock in their conversion technologies.

We are also seeking to develop a plant in a major metropolitan area. We are working to develop one or more locations where waste collected would be processed using our technology and the biomass produced used to create heat and/or power.

We were considering the possibility of implementing our technology in Maryville, Missouri. In late March 2011, the City of Maryville sent out Requests for Proposal for their transfer station site. At this time, the Company is not in a position to participate in this process. The biomass produced would have potentially been supplied to Northwest Missouri State University for research purposes in advanced biofuel technologies and to supply steam for the University. The University has used biomass to produce steam for more than twenty years.

In addition to the developments we are currently contemplating, other development opportunities are presented to us and we evaluate those potential developments. Upon operating a plant and after refining our know-how with respect to implementation of the technology, we intend to seek to partner with waste haulers, landfill owners and municipalities to implement the technology across the United States and internationally.

The further development of commercial plants and/or implementation of the licensing of our technology described above will require significant additional capital, which we currently do not have. We cannot provide any assurance that we will be able to raise this additional capital. While we anticipate that financing for the commercial biomass recovery plant and these other potential projects could also be provided in part via tax exempt bond financing or through the use of loan guarantees from local, state and federal authorities, we have not secured any such financing and there can be no assurance that we will be able to secure any such financing.

Diesel Fuel Production

We previously anticipated completing an agreement with Green Power, Inc. (“Green Power”) to provide biomass for testing at Green Power’s facility and if that proves successful, to build a 200 ton per day MSW processing station to provide biomass for an existing 100 ton per day diesel fuel production plant. To date we have not been able to reach an agreement as to the nature and amount of biomass to be produced or other key terms of this relationship that are required for us to proceed. These issues and a number of other items will be required to be resolved before we are able to complete any agreement with Green Power. We have not completed an agreement to date and there can be no assurance that we will complete any agreement and proceed with this development.

Bio-Fuel and Bio-Chemical Joint Testing/Research

As soon as we are able to process MSW into biomass through our future biomass recovery plant, our test vessel at Fiberight’s facility in Virginia, and/or in future commercial vessels, we plan to enter into joint research agreements with companies looking to process biomass in their system(s) for various types of energy and chemical production. This testing and research will provide possible revenue streams, projects and additional opportunities for use of our biomass.

In August 2009, we entered into a joint research agreement with GeoSyn Fuels, L.L.C. (“GeoSyn”) whereby we agreed to provide GeoSyn with biomass feedstock derived from MSW from the City of Chicago for GeoSyn’s testing of their proprietary process for converting biomass into ethanol and other products.

In May 2010, we entered into a joint research agreement with Ze-Gen, Inc., a developer of technology for converting biomass into a variety of fuel products and other chemical products, whereby we agreed to provide biomass to Ze-Gen, Inc. for testing in their proprietary processes.

New Technologies; Commercializing Existing Technologies

Because of our unique ability to produce a clean, homogenous biomass feedstock, we are frequently presented with the opportunity to partner with or acquire new technologies. In addition to developing our current technologies, we will continue to add technologies to our suite of solutions that complement our core operations. We believe that our current technologies and aspects of those in development will enable us to eventually expand our business to use organic material from other waste streams such as municipal bio-solids from waste water facilities and animal waste for fuel production.

To commercialize our technology, we intend to:

	•		construct and operate a commercial plant that: (i) processes MSW into cellulosic biomass for conversion into energy or chemical products and (ii) separates recyclables (metals, plastics, glass) for single-stream recycling;
	•		identify and partner with landfill owners, waste haulers and municipalities to identify locations suitable for our technology; and
	•		pursue additional opportunities to implement our technology in commercial settings at transfer stations and landfills in the United States and elsewhere in the world.

Our ability to implement this strategy will depend on our ability to raise significant amounts of additional capital and to hire appropriate managers and staff. Our success will also depend on a variety of market forces and other developments beyond our control.

Industry Overview

There are two types of MSW Disposal:

	•		Municipal Solid Waste Landfills (“MSWLFs”) — includes municipal solid waste, commercial waste, industrial waste, construction and demolition debris, and bioreactors.
	•		Mass Burn/Incineration Plants

Municipal Solid Waste Landfills

MSWLFs primarily receive household waste and commercial waste. MSWLFs can also receive non-hazardous sludge, industrial solid waste, and construction and demolition debris. All MSWLFs must comply with various federal, state and local laws and regulations.

Disposing of waste in a landfill involves burying waste, and this remains a common practice in most countries. Historically, landfills were often established in disused quarries, mining voids or borrow pits. A properly-designed and well-managed landfill can be a hygienic and relatively inexpensive method of disposing of waste materials. Older, poorly-designed or poorly-managed landfills can create a number of adverse environmental impacts such as wind-blown litter, attraction of vermin, and generation of liquid leachate. Another common byproduct of landfills is gas (mostly composed of methane and carbon dioxide), which is produced as organic waste breaks down anaerobically. This gas can create odor problems, kill surface vegetation, and contributes to global warming.

Waste haulers or municipalities pay tipping fees, or gate rates, on a per ton basis to dispose of garbage at a landfill. Gate rates operate in a manner similar to the published prices for airline tickets or hotels, before discounts or contract prices (which could be higher or lower) are considered. The gate rate is the true daily market value of the tipping fee. The average tipping fee in the United States has risen consistently from $8.20 per ton in 1985 to $34.29 in 2004 and continues to increase.

Mass Burn/Incineration Plants

Mass Burn — Mass burn is combusting MSW generally without any pre-processing or separation. The resulting steam is employed for industrial uses or for generating electricity. Mass burn facilities are sized according to the daily amount of solid waste they expect to receive. Most mass burn plants can remove non-combustible steel and iron for recycling before combustion using magnetic separation processes. Other non-ferrous metals can be recovered from the leftover ash.

Waste-to-Energy (WTE) Plants — Current operating WTE plants burn MSW in a controlled environment to create steam or electricity. Through this process the volume of solid waste is reduced by about 90%.

Modular Incinerators — Modular incinerators are small mass burn plants, with a capacity of 15 to 100 tons per day. The boilers for modular incinerators are built in a factory and shipped to the WTE site, rather than being built on the WTE site itself. The advantage of a modular WTE incinerator is flexibility. If more capacity is needed, modular WTE units can be added. These facilities are used primarily by small communities and industrial sites. Costs limit the use of this technology because the return on investment in terms of energy produced over time is much lower than in mass burn plants.

Refuse-Derived Fuel (RDF) Plants — RDF plants process solid waste before it is burned. A typical plant will remove non-combustible items, such as glass, metals and other recyclable materials. The remaining solid waste is then shredded into smaller pieces for burning. RDF plants require significantly more sorting and handling than mass burn, but can recover recyclables and remove some potentially environmentally harmful materials prior to combustion. RDF can be burned in power boilers at factories or even at large housing complexes. Sometimes RDF materials are “densified” (compacted at high pressure) to make fuel pellets. The “pellet fuel” may also include various sludges, by-products of municipal or industrial sewage treatment plants.

MSW contains a diverse mix of waste materials, some benign and some very toxic. Effective environmental management of MSW plants aims to exclude toxics from the MSW-fuel and to control air pollution emissions from the WTE plants. Toxic materials include trace metals such as lead, cadmium and mercury, and trace organics, such as dioxins and furans. Such toxins pose an environmental problem if they are released into the air with plant emissions or if they are dispersed in the soil and allowed to migrate into ground water supplies and work their way into the food chain. The control of such toxics and air pollution are key features of environmental regulations governing MSW fueled electric generation.

U.S. EPA rules are among the most stringent environmental standards for WTE facilities in the world. These rules mandate that all facilities use the most modern air pollution control equipment available to ensure that WTE smokestack emissions are as clean as possible, and are safe for human health and the environment.

Burning any fuel, including MSW, can produce a number of pollutants, such as carbon monoxide, sulfur dioxide, and fine particles containing heavy metals. Other toxic organic compounds, such as dioxins, are also potential emissions from any combustive activity where certain chemical compounds are present, a situation that could take place in the WTE process. Air emission control devices in a WTE facility usually include:

	•		Dry Scrubbers — these “wash” the air emissions from the WTE process (called the gas stream) and remove any acidic gases by passing the gas stream through a liquid.
	•		Electrostatic Precipitators (ESP) — these use high voltage electricity to remove up to 98% of all particles remaining in the gas stream after passing through the scrubbers, including any heavy metal particles.
	•		Fabric Filters (baghouses) — these consist of a series of nearly two thousand fabric bags made of heat-resistant material which filter remaining particles from the gas stream. This includes any large concentrations of condensed toxic organic compounds (such as dioxins) and heavy metal compounds.

Incinerators and RDF processors are paid tipping fees for the garbage that they accept. Typically, these fees are more costly than the fees paid to landfill operators. Average tipping fees are lower at landfills than at combustion facilities, largely because of the high capital costs at combustion facilities.

Environmental Matters

We believe our company will be subject to international, federal, state and local laws and regulations with regard to air and water quality, hazardous and solid waste disposal and other environmental matters upon commercial operations. There is always a risk that the federal agencies may enforce certain rules and regulations differently than state and local environmental administrators. Federal, state and local rules are subject to change, and any such changes could result in greater regulatory burdens on plant operations. We could also be subject to environmental or nuisance claims from adjacent property owners or residents in the areas arising from possible foul smells or other air or water discharges from the plant. We do not know the potential cost of these requirements or potential claims. Environmental laws and regulations that may affect us in the future may include, but are not limited to:

	•		The Clean Air Act, as well as state laws and regulations impacting air emissions, including State Implementation Plans related to existing and new national ambient air quality standards for ozone and particulate matter. Owners and/or operators of air emission sources are responsible for obtaining permits and for annual compliance and reporting.
	•		The Clean Water Act which requires permits for facilities that discharge wastewaters into the environment.
	•		The Solid Waste Disposal Act, as amended by the Resource Conservation and Recovery Act, which requires certain solid wastes, including hazardous wastes, to be managed pursuant to a comprehensive regulatory regime.
	•		The National Environmental Policy Act, which requires federal agencies to consider potential environmental impacts in their decisions, including siting approvals.

Government Approvals

The Company is not subject to any government approvals or oversight for its current operations other than normal corporate governance and taxes. Once we begin developing commercial production facilities, however, we will be subject to multiple federal, state and local environmental laws and regulations, such as those described above and for employee health and safety. In addition, some of these laws and regulations will require our facilities to operate under permits that are subject to renewal or modification. A violation of these laws and regulations or permit conditions can result in substantial fines, natural resource damages, criminal sanctions, permit revocations and/or facility shutdowns.

Our Technology

We believe we can convert MSW into cellulosic material using our Biomass Recovery Process, which can then be used by a variety of third party technologies as a feedstock to process that cellulosic material into a variety of energy and chemical products.

Biomass Recovery Process

MSW contains valuable resources if they can be recovered economically. Waste haulers often bring unsorted waste by truck to MRFs for sorting and removal of selected materials prior to disposal in sanitary landfills. To date, however, the amounts of materials recovered are relatively small, typically on the order of 20 percent of the total volume of waste.

The PSC technology was developed at the University of Alabama, Huntsville and improved by Anthony Noll into the technology we refer to as the Biomass Recovery Process. The process separates curbside MSW into organic and inorganic materials using a patented and proprietary process that involves a unique combination of steam, pressure and agitation. The separation is accomplished by placing waste material in a rotating pressure vessel, or autoclave. In the autoclave, the material is heated to several hundred degrees, which sterilizes the waste material, while the pressure and agitation cause a pulping action. This combination is designed to result in a large volume reduction, yielding the following two sterilized resource streams for further manufacturing of new products:

	•		Cellulosic biomass, a decontaminated, homogeneous feedstock that we expect will represent approximately 50 to 60 percent of the incoming MSW and will be suitable for conversion to multiple energy or chemical products.
	•		Separated recyclables (steel cans and other ferrous materials, aluminum cans, plastics, and glass), which we expect will represent about 25 percent of the MSW input and are sorted and can be sold to recyclers.

The process also creates residual waste (fines, rocks, soil, textiles and non-recyclable fractions), which we expect will represent the remaining 15 to 25 percent of the MSW input. We will not be able to recover any value in this residual waste. We will be required to deliver this waste to landfills and incur the tipping fees expense.

The process is currently working in a commercial plant in Coffs Harbor, Australia. We believe that our process represents a significant improvement over other autoclave technologies currently in use because of:

	•		the relationship between agitation of the waste material, moisture, and the temperature and pressure of steam in the vessel uses less energy while obtaining a cleaner biomass resource;
	•		the method of introduction of steam into the autoclave vessel, the pressure range, along with the method of full depressurization, and treatment of the steam being vented from the process to prevent air pollution make our process more environmentally friendly than any other means to handle MSW;
	•		the method of mixing the heat and steam with the waste uniformly throughout the vessel create a homogenous feedstock for fuel production; and,
	•		the direct and critical correlation between the length and diameter of the vessel, internal flighting and the total tonnage of waste to be processed for proper mixing and product yield.

Principal Products or Services and their Markets

If we determine that our licensed technologies are commercially viable and we are able to raise a significant amount of additional capital, we may be in a position to begin to license and/or enter into long-term contracts with municipalities, solid waste haulers, and operators of landfills and materials recovery facilities to process a large portion of their waste stream into biomass and recyclable materials.

Energy/Chemicals

We expect the primary product we will sell will be biomass from our Biomass Recovery Process to be used for energy or chemical production. We believe our biomass can be used in multiple varieties of energy production systems. We expect the uses for our biomass to expand as new energy production technologies are developed.

MSW Processing Services

We believe that the opportunity to help communities, haulers and landfill managers reduce the amount of material transported and deposited in landfills is large and growing. The Resource Conservation and Recovery Act of 1991, referred to as RCRA, requires landfills to install expensive liners and other equipment to control leaching toxics. Due to the increased costs and expertise required to manage landfills under RCRA, many small, local landfills closed during the 1990’s. Larger regional landfills were built requiring increased transportation costs for the waste haulers. As a result, landfill space is increasingly scarce and disposal costs have been increasing.

Currently, landfill operators charge a tipping fee to deliver MSW to a landfill, waste-to-energy facility, recycling facility, transfer station or similar facility. Tipping fees vary widely based on geographic location and the number of available places to dispose of MSW in a given location. Because of the increasing cost pressures on waste haulers and based on current tipping fee pricing, we believe we will be able to negotiate a payment of part of their tipping fee from waste haulers who deliver MSW to us for processing that would range from as low as $15 per ton in some central parts of the country to over $80 per ton in the Northeast and some parts of the Southeast. The availability of tipping fees at favorable rates will be a key component of our business.

Recyclable Byproducts

We anticipate that our Biomass Recovery Process will generate other recyclable byproducts from the processing of MSW, such as aluminum, metals, tin, steel, glass and plastic (typically 20 to 25 percent of the total waste stream). The markets for these recovered products are volatile and subject to rapid and unpredictable market changes making it impossible at this time to provide estimated per ton cost to revenue information.

Sources and Availability of Raw Materials

The emergence of technologies to convert MSW to energy or chemicals is opening new opportunities. What was once perhaps the greatest sanitation and health challenge for communities may now become an economic and environmental asset. Instead of adding to landfills already nearing capacity limits, converting MSW to biomass can provide one of the building blocks to a more sustainable energy future.

Americans produce more than 250 million tons of MSW annually. About 30 percent of this waste is currently recovered and recycled. We estimate that approximately an additional 50 percent could potentially be recovered. As various waste processing technologies are refined, competition for this future resource will intensify. As a result, it will be important for us to attempt to lock up as much of it as possible through long-term feedstock supply agreements with operators of materials recovery facilities and landfills.

Intellectual Property Terms

Biomass North America Licensing, Inc.

On September 15, 2008, the Company consummated the acquisition of Biomass North America Licensing, Inc. (“Biomass”) pursuant to a merger between Biomass and a wholly-owned subsidiary of the Company (with Biomass as the surviving subsidiary of the Company) in accordance with an Agreement and Plan of Merger by and between the Company and Biomass. By virtue of the merger, the Company acquired a license agreement pursuant to which the Company holds a license in the United States and Canada to use patented technology owned by Biomass North America, LLC, the former parent of Biomass (the “Licensor”), to clean and separate MSW (the “Biomass Recovery Process”). In July 2010, the United States Patent and Trademark Office issued US patent number 7,745,208 for this process (the “BRP Patent”).

The license requires that the Company pay a royalty in the amount of $1.00 per ton of bone-dry biomass produced using the Biomass technology. The license agreement is for a term of 21 years or the life of any patent issued for the Biomass technology. The Company has an exclusive license in the United States and Canada to use the Biomass technology, except that a principal owner of the Licensor has the right of first offer to manage and operate with respect to any development commenced using the licensed technology within 100 miles of the City of Chicago, Illinois. The license agreement further provides that all parties will work in good faith to complete a commercial development in the City of Chicago using the Biomass technology.

PSC Patent

The Company owns U.S. Patent No. 6,306,248 (the “PSC Patent”), which is the underlying technology upon which the BRP Patent is based. The Company acquired the PSC Patent on October 22, 2008, pursuant to a Patent Purchase Agreement with WWT. The Patent is the basis for the pressurized steam classification technology that cleans and separates MSW into its component parts, which we refer to as the PSC technology. The Company is now a licensor to Bio-Products for this patent. Bio-Products is the exclusive licensee of the PSC technology (but not the Biomass Recovery Process) and has the right to sublicense the PSC technology to any party. Under the Master License Agreement, we are entitled to be paid 5% of any revenue derived by Bio-Products from the use of the technology and 40% of any sublicensing fees paid to Bio-Products for the use of the technology. The Master License Agreement is for a term of 20 years that commenced on August 18, 2003. On September 22, 2010, the Company sent a Notice of Breach to the licensee of our PSC Patent. We received a response from the licensee on November 5, 2010. In February 2011, we became aware that the licensee effected a transfer of the license in violation of the License Agreement. As a result, on March 21, 2011, we sent a notice of termination to the licensee and the transferee terminating the License Agreement.

Employees

The Company currently has two full-time employees, its Chief Executive Officer, Edward P. Hennessey, Jr. and its Chief Financial Officer, Thomas Jennewein.

Access to SEC Filings

Interested readers can access, free of charge, all of our filings with the SEC and any amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended, through the About Us/Investor Relations/SEC Filings section of our website at www.cleantechbiofuels.net as soon as reasonably practicable after we electronically file such materials with, or furnish them to, the SEC. We will also provide a copy of these documents, free of charge, to any stockholder upon written request addressed to: CleanTech Biofuels, Inc., 7386 Pershing Ave, University City, MO 63130.

ITEM 1A.		Risk Factors

You should carefully consider the following risk factors and other information contained in this annual report on Form 10-K when evaluating our business and financial condition. Additional risks not presently known to us and risks that we currently deem immaterial may also impair our business operations.

Risks Related to Our Business

We need to obtain significant additional capital to fund our current operations and complete the implementation of our business plan, and the failure to secure additional capital will prevent us from commercializing our technology and executing our plan of operation.

We do not currently have enough cash to fund our operations. If we are not able to obtain additional financing in the immediate future, we will be required to delay our development until such financing becomes available and may be required to cease operations. In addition, in order to fund the development of our business plan, we will be required to:

	•		obtain additional debt or equity financing,
	•		secure significant government grants, and/or
	•		enter into a strategic alliance with a larger energy or chemical company to provide funding.

The amount of funding needed to complete the development of our business plan will be very substantial and may be in excess of the amount of capital we are able to raise. In addition, we have not identified the sources for the additional financing that we will require, and we do not have binding commitments from any third parties to provide this financing. Our ability to obtain additional funding will be subject to a number of factors, including market conditions, acceptance of our business plan, the quality of our biomass and investor sentiment. These factors may make the timing, amount, terms and conditions of additional funding unattractive. For these reasons sufficient funding, whether on terms acceptable to us or not, may not be available. If we are unable to obtain sufficient financing on a timely basis, the development of our technology, facilities and/or products could be delayed and we could be forced to limit or terminate our operations altogether. Further, any additional funding that we obtain in the form of equity will reduce the percentage ownership held by our existing shareholders.

We have no operating experience and may not be able to implement our business plan.

As an early stage company, there is no material operating history upon which to evaluate our business and prospects. We do not expect to commence any significant operations until we test and refine information from a commercial plant for biomass production and/or develop or license an operating facility. As a result, we will sustain losses without corresponding revenues, which will result in the Company incurring a net operating loss that will increase continuously for the foreseeable future. We cannot provide any assurance that we will be profitable in any given period or at all.

In addition, we currently have only two full-time employees, our Chief Executive Officer and Chief Financial Officer, each of whom spend at least 40 hours a week on our business. Collectively, they have less experience in operating an alternative energy company compared to many of our competitors. Moreover, given our newness and the rapid changes in the industry, we face challenges in planning and forecasting accurately. Our lack of expertise and resources may have a negative impact on our ability to implement our strategic plans, which may result in our inability to commence meaningful operations, achieve profitable operations or otherwise succeed in other aspects of our business plan.

Our Biomass Recovery Process technology may have design and engineering issues that may increase the costs of using the technology.

The Biomass Recovery Process technology involves the use of a rotating pressure vessel, or autoclave, to combine heat, pressure and agitation to convert MSW into biomass. Although technologies that involve the separation and processing of MSW using large-scale autoclaves have not been widely adapted in commercial applications, a vessel using this process is currently operating in Australia. We have completed a small scale research and testing vessel that initially processed MSW for testing purposes.

Although we believe the autoclaves will operate properly on a commercial scale, we may encounter design and engineering problems when we try to implement this technology on a large-scale for biomass and energy production. Any design, engineering or other issue may cause delays, increase production and development costs and require us to shut down our operation.

We may not have sufficient legal protection of our technologies and other proprietary rights, which could result in the loss of some or all of our rights or the use of our intellectual properties by our competitors.

Our success depends substantially on our ability to use our owned and/or licensed technologies and to keep our licenses in full force, and for us and our technology licensor to maintain our patents, maintain trade secrecy and not infringe the proprietary rights of third parties. We cannot be sure that the patents of others will not have an adverse effect on our ability to conduct our business. Further, we cannot be sure that others will not independently develop similar or superior technologies, duplicate elements of our technologies or design around them. Even if we are able to obtain or license patent protection for our process or products, there is no guarantee that the coverage of these patents will be sufficiently broad to protect us from competitors or that we will be able to enforce our patents against potential infringers. Patent litigation is expensive, and we may not be able to afford the costs. Third parties could also assert that our process or products infringe patents or other proprietary rights held by them.

We also rely on trade secrets, proprietary know-how and technology that we will seek to protect, in part, by confidentiality agreements with our prospective joint venture partners, employees and consultants. We cannot be sure that these agreements will not be breached, that we will have adequate remedies for any breach, or that our trade secrets and proprietary know-how will not otherwise become known or be independently discovered by others.

We will be dependent on our ability to negotiate favorable feedstock supply and biomass off-take agreements.

In addition to proving and commercializing our technology, the viability of our business plan will depend on our ability to develop long-term supply relationships with municipalities, municipal waste haulers or operators of material recovery facilities, also known as MRFs, and landfills to provide us with the necessary waste streams on a long-term basis. We also will depend on these haulers, operators and facilities to take residual waste streams from our plants and to deliver or accept these streams for land filling. We currently have no such relationships or agreements. If we are unable to create these relationships and receive supply agreements on terms favorable to us we may not be able to implement our business plan and achieve profitability.

We may not be able to attract and retain management and other personnel we need to succeed.

We currently have only two full-time employees, our Chief Executive Officer and Chief Financial Officer. As a result, part of our success depends on our ability to recruit senior management and other key technology development, construction and operations employees. We cannot be certain that we will be able to attract, retain and motivate such employees. The inability to hire and retain one or more of these employees could cause delays or prevent us from implementing our business strategy. The majority of our new hires could be engineers, project managers and operations personnel. There is intense competition from other companies and research and academic institutions for qualified personnel in the areas of our activities. If we cannot attract and retain, on acceptable terms, the qualified personnel necessary for the development of our business, we may not be able to commence operations or grow at an acceptable pace.

We incur significant costs as a result of being a public company.

As an operating public company, we are incurring significant legal, accounting and other expenses and our corporate governance and financial reporting activities have become more time-consuming. The Sarbanes-Oxley Act of 2002, as well as rules subsequently implemented by the Securities and Exchange Commission, has required changes in corporate governance practices of public companies. For example, as a result of becoming an operating public company, we are required to have independent directors, create board committees and approve and adopt policies regarding internal controls and disclosure controls and procedures. In addition, we are incurring significant additional costs associated with our public company reporting requirements. These rules and regulations could make it more difficult and more expensive for us to obtain director and officer liability insurance and we may be required to accept reduced policy limits and coverage or incur substantially higher costs to obtain the same or similar coverage. As a result, it may be more difficult for us to attract and retain qualified persons to serve on our board of directors or as executive officers.

Our failure to adequately adhere to the established corporate governance practices or the failure or circumvention of our controls and procedures could seriously harm our business.

Compliance with the evolving corporate governance practices has taken a significant amount of management time and attention, particularly with regard to disclosure controls and procedures and internal control over financial reporting. Although we have reviewed our disclosure and internal controls and procedures in order to determine whether they are effective, our controls and procedures may not be able to prevent errors or frauds in the future. Faulty judgments, simple errors or mistakes, or the failure of our personnel to adhere to established controls and procedures may make it difficult for us to ensure that the objectives of the control system are met. A failure of our controls and procedures to detect other than inconsequential errors or fraud could seriously harm our business and results of operations.

Our senior management’s limited experience managing a publicly traded company diverts management’s attention from operations and could harm our business.

Our management team has limited experience managing a publicly traded company and complying with federal securities laws, including compliance with disclosure requirements on a timely basis. Our management is required to design and implement appropriate programs and policies in response to increased legal, regulatory compliance and reporting requirements, and any failure to do so could lead to the imposition of fines and penalties and harm our business.

Risks Related to our Industry

As a new small company, we will be at a competitive disadvantage to most of our competitors, which include larger, established companies that have substantially greater financial, technical, manufacturing, marketing, distribution and other resources than us.

The alternative energy and waste hauling/landfill industries in the United States are highly competitive and continually evolving as participants strive to distinguish themselves. Competition is likely to continue to increase with the emergence and commercialization of new alternative energy technologies. If we are not successful, we will not be able to compete within these industries. Moreover, the success of alternative energy generation technologies may cause larger, conventional energy companies with substantial financial resources to enter the alternative energy industry. These companies, due to their greater capital resources and substantial technical expertise, may be better positioned to develop and exploit new technologies. Our inability to respond effectively to our competition could result in our inability to commence meaningful operations, achieve profitable operations or otherwise succeed in other aspects of our business plan.

Our success is dependent on continued high energy prices.

Prices for energy can vary significantly over time and decreases in price levels could adversely affect our profitability and viability. Worldwide energy prices are subject to a myriad of factors almost all of which are completely beyond our ability to control. Frequently, unforeseen events can have a dramatic impact on the price paid for energy. Negative changes in energy prices could cause our business model to be unviable and our technology worthless.

Waste processing and energy production is subject to inherent operational accidents and disasters from which we may not be able to recover, especially if we have only one or a very small number of facilities.

Our anticipated operations would be subject to significant interruption if any of our potential facilities experience a major accident or are damaged by severe weather or other natural disasters. In particular, processing waste and producing energy products is subject to various inherent operational hazards, such as equipment failures, fires, explosions, abnormal pressures, blowouts, transportation accidents and natural disasters. Some of these operational hazards may cause personal injury or loss of life, severe damage to or destruction of property and equipment or environmental damage, and may result in suspension of operations and the imposition of civil or criminal penalties. Currently we do not have any insurance to cover those risks. We intend to seek insurance appropriate for our business before we commence significant operations. The insurance that we plan to obtain, if obtained, may not be adequate to cover fully the potential operational hazards described above.

Alternative technologies could make our business obsolete.

Even if our technology currently proves to be commercially feasible, there is extensive research and development being conducted in alternative energy sources. Technological developments in any of a large number of competing processes and technologies could make our technology obsolete and we have little ability to manage that risk.

Risks Related to Government Regulation and Subsidization

Enforcement of energy policy regulations could change.

Energy policy in the United States is evolving rapidly. Within the last decade, the United States Congress has passed separate major pieces of legislation addressing energy policy and related regulations. We anticipate that energy policy will continue to be a very important legislative priority on a national, state and local level. As energy policy continues to evolve, the existing rules and regulations that benefit our industry may change. It is difficult, if not impossible, to predict changes in energy policy that could occur on a federal, state or local level in the future. The elimination of or a change in any of the current rules and regulations could create a regulatory environment that prevents us from developing a commercially viable or profitable business.

Costs of compliance may increase with changing environmental and operational safety regulations.

As we pursue our business plan, we will become subject to various federal, state and local environmental laws and regulations, including those relating to the discharge of materials into the air, water and ground, the generation, storage, handling, use, transportation and disposal of hazardous materials, and the health and safety of our employees. In addition, some of these laws and regulations require our contemplated facilities to operate under permits that are subject to renewal or modification. These laws, regulations and permits can often require expensive pollution control equipment or operational changes to limit actual or potential impacts to the environment. A violation of these laws and regulations or permit conditions can result in substantial fines, natural resource damages, criminal sanctions, permit revocations and/or facility shutdowns.

Furthermore, we may become liable for the investigation and cleanup of environmental contamination at any property that we would own or operate and at off-site locations where we may arrange for the disposal of hazardous substances. If these substances have been or are disposed of or released at sites that undergo investigation and/or remediation by regulatory agencies, we may be responsible under CERCLA, or other environmental laws for all or part of the costs of investigation and/or remediation, and for damages to natural resources. We may also be subject to related claims by private parties alleging property damage and personal injury due to exposure to hazardous or other materials at or from those properties. Some of these matters may require expending significant amounts for investigation, cleanup, or other costs.

In addition, new laws, new interpretations of existing laws, increased governmental enforcement of environmental laws, or other developments could require us to make additional significant expenditures. Continued government and public emphasis on environmental issues can be expected to result in increased future investments for environmental controls at any future production facility. Present and future environmental laws and regulations applicable to MSW processing and energy production, more vigorous enforcement policies and discovery of currently unknown conditions may require substantial expenditures that could have a material adverse effect on the results of our contemplated operations and financial position.

The hazards and risks associated with processing MSW and producing and/or transporting various energy or chemical products (such as fires, natural disasters, explosions, and abnormal pressures and blowouts) may also result in personal injury claims or damage to property and third parties. As protection against operating hazards, we intend to maintain insurance coverage against some, but not all, potential losses. We could, however, sustain losses for uninsurable or uninsured risks, or in amounts in excess of existing insurance coverage. Events that result in significant personal injury or damage to our property or third parties or other losses that are not fully covered by insurance could have a material adverse effect on the results of our contemplated operations and financial position.

Risks related to our Common Stock and Stock Price Fluctuation

Our stock is thinly traded, so you may be unable to sell at or near ask prices or at all.

Our common stock trades on the OTCQB. Shares of our common stock are thinly-traded, meaning that the number of persons interested in purchasing our common shares at or near ask prices at any given time may be relatively small or non-existent. This situation is attributable to a number of factors, including:

	•		we are a small company that is relatively unknown to stock analysts, stock brokers, institutional investors and others in the investment community that generate or influence sales volume; and
	•		stock analysts, stock brokers and institutional investors may be risk-averse and be reluctant to follow an unproven, early stage company such as ours or purchase or recommend the purchase of our shares until such time as we became more seasoned and viable.

As a consequence, our stock price may not reflect an actual or perceived value. Also, there may be periods of several days or more when trading activity in our shares is minimal or non-existent, as compared to a seasoned issuer that has a large and steady volume of trading activity that will generally support continuous sales without an adverse effect on share price. A broader or more active public trading market for our common shares may not develop or if developed, may not be sustained. Due to these conditions, you may not be able to sell your shares at or near ask prices or at all if you need money or otherwise desire to liquidate your shares.

Even if an active trading market develops, the market price for our common stock may be highly volatile and could be subject to wide fluctuations.

We believe that newer alternative energy companies and companies that effect reverse mergers, such as our company, are particularly susceptible to speculative trading that may not be based on the actual performance of the company, which increases the risk of price volatility in a common stock. In addition, the price of the shares of our common stock could decline significantly if our future operating results fail to meet or exceed the expectations of market analysts and investors. Some of the factors that could affect the volatility of our share price include:

	•		significant sales of our common stock or other securities in the open market;
	•		speculation in the press or investment community;
	•		actual or anticipated variations in quarterly operating results;
	•		changes in earnings estimates;
	•		publication (or lack of publication) of research reports about us;
	•		increases in market interest rates, which may increase our cost of capital;
	•		changes in applicable laws or regulations, court rulings and other legal actions;
	•		changes in market valuations of similar companies;
	•		additions or departures of key personnel;
	•		actions by our stockholders; and
	•		general market and economic conditions.

Trading in our common stock is subject to special sales practices and may be difficult to sell.

Our common stock is subject to the Securities and Exchange Commission’s “penny stock” rule, which imposes special sales practice requirements upon broker-dealers who sell such securities to persons other than established customers or accredited investors. Penny stocks are generally defined to be an equity security that has a market price of less than $5.00 per share. For purposes of the rule, the phrase “accredited investors” means, in general terms, institutions with assets in excess of $5,000,000, or individuals having a net worth in excess of $1,000,000 or having an annual income that exceeds $200,000 (or that, when combined with a spouse’s income, exceeds $300,000). For transactions covered by the rule, the broker-dealer must make a special suitability determination for the purchaser and receive the purchaser’s written agreement to the transaction prior to the sale. Consequently, the rule may affect the ability of broker-dealers to sell our securities and also may affect the ability of our shareholders in this offering to sell their securities in any market that might develop.

Stockholders should be aware that, according to Securities and Exchange Commission Release No. 34-29093, the market for penny stocks has suffered from patterns of fraud and abuse. Such patterns include:

	•		control of the market for the security by one or a few broker-dealers that are often related to the promoter or issuer;
	•		manipulation of prices through prearranged matching of purchases and sales and false and misleading press releases;
	•		“boiler room” practices involving high-pressure sales tactics and unrealistic price projections by inexperienced sales persons;
	•		excessive and undisclosed bid-ask differentials and markups by selling broker-dealers; and
	•		the wholesale dumping of the same securities by promoters and broker-dealers after prices have been manipulated to a desired level, along with the resulting inevitable collapse of those prices and with consequent investor losses.

Our management is aware of the abuses that have occurred historically in the penny stock market. Although we do not expect to be in a position to dictate the behavior of the market or of broker-dealers who participate in the market, management will strive within the confines of practical limitations to prevent the described patterns from being established with respect to our common stock.

Substantial future sales of our common stock shares in the public market could cause our stock price to fall.

If our stockholders sell substantial amounts of our common stock, or the public market perceives that stockholders might sell substantial amounts of our common stock, the market price of our common stock could decline significantly. Such sales also might make it more difficult for us to sell equity or equity-related securities in the future at a time and price that our management deems appropriate. As of December 31, 2010, we had 68,309,679 shares of our common stock outstanding. We also have outstanding convertible notes (including accrued interest) with warrants convertible into approximately 33 million shares of our common stock, 4,000,000 shares of our common stock in escrow to be released upon future conditions and requirements and warrants, immediately exercisable and representing the right to purchase 2,300,000 shares of our common stock. An additional 14,000,000 shares of our common stock have been reserved for issuance pursuant to our 2007 Stock Option Plan.

Potential issuance of additional common and preferred stock could dilute existing stockholders.

We are authorized to issue up to 240,000,000 shares of common stock. To the extent of such authorization, our board of directors has the ability, without seeking stockholder approval, to issue additional shares of common stock in the future for such consideration as the board of directors may consider sufficient. We are also authorized to issue up to ten million shares of preferred stock, the rights and preferences of which may be designated in series by the board of directors. Such designation of new series of preferred stock may be made without stockholder approval, and could create additional securities which would have dividend and liquidation preferences over the common stock offered hereby. Preferred stockholders could adversely affect the rights of holders of common stock by:

	•		exercising voting, redemption and conversion rights to the detriment of the holders of common stock;
	•		receiving preferences over the holders of common stock regarding a surplus of funds in the event of our dissolution or liquidation;
	•		delaying, deferring or preventing a change in control of our company; and
	•		discouraging bids for our common stock.

Additionally, some of our convertible securities and warrants to purchase common stock have anti-dilution protection. This means that if we issue securities for a price less than the price at which these securities are convertible or exercisable for shares of common stock, the securities will become eligible to acquire more shares of common stock at a lower price, which will dilute the ownership of our common stockholders.

Finally, we have filed a registration statement pursuant to a registration rights agreement with some of our stockholders. The registration rights agreement provides, among other things, that we keep the registration statement associated with those shares continuously effective. If we are unable to comply with these provisions of the registration rights agreements, we may be obligated to pay those stockholders liquidated damages in the form of warrants to purchase additional common stock.

In all the situations described above, the issuance of additional common stock in the future will reduce the proportionate ownership and voting power of our current stockholders.

ITEM 1B.		Unresolved Staff Comments

Not applicable.

ITEM 2.		Properties

We currently occupy 1,800 square feet of office space in St. Louis, Missouri. The lease has expired and we are in the process of renewing the lease while we continue to occupy the space. The monthly lease payment is $1,800, plus utilities. We took possession of the leased space in January, 2008.

ITEM 3.		Legal Proceedings

None.

ITEM 4.		(Removed and Reserved)

PART II

ITEM 5.		Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

Our common stock was originally listed on the Pink Sheets under the symbol “CLTH.PK.” On March 13, 2008 we became listed on the OTCBB under “CLTH.” The following table sets forth for the periods indicated the high and low bid prices per share of our common stock as quoted on the OTCBB or Pink Sheets, as appropriate (in February 2011, the market-makers in our common stock have completed their migration off of FINRA’s BB (Bulletin Board) to OTC Markets Group. As a result, the Company is categorized and quotes can currently be found under the OTCQB tier):

		Price Range of
		Common Stock (1)
Fiscal Year		High				Low
Year Ended December 31, 2008
First Quarter		$	1.50			$	0.55
Second Quarter		$	1.32			$	0.80
Third Quarter		$	1.20			$	0.21
Fourth Quarter		$	0.75			$	0.07
Year Ended December 31, 2009
First Quarter		$	0.28			$	0.02
Second Quarter		$	0.45			$	0.05
Third Quarter		$	0.15			$	0.10
Fourth Quarter		$	0.16			$	0.06
Year Ended December 31, 2010
First Quarter		$	0.15			$	0.05
Second Quarter		$	0.14			$	0.04
Third Quarter		$	0.08			$	0.01
Fourth Quarter		$	0.06			$	0.03

On March 22, 2011, the closing price of our common stock, as quoted on the OTCQB, was $0.07 per share. As of March 22, 2011, we had approximately 130 stockholders of record.

In connection with the merger with SRS Energy, we assumed SRS Energy’s 2007 Stock Option Plan, which was adopted by the SRS Energy Board of Directors on April 16, 2007 and approved by the SRS Energy shareholders on April 16, 2007.

Equity Compensation Plan Information

Weighted-Avg

Number of Securities Remaining

Number of securities to be

Exercise Price of

Available for Future Issuance

issued upon Exercise of

Outstanding

Under Equity Compensation Plans

Outstanding Options,

Options, Warrants

(excluding securities reflected in

Plan Category

Warrants and Rights

and Rights

column (a))

(a)

(b)

(c)

Equity compensation plans approved by security holders:

2007 Stock Option Plan

7,717,000

$

0.12

6,283,000

Equity compensation plans not approved by security holders

—

—

—

Totals

7,717,000

6,283,000

Dividend Policy

We have no material operating history and therefore have had no earnings to distribute to stockholders. Even though we have recommenced operations, we do not anticipate paying any cash dividends in the foreseeable future. Rather, we currently intend to retain our earnings, if any, and reinvest them in the development of our business. Any future determination to pay cash dividends will be at the discretion of our board of directors and will be dependent upon our financial condition, results of operations, capital requirements, restrictions under any existing indebtedness and other factors the board of directors may deem relevant.

Recent Sales of Unregistered Securities —

During April 2009, the Company commenced a second offering of units comprised of a convertible promissory note and a warrant (this offering closed in September 2010). The Company raised a total of $1,198,500 of investment proceeds. Each convertible promissory note carries a one-year term and a 6% interest rate. In addition, each note can be converted into shares of the Company’s common stock, par value $0.001 per share (the “Common Stock”), at $0.08 per share at the holder’s option. Each note was issued with a warrant to purchase additional shares of Common Stock to provide 100% coverage of the principal amount of the associated note at a price of $0.30 per share. Two notes have been converted leaving $1,163,500 face value of notes outstanding as of December 31, 2010. The issuance of units and the issuance of Common Stock upon conversion of notes were exempt from the registration requirements of the Securities Act of 1933, as amended (the “Securities Act”), pursuant to Rule 506 of Regulation D promulgated under the Securities Act (“Rule 506”) and/or Section 4(2) of the Securities Act.

During June 2010, the Company commenced another offering of units comprised of a convertible promissory note and a warrant. As of December 31, 2010, the Company had raised a total of $75,000 of investment proceeds. Each convertible promissory note carries a one-year term, a 12% interest rate and a payback provision of the note if $250,000 or more in the aggregate is raised by the Company in future offerings. In addition, each note can be converted, at the note holder’s option, at any time during the one-year term into shares of Common Stock at $0.08 per share, or prior to the closing of any Qualifying Equity Financing (minimum capital received of $5 million). Each note was issued with a warrant to purchase additional shares of Common Stock to provide for 100% coverage of the promissory note at a price of $0.30 per share. The issuance of units and the issuance of Common Stock upon conversion of notes were exempt from the registration requirements of the Securities Act, pursuant to Rule 506 and/or Section 4(2) of the Securities Act.

In September 2010, the Company issued a note in the amount of $100,000 (interest at 6.0% per annum and secured by a security interest in the PSC Patent) and issued warrants to purchase 2,000,000 shares of Common Stock at a price of $0.05 per share. The note is due the earlier of: (i) February 28, 2011 or (ii) the date on which $500,000 or more in the aggregate is raised by the Company in future offerings. The Company and CMS Acquisition, LLC entered into an amendment in February 2011 that extended the due date of the note to May 15, 2011 for payment of $25,000 towards the accrued interest to date and principal of the note. The warrants are exercisable at any time for five years from the date of issuance or reissuance. The issuance of Common Stock upon conversion of warrants was exempt from the registration requirements of the Securities Act, pursuant to Rule 506 and/or Section 4(2) of the Securities Act.

During November 2010, the Company commenced a third offering of units comprised of a convertible promissory note and a warrant. As of March 22, 2011, the Company raised a total of $141,000 of investment proceeds. Each convertible promissory note carries a one-year term and a 6% interest rate. In addition, each note can be converted into shares of Common Stock at $0.06 per share at the holder’s option. Two notes have been converted leaving $95,000 face value of notes outstanding as of February 28, 2011. Each note was issued with a warrant to purchase additional shares of Common Stock to provide 100% coverage of the principal amount of the associated note at a price of $0.30 per share. The issuance of units and the issuance of Common Stock upon conversion of notes were exempt from the registration requirements of the Securities Act, pursuant to Rule 506 and/or Section 4(2) of the Securities Act.

ITEM 6.		Selected Financial Data

Not applicable.

ITEM 7.		Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following discussion of our plan of operation should be read in conjunction with the financial statements and related notes to the financial statements included elsewhere in this report. This discussion contains forward-looking statements that relate to future events or our future financial performance. These statements involve known and unknown risks, uncertainties and other factors that may cause our actual results, levels of activity or performance to be materially different from any future results, levels of activity or performance. These risks and other factors include, among others, those listed under “Statement Regarding Forward-Looking Statements” and “Risk Factors” and those included elsewhere in this report.

Plan of Operation

Our focus is to secure sufficient capital to fund our current working capital requirements and the construction of a commercial plant as described further in this section. We currently do not have sufficient capital to continue operations. All of our developments/projects require a significant amount of capital that we currently do not have. While we continue to aggressively pursue capital, we have not had recent success securing meaningful amounts of financing. As a result, we can provide no assurance that we will secure any capital in the immediate time frame required and the failure to do so will likely result in an inability to continue operations.

Our company was initially conceived as a fully-integrated producer of cellulosic ethanol from MSW. Based on our investigation and acquisition of new technologies and research and development of our existing technologies in 2008, we re-focused our business to the commercialization of our Biomass Recovery Process technology for cleaning and separating MSW into its component parts and initiated a plan to consolidate the ownership and/or rights to use intellectual property around this technology. The technology is currently in use by another operator in a commercial setting in Australia. As a result, we believe this technology is ready for commercial implementation in the United States and elsewhere. In furtherance of our new focus, we are currently in the process of raising capital to design and build a commercial biomass recovery plant to provide biomass feedstock for customer evaluation and trial purchases. Initially, the biomass feedstock output will be sold or provided to electric utilities, power and steam producers, and biofuel research firms for evaluation. In addition to this capital raise for plant development, the Company is also working towards licensing and/or developing potential commercial projects as they present themselves. All of our developments plan to focus on cleaning and separating MSW into its component parts in order to obtain: (i) a homogenous feedstock of cellulosic biomass for producing energy and other chemical products and (ii) recyclable products (metals, plastics).

As a result of our focus on converting MSW into a biomass feedstock for energy or chemical products, we determined that we no longer would use the Brelsford and HFTA technologies. In the fourth quarter of 2008, Brelsford Engineering, Inc. terminated our license to the Brelsford technology for non-payment of certain fees. We decided not to use the technology going forward in our operations and wrote off the remaining asset as of December 31, 2008. The impairment loss of $97,500 is included in research and development expense on the statement of operations for the year ended December 31, 2008. Additionally, we terminated our agreement with HFTA, Inc. during the fourth quarter of 2009 as we determined to not use the HFTA technology going forward in our operations. We wrote off the related asset of approximately $693,000 as an impairment loss and the loss is included in research and development expense on the statement of operations for the year ended December 31, 2009.

Biomass Feedstock Production

The Company plans to design and build a commercial biomass recovery plant to provide biomass feedstock for customer evaluation and trial purchases. Initially, the biomass feedstock output will be sold or provided to electric utilities, power and steam producers, and biofuel and chemical research firms for evaluation. In addition to research and development, the Company is also working towards licensing and/or developing potential commercial projects.

We completed construction of a small test vessel in Kentucky and, beginning in April 2009, this vessel has processed approximately 12 tons of MSW into approximately 4-5 tons of biomass. We have provided the biomass produced during this testing phase to a number of fuel producers who are evaluating whether they can use our biomass as a feedstock for their technologies. In July 2010, we entered into an agreement with Fiberight to install this test vessel at Fiberight’s cellulosic ethanol pilot plant in Lawrenceville, Virginia. We anticipate our vessel to be installed and operational during the second quarter 2011. Once upgraded and installed, the vessel is expected to produce cellulosic biomass feedstock for Fiberight’s Targeted Fuel Extraction process. We expect such production should further validate our licensed Biomass Recovery Process, which we believe could then be used for on-site cellulosic biomass feedstock production for alternative energy producers. Additionally, we will have access to biomass produced at the Lawrenceville plant for delivery to other companies interested in testing it as feedstock in their conversion technologies.

We are also seeking to develop a plant in a major metropolitan area. We are working to develop one or more locations where waste collected would be processed using our technology and the biomass produced used to create heat and/or power.

We were considering the possibility of implementing our technology in Maryville, Missouri. In late March 2011, the City of Maryville sent out Requests for Proposal for their transfer station site. At this time, the Company is not in a position to participate in this process. The biomass produced would have potentially been supplied to Northwest Missouri State University for research purposes in advanced biofuel technologies and to supply steam for the University. The University has used biomass to produce steam for more than twenty years.

In addition to the developments we are currently contemplating, other development opportunities are presented to us and we evaluate those potential developments. Upon operating a plant and after refining our know-how with respect to implementation of the technology, we intend to seek to partner with waste haulers, landfill owners and municipalities to implement the technology across the United States and internationally.

The further development of commercial plants and/or implementation of the licensing of our technology described above will require significant additional capital, which we currently do not have. We cannot provide any assurance that we will be able to raise this additional capital. While we anticipate that financing for the commercial biomass recovery plant and these other potential projects could also be provided in part via tax exempt bond financing or through the use of loan guarantees from local, state and federal authorities, we have not secured any such financing and there can be no assurance that we will be able to secure any such financing.

Diesel Fuel Production

We previously anticipated completing an agreement with Green Power, Inc. (“Green Power”) to provide biomass for testing at Green Power’s facility and if that proves successful, to build a 200 ton per day MSW processing station to provide biomass for an existing 100 ton per day diesel fuel production plant. To date we have not been able to reach an agreement as to the nature and amount of biomass to be produced or other key terms of this relationship that are required for us to proceed. These issues and a number of other items will be required to be resolved before we are able to complete any agreement with Green Power. We have not completed an agreement to date and there can be no assurance that we will complete any agreement and proceed with this development.

Bio-Fuel and Bio-Chemical Joint Testing/Research

As soon as we are able to process MSW into biomass through our future biomass recovery plant, our test vessel at Fiberight’s facility in Virginia, and/or in future commercial vessels, we plan to enter into joint research agreements with companies looking to process biomass in their system(s) for various types of energy and chemical production. This testing and research will provide possible revenue streams, projects and additional opportunities for use of our biomass.

In August 2009, we entered into a joint research agreement with GeoSyn Fuels, L.L.C. (“GeoSyn”) whereby we agreed to provide GeoSyn with biomass feedstock derived from MSW from the City of Chicago for GeoSyn’s testing of their proprietary process for converting biomass into ethanol and other products.

In May 2010, we entered into a joint research agreement with Ze-Gen, Inc., a developer of technology for converting biomass into a variety of fuel products and other chemical products, whereby we agreed to provide biomass to Ze-Gen, Inc. for testing in their proprietary processes.

New Technologies; Commercializing Existing Technologies

Because of our unique ability to produce a clean, homogenous biomass feedstock, we are frequently presented with the opportunity to partner with or acquire new technologies. In addition to developing our current technologies, we will continue to add technologies to our suite of solutions that complement our core operations. We believe that our current technologies and aspects of those in development will enable us to eventually expand our business to use organic material from other waste streams such as municipal bio-solids from waste water facilities and animal waste for fuel production.

To commercialize our technology, we intend to:

	•		construct and operate a commercial plant that: (i) processes MSW into cellulosic biomass for conversion into energy or chemical products and (ii) separates recyclables (metals, plastics, glass) for single-stream recycling;
	•		identify and partner with landfill owners, waste haulers and municipalities to identify locations suitable for our technology; and
	•		pursue additional opportunities to implement our technology in commercial settings at transfer stations and landfills in the United States and elsewhere in the world.

Our ability to implement this strategy will depend on our ability to raise significant amounts of additional capital and to hire appropriate managers and staff. Our success will also depend on a variety of market forces and other developments beyond our control.

As a result of the limited operating history of our company, prior years’ financial statements provide little information and virtually no guidance as to our future performance. In order to finance our business beyond this stage, we will be required to raise additional capital. Management plans to secure additional funds through through future sales of the Company’s Common Stock, government grants, project financings, preferred stock or debentures, until such time as the Company’s revenues and cash flow are sufficient to meet its cost structure and ultimately achieve profitable operations. The consolidated financial statements do not include any adjustments that might result from the outcome of these uncertainties. We may not be able to secure financing on favorable terms, or at all. If we are unable to obtain acceptable financing on a timely basis, our business will likely fail and our common stock may become worthless.

Results of Operations

We experienced the following changes in our operations:

Year ended December 31, 2010 compared to the year ended December 31, 2009

		Years ended December 31,
		2010				2009				Change				% Change
Costs and expenses:
General and administrative		$	691,428			$	1,087,889			$	(396,461	)			-36	%
Professional fees			91,227				290,023				(198,796	)			-69	%
Research and development			—				693,146				(693,146	)			-100	%
			782,655				2,071,058				(1,288,403	)
Other expense (income):
Interest			407,197				906,535				(499,338	)			-55	%
Other income			—				(32,000	)			32,000				N/M
Interest income			(8,219	)			(11,771	)			3,552				-30	%
Net loss applicable to common stockholders		$	1,181,633			$	2,933,822			$	(1,752,189	)			-60	%

Costs and expenses:

General and administrative — The decrease in 2010 is due primarily to a decrease in salaries and share-based compensation of approximately $330,000 and a decrease of approximately $70,000 in marketing expenses.

Professional Fees — The decrease in 2010 is due to reductions in legal and consulting fees of approximately $132,000 and $65,000, respectively.

Research and Development — The expense in 2009 is entirely related to the write-off of our license asset related to the HFTA technology as we elected to terminate the license agreement during the fourth quarter of 2009. As we shifted our plan of operation from a fully-integrated producer of cellulosic ethanol to the commercialization of our technology for cleaning and separating MSW into its component parts as described earlier in this report, we have had no R&D expense in 2010.

Other expense (income):

Interest expense — The decrease in 2010 is due primarily to decreased amortization of approximately $500,000 of discounts related to various notes as the majority of these discounts became fully amortized during 2010.

Other income — The other income in 2009 was for a two-month lease and subsequent sale of the HFTA equipment previously purchased.

Year ended December 31, 2009 compared to the year ended December 31, 2008

		Years ended December 31,
		2009				2008				Change				% Change
Costs and expenses:
General and administrative		$	1,087,889			$	568,115			$	519,774				91	%
Professional fees			290,023				430,798				(140,775	)			-33	%
Research and development			693,146				392,471				300,675				77	%
			2,071,058				1,391,384				679,674
Other expense (income):
Interest			906,535				179,690				726,845				404	%
Amortization of technology license			—				15,000				(15,000	)			-100	%
Other income			(32,000	)			—				(32,000	)			N/M
Interest income			(11,771	)			(13,749	)			1,978				-14	%
Net loss applicable to common stockholders		$	2,933,822			$	1,572,325			$	1,361,497				87	%

Costs and expenses:

General and administrative — The increase in expense in 2009 is due primarily to accruing salaries for all employees in 2009 compared to salary earned only by the CEO in 2008 (an increase of approximately $300,000), an increase of approximately $143,000 in share-based compensation expense and an increase of approximately $88,000 in marketing expenses.

Professional Fees — The decrease in 2009 is due to a reduction in legal fees of approximately $182,000 offset by an increase in consulting fees of approximately $40,000.

Research and Development — The expense in 2009 is entirely related to the write-off of our license asset related to the HFTA technology as we elected to terminate the license agreement during the fourth quarter of 2009. As we shifted our plan of operation from a fully-integrated producer of cellulosic ethanol to the commercialization of our technology for cleaning and separating MSW into its component parts as described earlier in this report, we have had minimal other R&D expense in 2009 as compared to 2008.

Other expense (income):

Interest expense — The increase in 2009 is due primarily to increased amortization of approximately $675,000 of discounts related to various notes and increased interest of approximately $50,000 on those notes.

Amortization — The asset related to this amortization was written off as of December 31, 2008 as we no longer plan to use the technology in our plan of operations going forward. As we have not yet commenced our operations, we have no amortization in 2009 for our current technology assets.

Other income — The other income in 2009 was for a two-month lease and subsequent sale of the HFTA equipment previously purchased.

Liquidity and Capital Resources

As a development-stage company, we have no revenues and will be required to raise additional capital in order to execute our business plan and commercialize our products. Beginning in September 2008 and as of March 22, 2011, we raised an aggregate of $2,156,500, in separate offerings of units comprised of a convertible note and warrants. We are continuing to explore opportunities to raise cash through the issuance of these units and other financing opportunities. As of March 22, 2011, our current cash is not sufficient to fund our operations. Our liabilities are substantially greater than our current available funds. We are seeking additional financing through the sale of additional equity, various government funding opportunities and/or possibly through strategic alliances with larger energy or waste management companies. We have retained Houlihan Capital to assist the Company in exploring and evaluating a range of strategic financing alternatives and/or other transactions. However, we may not be successful in securing additional capital. If we are not able to obtain additional financing in the immediate future, we will be required to delay our development until such financing becomes available. Further, even assuming that we secure additional funds, we may never achieve profitability or positive cash flow. If we are not able to timely and successfully raise additional capital and/or achieve profitability or positive cash flow, we will not have sufficient capital resources to implement our business plan.

Debt

Convertible Notes Payable

During September 2008, the Company commenced an offering of units comprised of a convertible promissory note and a warrant. The Company raised a total of $642,000 of investment proceeds through March 31, 2009 and this offering is closed. As of March 31, 2010, all of these notes have either been converted to shares of Common Stock or re-priced to our second convertible note offering (resulting in new notes with a total face value of $539,829, which included the original principal and interest through the date of re-pricing). Each convertible promissory note carried a one-year term and a 6% interest rate. In addition, each note could have been converted, at the note holder’s option, at any time during the one-year term into shares of Common Stock at $0.25 per share, or prior to the closing of any Qualifying Equity Financing (minimum capital received of $5 million). Each note was issued with a warrant to purchase additional shares of Common Stock equal to the principal amount of the promissory note at a price of $0.45 per share. These promissory notes had been recorded as short-term debt (notes payable) in the financial statements, net of discounts for the conversion and warrant features. The discounts were being amortized on a straight-line basis over the term of each note and are fully expensed as of March 31, 2010. All outstanding warrants related to this offering have also been re-priced into our second note offering. For the years ended December 31, 2010 and 2009, amortization of approximately $7,000 and $524,000, respectively, for these discounts has been recorded in interest expense.

During April 2009, the Company commenced a second offering of units comprised of a convertible promissory note and a warrant. As of December 31, 2010, the Company raised a total of $1,198,500 of investment proceeds. One note was converted during the second quarter of 2009 and one note was converted during the second quarter 2010 leaving $1,163,500 face value of notes outstanding ($1,703,329 after adding the notes converted from our first offering as disclosed previously). Each convertible promissory note carries a one-year term and a 6% interest rate. In addition, each note can be converted, at the note holder’s option, at any time during the one-year term into shares of Common Stock at $0.08 per share, or prior to the closing of any Qualifying Equity Financing (minimum capital received of $5 million). Each note was issued with a warrant to purchase additional shares of Common Stock to provide for 100% coverage of the promissory note at a price of $0.30 per share. These promissory notes have been recorded as short-term debt (notes payable) in the financial statements, net of discounts for the conversion and warrant features. The discounts are being amortized on a straight-line basis over the term of each note. For the years ended December 31, 2010 and 2009, amortization of approximately $253,000 and $113,000, respectively for these discounts, has been recorded in interest expense.

During June 2010, the Company commenced another offering of units comprised of a convertible promissory note and a warrant. As of December 31, 2010, the Company had raised a total of $75,000 of investment proceeds. Each convertible promissory note carries a one-year term, a 12% interest rate and a payback provision of the note if $250,000 or more in the aggregate is raised by the Company in future offerings. In addition, each note can be converted, at the note holder’s option, at any time during the one-year term into shares of Common Stock at $0.08 per share, or prior to the closing of any Qualifying Equity Financing (minimum capital received of $5 million). Each note was issued with a warrant to purchase additional shares of Common Stock to provide for 100% coverage of the promissory note at a price of $0.30 per share. The promissory note has been recorded as short-term debt (notes payable) in the financial statements, net of discounts for the conversion and warrant features. The discounts are being amortized on a straight-line basis over the term of each note. For the year ended December 31, 2010, amortization of approximately $14,000 for these discounts has been recorded in interest expense.

During November 2010, the Company commenced a third offering of units comprised of a convertible promissory note and a warrant. As of December 31, 2010, the Company raised a total of $35,000 of investment proceeds. Each convertible promissory note carries a one-year term and a 6% interest rate. In addition, each note can be converted, at the note holder’s option, at any time during the one-year term into shares of Common Stock at $0.06 per share, or prior to the closing of any Qualifying Equity Financing (minimum capital received of $5 million). Each note was issued with a warrant to purchase additional shares of Common Stock to provide for 100% coverage of the promissory note at a price of $0.30 per share. These promissory notes have been recorded as short-term debt (notes payable) in the financial statements.

CMS Acquisition, LLC Note Payable

In September 2010, the Company issued a note in the amount of $100,000 (interest at 6.0% per annum and secured by a security interest in the PSC Patent) and issued warrants to purchase 2,000,000 shares of Common Stock at a price of $0.05 per share. The note is due the earlier of: (i) February 28, 2011 or (ii) the date on which $500,000 or more in the aggregate is raised by the Company in future offerings. The Company and CMS Acquisition, LLC entered into an amendment in February 2011 that extended the due date of the note to May 15, 2011 for payment of $25,000 towards the accrued interest to date and principal of the note. The warrants are exercisable at any time for five years from the date of issuance or reissuance. The value of these warrants has been recorded as a contra-balance amount discount with the note and is being amortized through interest expense. For the year ended December 31, 2010, amortization of approximately $7,000 for this discount has been recorded in interest expense.

Vertex (formerly WWT) Note Payable

On October 22, 2008, the Company completed the purchase of Patent No. 6,306,248 (the “PSC Patent”) pursuant to a Patent Purchase Agreement (“Agreement”) with World Waste Technologies, Inc. (“WWT”). The PSC Patent is the basis for the pressurized steam classification technology that cleans and separates municipal solid waste into its component parts, which the Company had licensed from Bio-Products International, Inc. Pursuant to the Agreement, the Company issued to WWT a note in the amount of $450,000 (interest at 6% per annum and a security interest in the PSC Patent) and a warrant to purchase 900,000 shares of Common Stock at a price of $0.45 per share and warrants to purchase an additional 900,000 shares of Common Stock at a price of $0.45 per share contingent on payment of the note by July 22, 2009 (the original maturity date). WWT assigned all of its rights, title and interest in the note, warrants, security agreement and purchase agreement to Vertex Energy, Inc. as a result of a merger in March 2009. We entered into amendments dated July 23, 2009 whereby: (i) the Company paid 10% of the original note and all accrued interest to date, (ii) all previous warrants (totaling 1,800,000 shares) were reissued at a price of $0.11 per share with no contingencies and (iii) the remaining payments on the note were scheduled to be paid on October 22, 2009 (50% of principal plus accrued interest to date not yet paid) and January 22, 2010 (remaining principal and accrued interest to date). We entered into amendments dated October 22, 2009 whereby: (i) the October 22, 2009 payment was deferred until November 22, 2009 and (ii) we issued additional warrants to Vertex for 500,000 shares of Common Stock at a price of $0.10 per share. The warrants are exercisable at any time for five years from the date of issuance or reissuance. The value of these warrants had been recorded as a contra-balance amount discount with the note and has been fully amortized through interest expense. For the years ended December 31, 2010 and 2009, amortization of approximately $7,000 and $178,000 for this discount has been recorded in interest expense. This note was paid in full in September 2010.

Series A Convertible Debentures

In April 2007, the Company sold $1,400,000 of Series A Convertible Debentures (“Debentures”), due April 16, 2010, that convert into shares of the Company’s Common Stock at $0.15 per share. The Company filed a registration statement with regard to the sale of these shares of Common Stock, which was declared effective by the Securities and Exchange Commission on January 2, 2008. The debentures accrue interest at 6% per annum. The interest is payable in cash or shares of the Company’s Common Stock at the Company’s option. The Debenture Holders can convert their amount into shares at any time until the due date.

During March 2008, various debenture holders converted an aggregate amount of $630,000 of our Debentures, plus interest earned, into 4,433,067 shares of Common Stock. During April 2008, various debenture holders converted an aggregate amount of $630,000 of our Debentures, plus interest earned, into 4,455,844 shares of Common Stock. As of April 16, 2010, the remaining principal of $140,000 matured and with accumulated interest earned, converted to 2,069,375 shares of our common stock.

Summary of Cash Flow Activity

		For the Years Ended December 31,
		2010				2009				2008
Net cash used by operating activities		$	(245,033	)		$	(715,264	)		$	(866,285	)
Net cash used by investing activities			—				(20,702	)			(200,180	)
Net cash provided by financing activities			250,094				640,261				1,042,726

Net cash used by operating activities

During 2010 and 2009, cash used by operating activities was impacted primarily by increases in accounts payable and other accrued liabilities.

Net cash used by investing activities

During 2009, cash used by investing activities was for capital expenditures. During 2008, cash used by investing activities was for the acquisition of a patent, the merger of Biomass North America Licensing, Inc. and capital expenditures.

Net cash provided by financing activities

During 2010, cash provided by financing activities was from the continued issuance of our Convertible Notes for $485,000 offset by payments against other Notes Payable. During 2009, cash provided by financing activities was from the continued issuance of our Convertible Notes for $958,500 offset by payments against other Notes Payable. During 2008, cash provided by financing activities was primarily from the issuance of our Convertible Notes for $607,000 and the remaining portion of the Series A Convertible Debentures plus interest of $474,900.

Contractual Obligations and Commitments

In the table below, we set forth our obligations as of December 31, 2010. Some of the figures we include in this table are based on our estimates and assumptions about these obligations, including their durations, anticipated actions by third parties and other factors. The obligations we may pay in future periods may vary from those reflected in this table because of estimates or actions of third parties as disclosed in the notes to the table.

		Payments due by Period
						Less than 1												More than 5
		Total				year				1 to 3 years				4 to 5 years				years
Convertible Notes (1)		$	1,927,000			$	1,927,000			$	—			$	—			$	—
CMS Acquition Note (2)			106,000				106,000				—				—				—
Capital Lease (3)			2,500				2,500				—				—				—
Operating Lease (4)			—								—				—				—
Total contractual obligations		$	2,035,500			$	2,035,500			$	—			$	—			$	—

Off-Balance Sheet Arrangements

We have no off-balance sheet arrangements.

We have not entered into any transaction, agreement or other contractual arrangement with an unconsolidated entity under which we have:

	•		a retained or contingent interest in assets transferred to the unconsolidated entity or similar arrangement that serves as credit;
	•		liquidity or market risk support to such entity for such assets; or
	•		an obligation, including a contingent obligation, arising out of a variable interest in an unconsolidated entity that is held by, and material to, us where such entity provides financing, liquidity, market risk or credit risk support to, or engages in leasing, hedging, or research and development services with us.

Critical Accounting Estimates

Long-Lived Assets — Our acquisition and merger activities have resulted in aggregate licensing and patent assets of approximately $2.1 million as of December 31, 2010. We are required to conduct impairment tests of long-lived assets on an annual basis and between annual tests if an event occurs or circumstances change that would more likely than not reduce the fair value of an asset below its carrying value. As we have not commenced commercial operations, these assets have not yet been placed in service. In the fourth quarter of 2008, we determined that we are no longer going to use the Brelsford technology for which an asset was previous capitalized and partially amortized. At December 31, 2008, the net remaining asset of $97,500 was written-off through our research and development expense for the year ended December 31, 2008. In the fourth quarter of 2009, we determined that we are no longer going to use the HFTA technology for which an asset was previous capitalized. The net remaining asset of $693,000 was written-off through our research and development expense for the year ended December 31, 2009.

Deferred Taxes — We recognize deferred income tax liabilities and assets for the expected future tax consequences of events that have been recognized in the financial statements or tax returns. Under this method, deferred tax liabilities and assets are determined based on the differences between the financial statement carrying amounts and the tax basis of assets and liabilities using enacted tax rates in effect in the years in which the differences are expected to reverse. The Company incurred no income taxes to date. Any benefits are the result of temporary differences (start-up costs, stock compensation and other items) and operating loss carryforwards. The difference between the expected income tax benefit and non-recognition of an income tax benefit in each period is the result of a valuation allowance applied to deferred tax assets. A valuation allowance in the same amount of the benefit has been provided to reduce the deferred tax asset, as realization of the asset is not assured.

Stock-Based Compensation — We account for stock-based compensation in accordance with accounting guidance that requires measuring all stock-based compensation awards at fair value and recognizing an expense in the financial statements. We compensate certain employees, officers, directors and consultants with share-based payment awards and recognize compensation costs for these awards based on their fair values and expense is recognized over the requisite service period. The fair values of certain awards are estimated on the grant date using the Black-Scholes-Merton option-pricing formula, which incorporates certain assumptions including the expected term of an award and expected stock price volatility.

Convertible Notes Payable and Warrants — The Company has issued Convertible Promissory Notes (“Notes”). These Notes may be converted at the option of the noteholder into shares of the Company’s common stock. Additionally, these Notes carry warrants for shares of the Company’s common stock. These promissory notes have been recorded as short-term debt (notes payable) in the financial statements, net of discounts for the conversion and warrant features. The discounts are being amortized on a straight-line basis over the term of each note.

Fair Value Measurement — We use fair value accounting and reporting to specify a hierarchy of valuation techniques based upon whether the inputs to those valuation techniques reflect assumptions other market participants would use based upon market data obtained from independent sources or reflect our own assumptions of market participant valuation. The hierarchy is broken down into three levels based on the reliability of the inputs as follows:

	•		Level 1 — Quoted prices in active markets that are unadjusted and accessible at the measurement date for identical, unrestricted assets or liabilities;
	•		Level 2 — Quoted prices for identical assets and liabilities in markets that are not active, quoted prices for similar assets and liabilities in active markets, or financial instruments for which significant inputs are observable, either directly or indirectly;
	•		Level 3 — Prices or valuations that require inputs that are both significant to the fair value measurement and unobservable.

As of and during the year ended December 31, 2010 and 2009, we utilized Level 1 inputs to determine the fair value of cash equivalents and we utilized Level 2 inputs to determine the fair value of certain long-lived assets.

Contingent Liabilities — We are, from time to time, subject to litigation to our business. Assessments regarding the ultimate cost of lawsuits require judgments concerning matters such as the anticipated outcome of negotiations, the number and cost of pending and future claims, and the impact of evidentiary requirements. A significant amount of judgment and use of estimates is required to quantify our ultimate exposure in these matters. We regularly review the valuation of these liabilities and account for changes in circumstances for ongoing and emerging issues. The Company intends to defend itself vigorously in all litigation.

ITEM 7A.		Quantitative and Qualitative Disclosures About Market Risk

As of December 31, 2010, all of our debt instruments (Notes Payable and Capital Lease) carry fixed interest rates. We do not have any arrangements for borrowings under a credit facility. We currently have no operations and are not subject to any currency fluctuations or credit risk.

ITEM 8.		Financial Statements and Supplemental Data

REPORTS OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and Stockholders of
CleanTech Biofuels, Inc.
St. Louis, Missouri

We have audited the accompanying balance sheet of CleanTech Biofuels, Inc. as of December 31, 2010 and the related Statements of Operations, Changes in Stockholder’s Equity, and Cash Flows for the year ended December 31, 2010. CleanTech Biofuels Inc.’s management is responsible for these financial statements. Our responsibility is to express an opinion on these financial statements based on our audit.

We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit 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 audit included consideration of the 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, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides 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 CleanTech Biofuels, Inc. as of December 31, 2010, and the results of its operations and its cash flows for the year then ended, 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’s significant operating losses and recent inability to secure additional capital to implement its business plan raise substantial doubt about its ability to continue as a going concern. The financial statements do not include any adjustments that might result from the outcome of this uncertainty.

MILHOUSE & NEAL, LLP
Certified Public Accountants

March 22, 2011

To the Board of Directors and Stockholders of
CleanTech Biofuels, Inc.
St. Louis, Missouri

We have audited the accompanying balance sheet of CleanTech Biofuels, Inc. as of December 31, 2009 and the related Statements of Operations, Changes in Stockholders’ Equity, and Cash Flows for the year ended December 31, 2009. CleanTech Biofuels, Inc.’s management is responsible for these financial statements. Our responsibility is to express an opinion on these financial statements based on our audit.

We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit 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 audit included consideration of the 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, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides 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 CleanTech Biofuels, Inc. as of December 31, 2009, and the results of its operations and its cash flows for the year then ended, in conformity with accounting principles generally accepted in the United States of America.

MILHOUSE & NEAL, LLP
Certified Public Accountants

March 15, 2011

To the Board of Directors and Stockholders of
CleanTech Biofuels, Inc.
St. Louis, Missouri

We have audited the accompanying Statements of Operations, Changes in Stockholder’s Equity and Cash Flows for the year ended December 31, 2008. CleanTech Biofuels, Inc.’s management is responsible for these financial statements. Our responsibility is to express an opinion on these financial statements based on our audit.

We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit 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 audit 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, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.

In our opinion, the financial statements referred to above present fairly, in all material respects, the results of operations and cash flows of CleanTech Biofuels, Inc. for the year ended December 31, 2008, in conformity with accounting principles generally accepted in the United States of America.

MILHOUSE & NEAL, LLP
Certified Public Accountants

March 15, 2011

CLEANTECH BIOFUELS, INC.
(formerly Alternative Ethanol Technologies, Inc.)
(A Development Stage Company)
CONSOLIDATED BALANCE SHEETS

		December 31,				December 31,
		2010				2009
ASSETS
Current Assets:
Cash and cash equivalents		$	5,973			$	912
Prepaids and other current assets			39,905				36,481
			45,878				37,393
Property and equipment, net			9,777				20,308
Non-Current Assets:
Technology licenses, net			1,521,250				1,521,250
Patents			600,000				600,000
Total Assets		$	2,176,905			$	2,178,951
LIABILITIES AND STOCKHOLDERS’ EQUITY (DEFICIT)
Current Liabilities:
Accounts payable		$	392,950			$	302,898
Accrued interest			121,260				83,142
Accrued professional fees and other			487,835				175,693
Notes payable, net			1,871,669				1,401,925
Series A convertible debentures			—				140,000
Deferred revenue			50,000				50,000
Capital lease			1,211				4,869
Total Current Liabilities			2,924,925				2,158,527
Capital Lease			—				1,235
STOCKHOLDERS’ EQUITY (DEFICIT)
Preferred stock, $0.001 par value; 10,000,000 authorized shares; no shares issued or outstanding			—				—
Common stock, $0.001 par value; 240,000,000 authorized shares; 68,309,679 and 66,256,824 shares issued and outstanding at December 31, 2010 and 2009, respectively			68,310				66,257
Additional paid-in capital			6,301,726				5,911,136
Notes receivable — restricted common stock			(295,057	)			(316,838	)
Deficit accumulated during the development stage			(6,822,999	)			(5,641,366	)
Total Stockholders’ Equity (Deficit)			(748,020	)			19,189
Total Liabilities and Stockholders’ Equity (Deficit)		$	2,176,905			$	2,178,951

The accompanying notes are an integral part of these financial statements

CLEANTECH BIOFUELS, INC.
(formerly Alternative Ethanol Technologies, Inc.)
(A Development Stage Company)
CONSOLIDATED STATEMENTS OF OPERATIONS

														July 14, 2004
														(inception) to
		Years ended December 31,												December 31,
		2010				2009				2008				2010
Costs and expenses:
General and administrative		$	691,428			$	1,087,889			$	568,115			$	2,847,067
Professional fees			91,227				290,023				430,798				1,140,691
Research and development			—				693,146				392,471				1,217,847
			782,655				2,071,058				1,391,384				5,205,605
Other expense (income):
Interest			407,197				906,535				179,690				1,560,190
Amortization of technology license			—				—				15,000				35,000
Deposit forfeiture			—				—				—				(25,000	)
Other income			—				(32,000	)			—				(32,000	)
Interest income			(8,219	)			(11,771	)			(13,749	)			(55,144	)
			398,978				862,764				180,941				1,483,046
Income tax benefit			—				—				—				—
Net loss		$	1,181,633			$	2,933,822			$	1,572,325			$	6,688,651
Basic and diluted net loss per common share		$	0.02			$	0.05			$	0.03			$	0.13
Weighted average common shares outstanding			67,924,219				63,069,675				56,857,870				50,727,711

The accompanying notes are an integral part of these financial statements

CLEANTECH BIOFUELS, INC.
(formerly Alternative Ethanol Technologies, Inc.)
(A Development Stage Company)

Consolidated Statements of Changes in Stockholders’ Equity (Deficit)

														Notes Rec -
										Additional				restricted				July 14, 2004
		Common Stock								Paid-in				common				(inception) to
		Shares				Amount				Capital				stock				Dec 31, 2010
Balances at December 31, 2007			49,343,680				49,344				364,260				(90,000	)			(1,135,219	)
Conversion of promissory notes in March and April 2008 at $.15 per share			8,888,911				8,889				1,324,448
Shares released from escrow to HFTA in Sep-08 at $.52/share			962,562				962				499,570
Shares issued in accordance with Biomass North America Licensing, Inc. merger in Sep-08 at $.75/share			1,895,000				1,895				1,419,355
Discounts on Notes Payable											783,853
Issuance of restricted shares to Employees in Dec-08 at $.36 per share			180,000				180				64,620				(64,800	)
Interest on Notes Receivable															(7,767	)
Stock-based compensation											218,992
Net loss																			(1,572,325	)
Balances at December 31, 2008			61,270,153				61,270				4,675,098				(162,567	)			(2,707,544	)
Conversions of convertible notes in 2009 at $.25 per share			466,268				466				116,102
Conversions of convertible notes in 2009 at $.08 per share			687,500				688				35,967
Discounts on Notes Payable											391,069
Issuances of shares in August 2009 at $.13 per share for Net Issuance Elections for warrants			357,778				358				(358	)
Issuance of restricted shares in June and December 2009 at $.12 and $.06 per share, respectively			1,250,000				1,250				111,250				(112,500	)
Shares released from escrow to HFTA in Aug-09 at $.10/share			1,925,125				1,925				190,587
Issuance of restricted shares to Directors in Sep-09 at $.10 per share			300,000				300				29,700				(30,000	)
Interest on Notes Receivable															(11,771	)
Stock-based compensation											361,721
Net loss																			(2,933,822	)
Balances at December 31, 2009			66,256,824				66,257				5,911,136				(316,838	)			(5,641,366	)
Discounts on Notes Payable											128,054
Issuance of restricted shares to a Director in Feb-10 at $.10 per share			150,000				150				14,850				(15,000	)
Conversion of Debentures in Apr-10 at $.08 per share			2,069,375				2,069				163,480
Conversion of Convertible Note in June-10 at $.08 per share			133,480				134				10,545
Interest on Notes Receivable															(16,815	)
Expiration of certain Notes Receivable in Aug-10 at $.15 per share			(300,000	)			(300	)			(44,700	)			53,596
Stock-based compensation											118,361
Net loss																			(1,181,633	)
Balances at December 31, 2010			68,309,679			$	68,310			$	6,301,726			$	(295,057	)		$	(6,822,999	)

The accompanying notes are an integral part of these financial statements.

CLEANTECH BIOFUELS, INC.
(formerly Alternative Ethanol Technologies, Inc.)
(A Development Stage Company)

CONSOLIDATED STATEMENTS OF CASH FLOWS

														July 14, 2004
		Year Ended												(inception) to
		December 31,												December 31,
		2010				2009				2008				2010
Operating Activities
Net loss applicable to common stockholders		$	(1,181,633	)		$	(2,933,822	)		$	(1,572,325	)		$	(6,688,651	)
Adjustments to reconcile net loss applicable to common stockholders to net cash used by operating activities:
Items that did not use (provide) cash:
Common stock issued for organizational costs			—				—				—				100
Depreciation			10,531				19,220				28,572				58,579
Amortization			—				—				15,000				35,000
Interest income			(8,219	)			(11,771	)			(7,767	)			(27,757	)
Amortization of discounts (interest expense) and other financing charges			287,968				815,526				138,952				1,242,444
Share-based compensation expense			118,361				361,721				218,992				738,203
Write-off of technology license			—				693,045				97,500				790,545
Fair value of RAM warrant settlement			—				—				—				125,027
Changes in operating assets and liabilities that provided (used) cash, net:
Prepaids and other current assets			7,191				53,440				3,681				(7,531	)
Technology license			—				—				—				(132,500	)
Accounts payable			90,052				63,973				146,937				392,950
Other assets and other liabilities			118,574				113,961				34,523				308,174
Accrued liabilities			312,142				109,443				29,650				487,835
Net cash used by operating activities			(245,033	)			(715,264	)			(866,285	)			(2,677,582	)
Cash Flows Provided (Used) by Investing Activities
Acquisition of patent, net			—				—				(150,000	)			(150,000	)
Merger of Biomass North America Licensing, Inc., net			—				—				(20,000	)			(20,000	)
Acquisition of HFTA technology, net			—				—				—				—
Expenditures for equipment			—				(20,702	)			(30,180	)			(54,237	)
Net cash used by investing activities			—				(20,702	)			(200,180	)			(224,237	)
Cash Flows Provided (Used) by Financing Activities
Advances — related parties			(10,615	)			(21,576	)			—				(32,373	)
Payments on capital lease, including interest			(4,959	)			(5,049	)			(3,787	)			(13,903	)
Series A Convertible Debentures, including interest			—				—				474,900				1,424,900
Issuance of Note Payable			100,000				—				—				100,000
Issuance of Convertible Notes Payable			385,000				958,500				607,000				1,950,500
Payments on Note Payable			(219,332	)			(291,614	)			(35,387	)			(546,332	)
Sale of common stock			—				—				—				25,000
Net cash provided by financing activities			250,094				640,261				1,042,726				2,907,792
Net increase (decrease) in cash and cash equivalents			5,061				(95,705	)			(23,739	)			5,973
Cash and cash equivalents at beginning of period			912				96,617				120,356				—
Cash and cash equivalents at end of period		$	5,973			$	912			$	96,617			$	5,973

CLEANTECH BIOFUELS, INC.
(formerly Alternative Ethanol Technologies, Inc.)
(A Development Stage Company)
CONSOLIDATED STATEMENTS OF CASH FLOWS cont’d

														July 14, 2004
		Year Ended												(inception) to
		December 31,												December 31,
		2010				2009				2008				2010
Supplemental disclosure of cash flow information:
Cash paid for interest		$	721			$	3,036			$	1,174			$	10,967
Supplemental disclosure of noncash investing and financing activities:
Promissory notes receivable related to Series A Convertible Debentures		$	—			$	—			$	—			$	450,000
Capital lease related to the purchase of equipment		$	—			$	—			$	14,119			$	14,119
Common stock issued for organizational costs		$	—			$	—			$	—			$	100
Common stock issued for promissory notes		$	—			$	—			$	—			$	133,596
Common stock issued for Debentures converted		$	165,550			$	—			$	1,333,337			$	1,498,887
Common stock issued for convertible notes converted		$	10,678			$	153,009			$	—			$	182,770
Common stock and note payable issued for acquistion of Biomass		$	—			$	—			$	1,501,250			$	1,501,250
Common stock issued for HFTA		$	—			$	192,513			$	500,532			$	693,045

The accompanying notes are an integral part of these financial statements

CLEANTECH BIOFUELS, INC.
(A DEVELOPMENT STAGE COMPANY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 1 — Organization and Business

Alternative Ethanol Technologies, Inc. (the “Company”), was incorporated in Delaware on December 20, 1996. Effective August 2, 2007, the Company changed its name to CleanTech Biofuels, Inc.

On March 27, 2007, the Company acquired SRS Energy, Inc., a Delaware corporation (“SRS Energy”), pursuant to an Agreement and Plan of Merger and Reorganization. In accordance with the merger agreement, SRS Acquisition Sub, Inc., a Delaware corporation and wholly-owned subsidiary of the Company, merged with and into SRS Energy. The merger was consummated on May 31, 2007 and resulted in SRS Energy becoming a wholly-owned subsidiary of the Company. As a result of the merger, the stockholders of SRS Energy surrendered all of their issued and outstanding common stock and received shares of the Company’s common stock, $.001 par value per share (“Common Stock”). The former parent of SRS Energy, Supercritical Recovery Systems, Inc., immediately prior to the merger, distributed 78.8% of its 96% ownership in SRS Energy to its shareholders on a pro rata basis.

For accounting purposes, because the Company had been a public shell company prior to the merger, the merger was treated as an acquisition of the Company and a recapitalization of SRS Energy. As a result, the historical information of the Company prior to the merger is that of SRS Energy. In addition, historical share amounts have been restated to reflect the effect of the merger.

The Company is a development stage company that has been engaged in technology development and pre-operational activities since its formation. The Company is currently in the process of raising capital to design and build a commercial biomass recovery plant to provide biomass feedstock for customer evaluation and trial purchases. Initially, the biomass feedstock output will be sold or provided to electric utilities, power and steam producers, and biofuel and chemical research firms for evaluation. In addition to research and development, the Company is also working towards licensing and/or developing potential commercial projects. These projects plan to focus on cleaning and separating municipal solid waste (also referred to as MSW) into its component parts in order to obtain: (i) a homogenous feedstock of cellulosic biomass for producing energy and other chemical products and (ii) recyclable products (metals, plastics, aluminum).

The Company has no operating history as a producer of biomass or energy sources and has not constructed any plants to date. We have no revenues and will be required to raise additional capital in order to execute our business plan and commercialize our products. Our current cash is not sufficient to fund our current operations. Our liabilities are substantially greater than our current available funds. Although we continue to seek additional financing through the sale of additional equity, various government funding opportunities and/or possibly through strategic alliances with larger energy or waste management companies, we have not had recent success securing meaningful amounts of financing. The Company will require substantial additional capital to implement its business plan and it may be unable to obtain the capital required to do so. If we are not able to immediately and successfully raise additional capital and/or achieve profitability or positive cash flow, we may not be able to continue operations.

As previously disclosed in our Forms 8-K and 8-K/A filed in October 2010 and January 2011, respectively, the Company’s financial statements for the years ended December 31, 2008 and 2009 required re-audits due to our previous independent registered public accounting firm having its registration with the Public Company Accounting Oversight Board revoked in December 2010. Included in this report are our financial statements for the years ended December 31, 2008 and 2009 with no adjustments from those previously issued.

Note 2 — Summary of Significant Accounting Policies

Use of Estimates — The preparation of financial statements in conformity with United States generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Management makes these estimates using the best information available at the time the estimates are made; however, actual results could differ materially from those estimates.

Except where otherwise noted, the words “we,” “us,” “our,” and similar terms, as well as “Cleantech” or the “Company,” refer to Cleantech Biofuels, Inc. and its’ subsidiaries, collectively.

Consolidation — The financial statements include the accounts of Cleantech Biofuels, Inc. and its wholly owned subsidiaries, SRS Energy, Inc. and CTB Licensing, LLC. All significant intercompany transactions and balances are eliminated in consolidation.

Research and Development Costs — Research and development expenditures (which are comprised of costs incurred in performing research and development activities including wages and associated employee benefits, facilities and overhead costs), including payments to collaborative research partners are expensed as incurred.

Impairment of Long-Lived Assets — The Company continually evaluates whether events and circumstances have occurred that indicate the remaining estimated useful life of long-lived assets may warrant revision or that the remaining balance may not be recoverable primarily through reviewing changes in business plans and use of such assets. When factors indicate that an asset should be evaluated for possible impairment, the Company reviews long-lived assets to assess future use or recoverability of such asset. Impairments are recognized in earnings to the extent that the carrying value exceeds fair value. Impairment losses of approximately $690,000 and $97,500 were recorded in the years ended December 31, 2009 and 2008, respectively. See further footnote disclosures for details of these impairments.

Intellectual Property — Intellectual property, consisting of our licensed/owned patents and other proprietary technology, are stated at cost and will be amortized on a straight-line basis over their economic estimated useful life. Costs and expenses incurred in creating intellectual property are expensed as incurred. The cost of purchased intellectual property is capitalized. Amortization of these assets has not yet begun as the assets have not been placed in service as we have not yet commenced operations.

Property, plant and equipment — Newly acquired property, plant and equipment are carried at cost less accumulated depreciation. Depreciation is provided over the estimated useful lives of the assets, on the straight-line method for financial reporting purposes. Expenditures for maintenance and repairs are charged to expense as incurred.

Income Taxes — The Company accounts for income taxes in accordance with accounting guidance, which requires the Company to provide a net deferred tax asset/liability equal to the expected future tax benefit/expense of temporary reporting differences between financial statement and tax accounting methods and any available operating loss or tax credit carry forwards. The deferred tax assets and liabilities represent the future tax return consequences of those differences, which will either be deductible or taxable when the assets and liabilities are recovered or settled. Deferred taxes also are recognized for operating losses and tax credits that are available to offset future taxable income.

The standards on accounting for uncertainty in income taxes (incorporated into the FASB Accounting Standards Codification (Codification) Topic 740, Income Taxes, effective for periods ending after September 15, 2009) clarify the accounting and recognition for income tax positions taken or expected to be taken in the Company’s income tax returns. The Company’s income tax filings are subject to audit by various taxing authorities. The Company’s open audit periods are 2007-2010. In evaluating the Company’s tax provisions and accruals, future taxable income, and the reversal of temporary differences, interpretations and tax planning strategies are considered. The Company believes their estimates are appropriate based on facts and circumstances.

Convertible Notes Payable and Warrants — The Company has issued Convertible Promissory Notes (“Notes”). These Notes may be converted at the option of the noteholder into shares of the Company’s common stock. Additionally, these Notes carry warrants for shares of the Company’s common stock. These promissory notes have been recorded as short-term debt (notes payable) in the financial statements, net of discounts for the conversion and warrant features. The discounts are being amortized on a straight-line basis over the term of each note.

Stock-based compensation — The Company accounts for stock-based compensation in accordance with accounting guidance that requires measuring all stock-based compensation awards at fair value and recognizing an expense in the financial statements. In March 2007, the Company adopted the 2007 Stock Option Plan (“Stock Plan”) for its employees, officers, directors and consultants. The Company has reserved a maximum of 14,000,000 shares of common stock to be issued for stock options or shares of restricted stock under the Stock Plan. We compensate certain employees, officers, directors and consultants with stock-based payment awards and recognize compensation costs for these awards based on their fair values and expense is recognized over the requisite service period. The fair values of certain awards are estimated on the grant date using the Black-Scholes-Merton option-pricing formula, which incorporates certain assumptions including the expected term of an award and expected stock price volatility. Our key assumptions are described in further detail in the Share-Based Payments Note to the Consolidated Financial Statements.

Fair Value Measurement — We use fair value accounting and reporting to specify a hierarchy of valuation techniques based upon whether the inputs to those valuation techniques reflect assumptions other market participants would use based upon market data obtained from independent sources or reflect our own assumptions of market participant valuation. The hierarchy is broken down into three levels based on the reliability of the inputs as follows:

•

Level 1 — Quoted prices in active markets that are unadjusted and accessible at the measurement date for identical, unrestricted assets or liabilities;

•

Level 2 — Quoted prices for identical assets and liabilities in markets that are not active, quoted prices for similar assets and liabilities in active markets, or financial instruments for which significant inputs are observable, either directly or indirectly;

•

Level 3 — Prices or valuations that require inputs that are both significant to the fair value measurement and unobservable.

As of and during the year ended December 31, 2010, we utilized Level 1 inputs to determine the fair value of cash equivalents and we utilized Level 2 inputs to determine the fair value of certain long-lived assets.

Contingent Liabilities — We are, from time to time, subject to litigation to our business. Assessments regarding the ultimate cost of lawsuits require judgments concerning matters such as the anticipated outcome of negotiations, the number and cost of pending and future claims, and the impact of evidentiary requirements. A significant amount of judgment and use of estimates is required to quantify our ultimate exposure in these matters. We regularly review the valuation of these liabilities and account for changes in circumstances for ongoing and emerging issues. The Company intends to defend itself vigorously in all litigation. The Company is not currently in any litigation and is not aware of any pending litigation against the Company.

Dividends — We have no material operating history and therefore have had no earnings to distribute to stockholders. We currently intend to retain our earnings, if any, and reinvest them in the development and growth of our business and do not foresee payment of a dividend in any upcoming fiscal period.

Net Loss per Common Share — The Company calculates basic loss per share (“EPS”) and diluted EPS. Basic loss per share is computed as net loss divided by the weighted average number of common shares outstanding for the period. Diluted EPS would reflect the potential dilution that could occur from common shares issuable through stock options, warrants, and other convertible securities. As of December 31, 2010, 2009 and 2008, the Company had options, warrants and convertible notes to purchase an aggregate of approximately 44 million, 32 million and 21 million shares of common stock, respectively, that were excluded from the calculation of diluted loss per share as their effects would have been anti-dilutive. Therefore, the Company only presents basic loss per share on the face of the statements of operations and in its disclosure of unaudited quarterly financial data in Note 14.

Recent Accounting Pronouncements — In December 2010, the FASB issued accounting guidance on Business Combinations regarding how public entities disclose supplemental pro forma information for business combinations that occur during the year. Entities that present comparative financial statements for business combinations must disclose the revenue and earnings of the combined entity as though the business combination that occurred during the current year had occurred as of the beginning of the prior annual reporting period. The authoritative guidance also expanded the disclosures for entities to provide the nature and amount of material, nonrecurring pro forma adjustments directly related to the business combination that is included in the reported pro forma revenue and earnings. The authoritative guidance is effective for business combinations completed in the periods beginning after December 15, 2010 and is applied prospectively as of the date of adoption. We adopted the authoritative guidance on January 1, 2011.

In December 2010, the FASB issued accounting guidance on Intangibles—Goodwill and Other, which requires entities with a zero or negative carrying value to assess, considering qualitative factors, whether it is more likely than not that a goodwill impairment exists, the entity must perform step 2 of the goodwill impairment test. The authoritative guidance does not prescribe a specific method of calculating the carrying value of a reporting unit in the performance of step 1 of the goodwill impairment test. The authoritative guidance is effective for impairment tests performed for fiscal years beginning after December 15, 2010. We adopted the authoritative guidance on January 1, 2011.

In February 2010, the FASB accounting guidance on Amendments to Certain Recognition and Disclosure Requirements, which amends authoritative guidance on certain implementation issues related to the requirement for entities to perform and disclose subsequent events procedures. The authoritative guidance requires SEC filers to evaluate subsequent events through the date the financial statements are available to be issued and exempts SEC filers from disclosing the date through which subsequent events have been evaluated. The authoritative guidance was effective immediately for financial statements that are issued or available to be issued. We adopted the authoritative guidance as of January 1, 2010, and it did not have a material impact on our consolidated financial statements.

In January 2010, the FASB issued an amendment to the fair value measurement and disclosure standard improving disclosures about fair value measurements. The guidance requires additional disclosure for transfer activity pertaining to Level 1 and 2 fair value measurements and purchase, sale, issuance, and settlement activity for Level 3 fair value measurements. The guidance for the Level 1 and 2 disclosures was adopted on January 1, 2010 and did not have an impact on our consolidated financial statements. The guidance for the activity in Level 3 disclosures is effective for fiscal years beginning after December 15, 2010. The Company had no transfers between Level 1, 2 or 3 inputs during the year ended December 31, 2010.

On July 1, 2009, the FASB released the Codification becoming the single source of authoritative nongovernmental generally accepted accounting principles (GAAP) in the United States of America. The Codification is a reorganization of current GAAP into a topical format that eliminates the current GAAP hierarchy and establishes two levels of guidance — authoritative and non-authoritative. According to the FASB, all “non-grandfathered, non-SEC accounting literature” that is not included in the Codification would be considered non-authoritative. The FASB has indicated that the Codification does not change current GAAP. Instead, the proposed changes aim to (1) reduce the time and effort it takes for users to research accounting questions and (2) improve the usability of current accounting standards. The Codification is effective for interim and annual periods ending after September 15, 2009.

Note 3 — Mergers/Acquisitions

On September 15, 2008, the Company consummated the acquisition of Biomass North America Licensing, Inc. (“Biomass”) pursuant to a merger between Biomass and a wholly-owned subsidiary of the Company (with Biomass as the surviving subsidiary of the Company) in accordance with an Agreement and Plan of Merger by and between the Company and Biomass. By virtue of the merger, the Company acquired a license agreement pursuant to which the Company holds a license in the United States and Canada to use patented technology owned by Biomass North America, LLC, the former parent of Biomass (the “Licensor”), to clean and separate MSW (the “Biomass Recovery Process”). In July 2010, the United States Patent and Trademark Office issued US patent number 7,745,208 for this process (the “BRP Patent”).

Upon consummation of the merger, the Company paid $20,000 in cash and issued a promissory note in the original principal amount of $80,000 bearing interest at an annual rate of 6% (the “Note”) to a shareholder of the Licensor. This note has been paid in full. Additionally, the Company issued to the four shareholders of the Licensor a total of 1,895,000 shares of Common Stock and deposited an additional 4,000,000 shares of Common Stock into an escrow account (collectively, the “Shares”). The Shares were issued as part of the merger consideration received by the shareholders of the Licensor. The escrowed shares will be released to the Licensor’s shareholders if and when the Company commences a commercial development that utilizes the Biomass Recovery Process. The Company recorded a long-term asset of $1.5 million which it will begin to amortize upon utilizing the license in our operations. If the escrowed shares are released based on the specified future events, an increase to the value of the asset will be recorded at that time. Based on the market value of Common Stock as of December 31, 2010, it would result in an increase of approximately $160,000 to the asset. Any future increase in the value of the asset would depend on the market value of our Common Stock at the time of utilization.

Note 4 — Property and Equipment

At December 31, our property and equipment consisted of:

		December 31,
		2010				2009
Computers		$	7,999			$	8,857
Furniture and fixtures			15,799				15,799
Plant and equipment			18,700				18,700
			42,498				43,356
Accumulated Depreciation			(32,721	)			(23,048	)
Total		$	9,777			$	20,308

For the years ended December 31, 2010 and 2009, we had depreciation expense of $10,531 and $19,220, respectively. In 2009, we sold equipment that was fully depreciated resulting in a gain of $7,000, which is recorded in Other Income on the Statement of Operations for the year ended December 31, 2009.

Note 5 — Patent

On October 22, 2008, the Company completed the purchase of Patent No. 6,306,248 (the “PSC Patent”), pursuant to a Patent Purchase Agreement (“Agreement”) with World Waste Technologies, Inc. (“WWT”). The PSC Patent is the basis for the pressurized steam classification technology from which our Biomass Recovery Process was developed. As part of the acquisition of the PSC Patent, we also became the licensor of such technology to Bio-Products International, Inc. Upon signing the Agreement, the Company paid WWT $150,000, issued a note in the amount of $450,000 (interest at 6.0% per annum and secured by a security interest in the PSC Patent) and issued warrants to purchase 900,000 shares of Common Stock at a price of $0.45 per share and to purchase an additional 900,000 shares of Common Stock at a price of $0.45 per share contingent on payment of the note by July 22, 2009 (the original maturity date). WWT assigned all of its rights, title and interest in the note, warrants, security agreement and purchase agreement to Vertex Energy, Inc. (“Vertex”) as a result of a merger in March 2009. We entered into amendments dated July 23, 2009 whereby: (i) the Company paid 10% of the original note and all accrued interest to date, (ii) all previous warrants (totaling 1,800,000 shares) were reissued at a price of $0.11 per share with no contingencies and (iii) the remaining payments on the note were scheduled to be paid on October 22, 2009 (50% of principal plus accrued interest to date not yet paid) and January 22, 2010 (remaining principal and accrued interest to date). We entered into amendments dated October 22, 2009 whereby: (i) the October 22, 2009 payment was deferred until November 22, 2009 and (ii) we issued additional warrants to Vertex for 500,000 shares of Common Stock at a price of $0.10 per share. The warrants are exercisable at any time for five years from the date of issuance or reissuance. The cost of the PSC Patent acquisition of $600,000 is recorded as a long-term asset on the Balance Sheet. The value of the warrants had been recorded as a contra-balance amount with the note and has been fully amortized through interest expense. The note had been recorded as short-term debt (notes payable) in the financial statements, net of the discount for the warrant feature. This note was paid in full in September 2010. For the year ended December 31, 2010 and 2009, amortization of this discount of approximately $7,000 and $178,000, respectively, has been recorded in interest expense.

On September 1, 2010, the Company issued a promissory note to CMS Acquisition, LLC (“CMS”) in the amount of $100,000 and entered into a related Security Agreement. The Note matures on February 28, 2011 (see Subsequent Event footnote for extension of due date), bears interest at 6.0% per annum and is secured by a security interest in the PSC Patent. In connection with the financing, the Company issued a warrant to CMS to purchase 2,000,000 shares of the Company’s Common Stock at a price of $0.05 per share. The warrant is exercisable at any time for five years from the date of issuance.

Note 6 — Technology Licenses

Biomass North America Licensing, Inc.

On September 15, 2008, in connection with the acquisition of Biomass described in Note 3 — Mergers/Acquisitions, we acquired a license in the United States and Canada to use technology owned by Biomass North America, LLC, the former parent of Biomass (the “Licensor”), to clean and separate MSW into cellulosic biomass feedstock, which we refer to as the Biomass Recovery Process. In July 2010, the United States Patent and Trademark Office issued US Patent number 7,745,208 for this process (the “BRP Patent”). As a result of the merger, a long-term asset of $1.5 million was recorded for the value of this license. Amortization of this asset will begin upon commencement of the use of the Biomass Recovery Process. The Company also deposited an additional 4,000,000 shares of the Company’s Common Stock into an escrow account for the benefit of the Licensor. For accounting purposes, the shares remaining in escrow are not considered issued and outstanding as a project has not started using the Biomass Recovery Process. The shares are not deemed issued or vested until that time as described above.

The license requires that the Company pay a royalty in the amount of $1.00 per ton of bone-dry biomass produced using the Biomass Recovery Process. The license agreement is for a term of 21 years or the life of any patent issued for the Biomass Recovery Process. The Company has an exclusive license in the United States and Canada to use the Biomass Recovery Process, except that a principal owner of the Licensor has the right of first offer to manage and operate with respect to any development commenced using the licensed technology within 100 miles of the City of Chicago, Illinois. The license agreement further provides that the Company and the Licensor will work in good faith to complete a commercial development in the City of Chicago using the Biomass Recovery Process.

HFTA, Inc.

On March 20, 2008, the Company entered into a license agreement with HFTA, Inc. (“HFTA”) granting the Company the exclusive worldwide right to use the HFTA technology for the production of ethanol from MSW. The terms in the original agreement required us to pay an initial license fee of $25,000 to HFTA on execution of the agreement and a second license fee of $150,000 on September 1, 2009 if we were using the technology at that time. On August 24, 2009, we entered into an amendment with HFTA that moved the September 1, 2009 payment, plus interest at 6% per annum from the date of the amendment, to March 1, 2010.

Additionally, we deposited 2,887,687 shares of our Common Stock into an escrow account on May 12, 2008. The shares held in escrow were released to HFTA as follows: the first third of the shares (962,562 shares) were released from escrow on September 20, 2008 (six months from the date of the original agreement) and the remaining 1,925,125 shares were released upon the amendment in August 2009. As a result, the Company recorded an asset for the value of the first third share payment of approximately $500,000 in September 2008 and recorded an addition to the asset of approximately $190,000 related to the release of the remaining shares in August 2009. During the fourth quarter 2009, the Company decided not to use this technology going forward in our operations and thus have written off the asset as of December 31, 2009. The impairment loss of approximately $690,000 is included in research and development expense on the statement of operations for the year ended December 31, 2009.

Bio-Products International, Inc.

On August 17, 2005, the Company entered into a license agreement with Bio-Products International, Inc. (“Bio-Products”) giving the Company limited exclusive rights to use the PSC Patent to process MSW and convert the cellulosic component of that waste to a homogenous feedstock to produce ethanol in the United States, subject to the right of Bio-Products to request five sites to construct MSW-to-ethanol plants in the United States. The Company’s license with Bio-Products was for a period of twenty years. Under the license, Bio-Products was to be paid a process royalty of $1.50 for every ton of waste received and processed at each facility to be constructed and operated under the agreement. The Company also was required to pay a by-product royalty of 2.5 percent of the gross sales price in excess of $10 per ton obtained from the sale of recyclable by-products, excluding the cellulosic biomass. Bio-Products would also have been paid a monthly fee for technical services to be provided by Bio-Products for each facility to be constructed and operated which initially would have been $10,000 per month and increase to $20,000 per month when vessels for processing waste are ordered for the facility. The $20,000 per month fee would have continued until construction of a facility was completed. The Company’s litigation involving Bio-Products was settled in March 2009 and as a result, this sublicense has been mutually terminated by all parties.

As disclosed in Note 5 — Patent, the Company acquired the PSC Patent pursuant to an Agreement with WWT. The Company is now the licensor to Bio-Products for the PSC Patent. Bio-Products (a wholly-owned subsidiary of Clean Earth Solutions, Inc., “CES”) is the exclusive licensee of the PSC Patent and has the right to sublicense the technology that is part of the PSC Patent (but not the BRP Patent) to any party. Under the Master License Agreement, we are entitled to be paid 5% of any revenue derived by Bio-Products from the use of the technology and 40% of any sublicensing fees paid to Bio-Products for the use of the technology. The Master License Agreement is for a term of 20 years that commenced on August 18, 2003. On September 22, 2010, the Company sent a Notice of Breach to the licensee of our PSC Patent. We received a response from the licensee on November 5, 2010. In February 2011, we became aware that the licensee effected a transfer of the license in violation of the License Agreement. As a result, on March 21, 2011, we sent a notice of termination to the licensee and the transferee terminating the License Agreement.

All intangible assets are reviewed for impairment whenever events or other changes in circumstances indicate that the carrying amount may not be recoverable. An impairment charge is recognized if the carrying amount of an intangible asset exceeds its implied fair value.

Note 7 — Debt

		December 31,
		2010				2009
Convertible Notes Payable, net of discounts of $-0- and $7,137 at December 31, 2010 and 2009, respectively, which are made up of various individual notes with an aggregate face value of $-0- and $502,000 at December 31, 2010 and 2009, respectively, interest at 6.0%		$	—			$	494,863
Convertible Notes Payable, net of discounts of $26,596 and $187,880 at December 31, 2010 and 2009, respectively, which are made up of various individual notes with an aggregate face value of $1,703,329 and $898,500 at December 31, 2010 and 2009, respectively, due in one year from date of note, interest at 6.0%			1,676,733				710,620
Convertible Notes Payable, net of discounts of $-0- and $-0- at December 31, 2010 and 2009, respectively, which are made up of various individual notes with an aggregate face value of $35,000 and $-0- at December 31, 2010 and 2009, respectively, due in one year from date of note, interest at 6.0%			35,000				—
CMS Acquisition, LLC Note Payable, net of discount of $3,492 and $-0- at December 31, 2010 and 2009, respectively, with a face value of $100,000 and $-0- at December 31, 2010 and 2009, respectively, due on February 28, 2011, interest at 6.0%			96,508				—
Convertible Note Payable, net of discounts of $11,573 and $-0- at December 31, 2010 and 2009, respectively, which is made up of an individual note with a face value of $75,000 and $-0- at December 31, 2010 and 2009, respectively, due in one year from date of note, interest at 12.0%			63,427				—
Vertex (formerly WWT) Note Payable, net of discount of $-0- and $6,558 at December 31, 2010 and 2009, respectively, with a face value of $-0- and $203,000, respectively. Repaid September 1, 2010, interest at 6.0%			—				196,442
Series A Convertible Debentures, converted April 16, 2010, interest at 6.0%			—				140,000
Total debt			1,871,668				1,541,925
Current maturities			(1,871,668	)			(1,541,925	)
Long-term portion, less current maturities		$	—			$	—

Convertible Notes Payable

During September 2008, the Company commenced an offering of units comprised of a convertible promissory note and a warrant. The Company raised a total of $642,000 of investment proceeds through March 31, 2009 and this offering is closed. As of March 31, 2010, all of these notes have either been converted to shares of our common stock or re-priced to our second convertible note offering (resulting in new notes with a total face value of $539,829, which included the original principal and interest through the date of re-pricing). Each convertible promissory note carried a one-year term and a 6% interest rate. In addition, each note could have been converted, at the note holder’s option, at any time during the one-year term into shares of Common Stock at $0.25 per share, or prior to the closing of any Qualifying Equity Financing (minimum capital received of $5 million). Each note was issued with a warrant to purchase additional shares of Common Stock equal to the principal amount of the promissory note at a price of $0.45 per share. These promissory notes had been recorded as short-term debt (notes payable) in the financial statements, net of discounts for the conversion and warrant features. The discounts were being amortized on a straight-line basis over the term of each note and are fully expensed as of March 31, 2010. For the years ended December 31, 2010 and 2009, amortization of approximately $7,000 and $524,000, respectively, for this discount has been recorded in interest expense. All outstanding warrants related to this offering have also been re-priced into our second note offering.

During April 2009, the Company commenced another offering of units comprised of a convertible promissory note and a warrant. As of December 31, 2010, the Company had raised a total of $1,198,500 of investment proceeds and this offering is now closed. One note was converted during the second quarter of 2009 and one note was converted during the second quarter 2010 leaving $1,163,500 face value of notes outstanding ($1,703,329 after adding the notes from our first offering previously disclosed). Each convertible promissory note carries a one-year term and a 6% interest rate. In addition, each note can be converted, at the note holder’s option, at any time during the one-year term into shares of Common Stock at $0.08 per share, or prior to the closing of any Qualifying Equity Financing (minimum capital received of $5 million). Each note was issued with a warrant to purchase additional shares of Common Stock to provide for 100% coverage of the promissory note at a price of $0.30 per share. These promissory notes have been recorded as short-term debt (notes payable) in the financial statements, net of discounts for the conversion and warrant features. The discounts are being amortized on a straight-line basis over the term of each note. For the years ended December 31, 2010 and 2009, amortization of approximately $253,000 and $113,000, respectively, for this discount has been recorded in interest expense. These notes began maturing in April 2010. The notes that have matured, have not yet been repaid, refinanced or converted to shares of our common stock. We plan to work with each noteholder to extend the terms of, or convert, these promissory notes. There can be no assurance that we will reach agreements with any or all of these noteholders and we may be required to repay such amounts.

During June 2010, the Company commenced another offering of units comprised of a convertible promissory note and a warrant. As of December 31, 2010, the Company had raised a total of $75,000 of investment proceeds and is closed. Each convertible promissory note carries a one-year term, a 12% interest rate and a payback provision of the note if $250,000 or more in the aggregate is raised by the Company in future offerings. In addition, each note can be converted, at the note holder’s option, at any time during the one-year term into shares of Common Stock at $0.08 per share, or prior to the closing of any Qualifying Equity Financing (minimum capital received of $5 million). Each note was issued with a warrant to purchase additional shares of Common Stock to provide for 100% coverage of the promissory note at a price of $0.30 per share. The promissory note has been recorded as short-term debt (notes payable) in the financial statements, net of discounts for the conversion and warrant features. The discounts are being amortized on a straight-line basis over the term of each note. For the year ended December 31, 2010, amortization of approximately $14,000 for this discount has been recorded in interest expense.

During November 2010, the Company commenced another offering of units comprised of a convertible promissory note and a warrant. As of December 31, 2010, the Company had raised a total of $35,000 of investment proceeds. Each convertible promissory note carries a one-year term and a 6% interest rate. In addition, each note can be converted, at the note holder’s option, at any time during the one-year term into shares of Common Stock at $0.06 per share, or prior to the closing of any Qualifying Equity Financing (minimum capital received of $5 million). Each note was issued with a warrant to purchase additional shares of Common Stock to provide for 100% coverage of the promissory note at a price of $0.30 per share. These promissory notes have been recorded as short-term debt (notes payable) in the financial statements and carry no discounts. See the Subsequent Event footnote for an update on the continuation of this offering.

CMS Acquisition, LLC Note Payable

In September 2010, the Company issued a note in the amount of $100,000 (interest at 6.0% per annum and secured by a security interest in the PSC Patent) and issued warrants to purchase 2,000,000 shares of Common Stock at a price of $0.05 per share. The note is due the earlier of: (i) February 28, 2011 (see the Subsequent Event footnote for disclosure on extension of the due date) or (ii) the date on which $500,000 or more in the aggregate is raised by the Company in future offerings. The warrants are exercisable at any time for five years from the date of issuance or reissuance. The value of these warrants has been recorded as a contra-balance amount discount with the note and is being amortized through interest expense. For the year ended December 31, 2010, amortization of approximately $7,000 for this discount has been recorded in interest expense.

Vertex (formerly WWT) Note Payable

As disclosed previously, as part of the purchase of the PSC Patent, the Company issued a note in the amount of $450,000 (interest at 6.0% per annum and secured by a security interest in the PSC Patent) and issued warrants to purchase 900,000 shares of Common Stock at a price of $0.45 per share and to purchase an additional 900,000 shares of Common Stock at a price of $0.45 per share contingent on payment of the note by July 22, 2009 (the original maturity date). WWT assigned all of its rights, title and interest in the note, warrants, security agreement and purchase agreement to Vertex Energy, Inc. as a result of a merger in March 2009. We entered into amendments dated July 23, 2009 whereby: (i) the Company paid 10% of the original note and all accrued interest to date, (ii) all previous warrants (totaling 1,800,000 shares) were reissued at a price of $0.11 per share with no contingencies and (iii) the remaining payments on the note were scheduled to be paid on October 22, 2009 (50% of principal plus accrued interest to date not yet paid) and January 22, 2010 (remaining principal and accrued interest to date). We entered into amendments dated October 22, 2009 whereby: (i) the October 22, 2009 payment was deferred until November 22, 2009 and (ii) we issued additional warrants to Vertex for 500,000 shares of Common Stock at a price of $0.10 per share. The warrants are exercisable at any time for five years from the date of issuance or reissuance. This note was paid in full in September 2010. The value of these warrants has been recorded as a contra-balance amount discount with the note and is being amortized through interest expense over the life of the note. For the years ended December 31, 2010 and 2009, amortization of approximately $7,000 and $178,000, respectively, for this discount has been recorded in interest expense

Series A Convertible Debentures

In April 2007, the Company sold $1,400,000 of Series A Convertible Debentures (“Debentures”), due April 16, 2010, that convert into shares of the Company’s common stock at $.15 per share. The Company filed a registration statement with regard to the sale of these shares of common stock, which was declared effective by the Securities and Exchange Commission on January 2, 2008. The debentures accrue interest at 6% per annum. The interest is payable in cash or shares of the Company’s common stock at the Company’s option.

The Company received cash of $950,000 and Promissory Notes (“Notes”) with an aggregate principal amount of $450,000 that accrue interest at 6.0%. Effective with the listing of our common stock on the OTCBB on March 13, 2008 (previously traded on Pink Sheets) we received full payment on all principal and accrued interest on the Notes totaling approximately $475,000 on March 14, 2008.

During March 2008, various debenture holders converted an aggregate amount of $630,000 of our Debentures, plus interest earned, into 4,433,067 shares of our common stock. During April 2008, various debenture holders converted an aggregate amount of $630,000 of our Debentures, plus interest earned, into 4,455,844 shares of our common stock. The remaining $140,000 of Debentures matured on April 16, 2010 and, with interest earned, were converted into 2,069,375 shares of our common stock.

Note 8 — Stockholders’ Deficit

In March 2008, the Company issued 4,433,067 shares of Common Stock ($0.15 per share) upon the conversion of an aggregate amount of $630,000 of the Company’s Debentures and accrued interest of approximately $35,000. In April 2008, the Company issued 4,455,844 shares of Common Stock ($0.15 per share) upon the conversion of an aggregate amount of $630,000 of the Company’s Debentures and accrued interest of approximately $38,000.

In September 2008, the Company released 962,562 shares of Common Stock ($0.52 per share) to HFTA in accordance with the previously disclosed licensing agreement with HFTA representing one-third of the total shares escrowed as part of the compensation for the licensing agreement. The Company released the remaining 1,925,125 shares of Common Stock ($0.10 per share) to HFTA in accordance with the previously disclosed amendment to the licensing agreement with HFTA representing the remaining shares previously held in escrow.

In September 2008, the Company issued 1,895,000 shares of Common Stock ($0.75 per share) to Biomass in accordance with the previously disclosed merger agreement.

In December 2008, June, September and December 2009, the Company issued 180,000, 625,000, 300,000 and 625,000, respectively, of restricted shares of Common Stock at $0.36, $0.12, $0.10 and $0.06 per share, respectively, to employees, a consultant pursuant to the consulting agreement and directors. For all of these restricted common stock grants, each individual issued promissory notes to the Company in exchange for their stock purchases. See the share-based footnote for further details.

During 2009, the Company issued 466,268 shares of Common Stock ($0.25 per share) and 687,500 shares of Common Stock ($0.08 per share) to investors upon their conversions of Convertible Notes.

In August 2009, the Company issued 357,778 shares of Common Stock ($0.13 per share) to the holders of two separate warrants under the Net Issuance clause of the warrant agreements.

In February 2010, the Company issued 150,000 restricted shares of our common stock at $0.10 per share to our newly elected director. The director issued a promissory note to the Company in exchange for the stock purchases similar to the restricted share grants to all other directors. See the share-based footnote for further details.

In April 2010, the Company issued 2,069,375 shares of Common Stock ($0.08 per share) upon the conversion of $140,000 of the Company’s Debentures and accrued interest of approximately $25,000.

In June 2010, the Company issued 133,480 shares of Common Stock ($0.08 per share) to an investor upon the conversion of a Convertible Note.

In August 2010, certain notes receivable from former and current members of our Board of Directors matured. The notes were originally issued in August 2007 to purchase shares of our common stock. Two of the former directors declined to pay these notes or extend the due date. As a result, 300,000 shares of restricted stock, issued at $0.15 per share, were forfeited and cancelled. The two other Directors agreed to extend the due date of their notes to August 2012. As the notes were carried in additional paid-in capital, there was no effect on our financial results for the period from the write-off of these notes.

Note 9 — Related Party Transactions

The Company had a $72,103 advance from one of its board of director members at December 31, 2006 evidenced by a promissory note that accrued interest at 9.5% per annum. The promissory note also contained an option to acquire 5% of the outstanding capital stock of SRS Energy at a price of $250,000. In April 2007, the indebtedness under the promissory note was repaid and the promissory note was cancelled. Under its terms, the right to exercise the option to purchase shares survived after the repayment of the indebtedness under the note. As part of the merger consideration issued by the Company pursuant to the acquisition of SRS Energy, the Company issued a warrant exercisable until August 31, 2009 to purchase 1,923,495 shares of its common stock at $0.13 per share to replace the option included in the promissory note on substantially similar terms as the option. In August 2009, this warrant was exercised under the Net Issuance clause of the warrant agreement resulting in 178,889 shares being issued.

In September 2009 and February 2010, the Company entered into stock purchase agreements with certain members of the Board of Directors. In December 2008, the Company entered into stock purchase agreements with the executive officers. The directors and executive officers issued notes to the Company in exchange for their stock purchases. See Share-Based Payments footnote for further discussion. These notes and accumulated interest are recorded as notes receivable in Stockholders’ Deficit.

In August 2010, certain notes receivable from former and current members of our Board of Directors matured. The notes were originally issued in August 2007 to purchase shares of our common stock. Two of the former directors declined to pay these notes or extend the due date. As a result, 300,000 shares of restricted stock, issued at $0.15 per share, were forfeited and cancelled. The two other Directors agreed to extend the due date of their notes to August 2012.

The Company had engaged the law firm of Sauerwein, Simon and Blanchard (“SSB”) related to various issues including our reverse merger, our SB-2 registration statement, litigation matters and general business activity. A member of our board of directors is a partner of SSB. For the years ended December 31, 2010, 2009 and 2008, we incurred $-0-, $10 and $181,000, respectively, in legal fees with SSB. As of December 31, 2010, all amounts have been paid to SSB except for approximately $90,000.

The Company uses the Crane Agency (“Crane”) as its broker for business and property insurance. Our CEO’s brother was employed by Crane through 2010 and was involved in the negotiation of coverage and premiums related to policies. For the years ended December 31, 2010 and 2009, the Company paid less than $3,000 and $3,000, respectively, in commissions on policies placed by Crane.

Beginning in 2009, the Company has provided advances to two employees — Ed Hennessey and Mike Kime (Mr. Kime resigned from his positions with the Company effective June 21, 2010). As of December 31, 2010 and 2009, the aggregate balances of advances totaled approximately $20,000 and $22,000, respectively. The balances are included in Prepaids and Other Current Assets on the Balance Sheet.

Three members of our Board of Directors, Dr. Jackson Nickerson, Mr. Jose Bared, Sr. and David Bransby are parties in investments made in our convertible note offerings. As of December 31, 2010 and December 31, 2009, the aggregate amount due on these investments, including interest, is approximately $613,000 and $518,000, respectively.

Note 10 — Share-based Payments

The Company recognizes share-based compensation expense for all share-based payment awards including stock options and restricted stock issued to employees, directors and consultants and is measured at the grant date, based on the estimated fair value of the award, and is recognized as expense over the requisite service period. The Company has no awards with market or performance conditions.

In March 2007, the Company adopted the 2007 Stock Option Plan (“Stock Plan”) for its employees, directors and consultants, which includes an equity compensation plan for non-employee directors pursuant to which stock options and shares of restricted stock may be granted. The Company currently has reserved a maximum of 14,000,000 shares of common stock to be issued for stock options or restricted shares awarded under the Stock Plan.

The estimated fair value of stock option grants is computed using the binomial option-pricing model. Generally, expected volatility is based on historical periods commensurate with contractual term of options. However, since we have no history of stock price volatility as a public company at the time of the grants, we calculated volatility by considering historical volatilities of public companies in our industry. Due to the short history of our industry, the historical period used in our calculations is shorter than the contractual term of the options. The fair value for options granted was determined at the date of grant. The following assumptions were used for options granted in the corresponding year.

		For the years ended December 31,
		2010				2009				2008
Risk-free interest rate		1.76%-2.58%				2.44%				1.57%
Dividend yield		0%				0%				0%
Volatility		24.3%-28.9				29.58%				36.91%
Expected term (years)		5.0				5.0				4.8
Weighted-average Fair Value		$.02-$.03				$0.03				$0.12

Stock option expense is recognized in the statements of operations ratably over the vesting period based on the number of options that are expected to ultimately vest. Our options have characteristics significantly different from those of traded options and changes in the assumptions can materially affect the fair value estimates. The following table presents the components of share-based compensation recorded as general and administrative expense.

		For the Year Ended December 31,
		2010				2009				2008
Pre-tax compensation expense:
Stock options		$	118,361			$	361,721			$	218,992
Warrants			—				—				—
Total expense			118,361				361,721				218,992
Tax benefit, net			—				—				—
After-tax compensation expense		$	118,361			$	361,721			$	218,992

Related to all grants, the Company will record future compensation expense for stock options of approximately $25,000 for 2011. The potential tax benefit realizable for the anticipated tax deductions of the exercise of share-based payments pertaining to stock options totaled approximately $287,000 at December 31, 2010. However, due to the uncertainty that the tax benefits will be realized, these potential benefits were not recognized currently.

As of December 31, 2010, there was approximately $25,000 of unrecognized compensation cost related to all share-based payment arrangements, which will be recognized over a remaining period of approximately 1.3 years. There are 613,333 options granted that are not yet vested as of December 31, 2010. These options have a weighted average exercise price of $0.20.

A summary of the Company’s stock option activity and related information as of and for the three years ended December 31, 2010, is set forth in the following table:

						Weighted				Aggregate
		Shares Under				Average				intrinsic
		Option				Exercise Price				value
Options outstanding at December 31, 2007			4,010,000			$	0.15				(1	)
Granted			2,500,000				0.26
Exercised			—
Forfeited			—
Options outstanding at December 31, 2008			6,510,000			$	0.19				(1	)
Granted			305,000				0.10
Exercised			—
Forfeited			—
Options outstanding at December 31, 2009			6,815,000			$	0.19				(1	)
Granted			322,000				0.07
Exercised			—
Forfeited			(1,600,000	)			0.26
Options outstanding at December 31, 2010			5,537,000			$	0.16				(1	)
Options exercisable at December 31, 2010			4,923,667			$	0.14				(1	)