S-1/A 1 d257673ds1a.htm AMENDMENT NO. 1 TO FORM S-1 Amendment No. 1 to Form S-1
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As filed with the Securities and Exchange Commission on December 1, 2011

Registration No. 333-168742

 

 

 

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

Amendment No. 1

to

Form S-1

REGISTRATION STATEMENT

UNDER

THE SECURITIES ACT OF 1933

 

 

PetroAlgae Inc.

(Exact name of registrant as specified in its charter)

 

Delaware   2860   33-0301060
(State or other jurisdiction of
incorporation or organization)
  (Primary Standard Industrial
Classification Code Number)
  (I.R.S. Employer
Identification Number)

 

 

1901 S. Harbor City Blvd., Suite 600

Melbourne, FL 32901

(321) 409-7500

(Address, including zip code, and telephone number, including area code, of registrant’s principal executive offices)

 

 

Anthony John Phipps Tiarks

Chief Executive Officer

PetroAlgae Inc.

1901 S. Harbor City Blvd., Suite 600

Melbourne, FL 32901

(321) 409-7500

(Name, address, including zip code, and telephone number, including area code, of agent for service)

 

 

With copies to:

 

Andrew J. Beck, Esq.

Daniel P. Raglan, Esq.

Torys LLP

1114 Avenue of the Americas

New York, NY 10036

(212) 880-6000

 

James P. Dietz

Chief Financial Officer

PetroAlgae Inc.

1901 S. Harbor City Blvd., Suite 600

Melbourne, FL 32901

(321) 409-7500

 

Robert E. Buckholz, Jr., Esq.

Sullivan & Cromwell LLP

125 Broad Street

New York, NY 10004

(212) 558-4000

 

 

Approximate date of commencement of proposed sale to the public: As soon as practicable after the effective date of this Registration Statement.

 

 

If any of the securities being registered on this Form are to be offered on a delayed or continuous basis pursuant to Rule 415 under the Securities Act of 1933, check the following box.  ¨

If this Form is filed to register additional securities for an offering pursuant to Rule 462(b) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.  ¨

If this Form is a post-effective amendment filed pursuant to Rule 462(c) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.  ¨

If this Form is a post-effective amendment filed pursuant to Rule 462(d) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.  ¨

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   ¨     Accelerated filer   ¨
Non-accelerated filer   x   (Do not check if a smaller reporting company)   Smaller reporting company   ¨

 

 

The registrant hereby amends this registration statement on such date or dates as may be necessary to delay its effective date until the registrant shall file a further amendment which specifically states that this registration statement shall thereafter become effective in accordance with Section 8(a) of the Securities Act of 1933, as amended, or until this registration statement shall become effective on such date as the Securities and Exchange Commission, acting pursuant to said Section 8(a), may determine.


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The information in this preliminary prospectus is not complete and may be changed. We and the selling stockholders may not sell these securities until the registration statement filed with the Securities and Exchange Commission is effective. This preliminary prospectus is not an offer to sell these securities and it is not soliciting offers to buy these securities in any jurisdiction where such offer or sale is not permitted.

 

Subject to Completion. Dated December 1, 2011.

Shares

LOGO

Common Stock

 

 

This is an initial public offering of shares of the common stock of PetroAlgae Inc.

PetroAlgae is offering              of the shares to be sold in this offering. The selling stockholders identified in this prospectus are offering an additional              shares in this offering. PetroAlgae will not receive any of the proceeds from the sale of the shares being sold by the selling stockholders.

Our common stock is currently quoted on the OTCQB under the symbol “PALG.” On November 30, 2011, the last reported sale price of our common stock was $5.50. It is currently estimated that the initial public offering price per share will be between $             and $            .

Application has been made for listing on              under the symbol “        ”.

Investing in our common stock involves a high degree of risk. See “Risk Factors” on page 15 to read about factors you should consider before buying shares of our common stock.

Neither the Securities and Exchange Commission nor any other regulatory body has approved or disapproved of these securities or passed upon the accuracy or adequacy of this prospectus. Any representation to the contrary is a criminal offense.

 

 

 

     Per Share      Total  

Initial public offering price

   $                    $                

Underwriting discount

   $         $     

Proceeds, before expenses, to PetroAlgae

   $         $     

Proceeds, before expenses, to the Selling Stockholders

   $         $     

The underwriters have the option, exercisable until the date which is              days following the closing of this offering, to purchase up to an additional              shares at the initial public offering price less the underwriting discount.

 

 

The underwriters expect to deliver the shares against payment in New York, New York on                     , 2012.

 

Goldman, Sachs & Co.    UBS Investment Bank    Citigroup

 

 

 

Baird    Cowen and Company

Prospectus dated                     , 2012.


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TABLE OF CONTENTS

 

     Page  

PROSPECTUS SUMMARY

     1   

THE OFFERING

     11   

SUMMARY CONSOLIDATED FINANCIAL DATA

     13   

RISK FACTORS

     15   

SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS

     30   

USE OF PROCEEDS

     31   

DIVIDEND POLICY

     32   

MARKET INFORMATION

     33   

CAPITALIZATION

     34   

DILUTION

     35   

SELECTED CONSOLIDATED FINANCIAL DATA

     37   

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

     38   

BUSINESS

     60   

MANAGEMENT

     79   

EXECUTIVE COMPENSATION

     85   

RELATIONSHIPS AND RELATED PARTY TRANSACTIONS

     93   

PRINCIPAL AND SELLING STOCKHOLDERS

     97   

DESCRIPTION OF CAPITAL STOCK

     99   

SHARES ELIGIBLE FOR FUTURE SALE

     105   

MATERIAL U.S. FEDERAL INCOME AND ESTATE TAX CONSIDERATIONS FOR NON-U.S. HOLDERS OF OUR COMMON STOCK

     107   

UNDERWRITING

     110   

VALIDITY OF COMMON STOCK

     116   

EXPERTS

     117   

WHERE YOU CAN FIND MORE INFORMATION

     118   

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

     F-1   

Neither we nor the selling stockholders have authorized anyone to provide any information or to make any representations other than those contained in this prospectus or in any free writing prospectuses we have prepared. Neither we nor the selling stockholders take any responsibility for, and can provide any assurance as to the reliability of, any other information that others may give you. This prospectus is not an offer to sell these securities and it is not soliciting offers to buy these securities in any jurisdiction where such offer or sale is not permitted. The information contained in this prospectus is current only as of its date. Our business, financial condition, results of operations and prospects may have changed since that date.

For investors outside the United States, neither we, the selling stockholder nor any of the underwriters have done anything that would permit this offering or possession or distribution of this prospectus in any jurisdiction where action for that purpose is required, other than in the United States. You are required to inform yourselves about and to observe any restrictions relating to this offering and the distribution of this prospectus.

 

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PROSPECTUS SUMMARY

This summary highlights information contained elsewhere in this prospectus and does not contain all of the information that you should consider before deciding to invest in our common stock. Before investing in our common stock, you should carefully read this entire prospectus, including our audited consolidated financial statements and the related notes thereto and the information set forth under the sections “Risk Factors” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” in each case included in this prospectus. Unless otherwise stated, (1) we use the terms “PetroAlgae,” “company,” “we,” “us” and “our” in this prospectus to refer to PetroAlgae Inc. and its sole operating subsidiary, PA LLC, (2) we use the term “selling stockholders” in this prospectus to refer to                                                                      , and (3) information presented in this prospectus assumes that the underwriters do not exercise their option to purchase additional shares.

Our Company

We provide renewable technology and solutions to address the global demand for new economical sources of feed, food and fuel.

Our objective is to be the leading global provider of technology and processes for the commercial production of micro-crop biomass. We have developed proprietary technology, which we believe will allow our customer licensees to grow aquatic micro-crops at accelerated rates for conversion into products for both agriculture and energy markets. We seek to license this renewable technology to meet the significant and growing demand in these markets in both emerging and developed economies. Furthermore, we expect that our solution will deliver strong and consistent economic returns to our customer licensees as a consequence of continuous, predictable, year-round operations without the need for government subsidies.

Our strategy is to license and provide management support for micro-crop production facilities in equatorial regions around the world. Our solution is scalable and flexible, which we believe will allow our customer licensees to expand in order to meet market demand. We intend to generate revenue from licensing fees and royalties primarily from customer licensees. Our licensing approach is designed to minimize our capital expenditures, because our customer licensees will be expected to invest in the development and construction of the production facilities.

Our proprietary technology uses indigenous micro-crops that are not genetically modified and demonstrate an optimal growth profile for a particular geography and environment. These micro-crops will then be grown, harvested and processed in a manner that we believe will optimize the production of our micro-crop biomass, which our customer licensees can use to produce three products:

 

  Ÿ  

Lemna Protein Concentrate, or LPC: LPC is a free-flowing powder containing a minimum 65% crude protein. We expect that our customer licensees will manufacture LPC for use in both animal and, potentially, human markets. Based on internal and third-party testing, we believe that LPC is similar in quality to fish meal and represents a potentially viable protein source for feed formulations in multiple industries, including aquaculture and swine. We believe that LPC can also be used as an alternative to kelp meal in fertilizer applications.

 

  Ÿ  

Lemna Meal, or LM: LM is a carbohydrate-rich free-flowing powder containing a minimum 15% crude protein. We expect that our customer licensees will manufacture LM for use in animal feed markets. Based on internal and third-party testing, we believe that LM is similar in quality to alfalfa meal and represents a potentially viable feed ingredient for formulations in multiple industries, including dairy and swine. We also believe that LM could be used in fertilizer and animal bedding applications.

 

 

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Biocrude: With a small change in process parameters (but not equipment), our processing system can produce Biocrude rather than LM. Biocrude is a renewable energy feedstock that, through the use of a variety of third-party conversion systems currently under development, could potentially be converted into renewable fuels.

In 2011, we entered into a license agreement with a customer licensee in South America. See “Business—Our Customer Licensees—AIQ”. We are currently negotiating additional agreements with prospective customer licensees, including, among others, state-owned enterprises and multinational food companies. We expect that the successful execution of early projects will help validate our technology and ultimately enhance our ability to enter into commercial-scale agreements with other prospective customer licensees.

Our Markets

Our current product strategy is to enable customer licensees to sell our LPC product in the global animal feed market as a fish meal alternative and our LM product in the global animal feed market as an alternative to alfalfa meal. We believe that focusing in the near-term on the deployment of our technology for the production of animal feed helps to reduce the market risks associated with our solution, given the relatively high-value, high demand and low complexity of our animal feed products. We also believe that LPC is well positioned as an alternative to kelp meal, commonly used in fertilizers for turf grasses, such as those on golf courses, and that LM could potentially be used as an ingredient in organic fertilizers and in animal bedding applications.

Our research also indicates that LPC has the potential to be used in human food applications. We have commissioned and will continue to commission third-party testing regarding human food applications and are seeking regulatory approvals. If successful, we believe that the human use of our products would significantly increase the value of LPC.

We also expect to benefit from the development of third-party technology that will facilitate the commercial production of renewable fuel from Biocrude. We expect these efforts to provide our customer licensees with the option to pursue multiple fuel options with our Biocrude product, including use as a renewable energy feedstock that can be converted into fuel products or burned directly as a combustion fuel. The process of developing our fuel technology is ongoing through a number of joint development and collaboration efforts with petrochemical companies, which we believe will accelerate our fuel product platform commercialization.

 

 

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Our Industry

The food, feed and fuel markets are global and significant in size and the demand in these markets is expected to grow rapidly. We believe that our products will meet a portion of that growing demand. We also believe that our technology will deliver high production yields, particularly in equatorial regions, in which we expect the demand for our feed and food substitutes will be strong, and will enable our customer licensees to address the needs of the following markets.

Animal Feed

 

  Ÿ  

Fish Meal: Fish meal, most of which is produced by the commercial fishing of wild schools of small fish, is a critical ingredient in the diets of nursery animals and aquaculture stocks. The fish meal supply is currently limited due to the effects of overfishing, while the demand for fish meal as a source of protein in animal diets continues to rise sharply. Global fish meal demand for aquafeed is expected to reach approximately 7 million metric tonnes in 2012 and to rise every year thereafter to approximately 16 million metric tonnes in 2020, a rate which is expected to significantly outpace supply. As a consequence, there is a large and growing need for an alternative protein source to address this supply and demand imbalance.

Based on research conducted by the University of Idaho, we believe that LPC is strongly positioned as a fish meal alternative due to its nutritive qualities. We expect that our ability to locate production near sources of demand will provide our customer licensees with several commercial advantages, including the potential to reduce freight and duty import expenses, along with the ability to offer continuous production and just-in-time inventory management. Based on these factors, we expect the market price of LPC to be comparable to fish meal.

 

  Ÿ  

Alfalfa Meal: Alfalfa meal is a premium forage ingredient, used to meet nutrition and growth requirements in numerous animal diets. The supply of alfalfa is limited due to the concentration of production in specific areas, such as the United States and Europe. Meanwhile, demand is continuing to rise, particularly in Asia. For dairy and swine alone, the global demand for alfalfa meal will be approximately 254 million metric tonnes in 2012, rising every year thereafter to approximately 262 million metric tonnes in 2020.

Trials conducted by the University of Minnesota demonstrated that LM is a high quality alternative for alfalfa meal in diets for dairy cattle. Third-party testing is continuing with other animals that are customarily fed alfalfa, such as swine and horses. Based on LM’s nutritional similarity with alfalfa meal, we expect that its market price will be comparable.

Fertilizer

Kelp and other high nitrogen biomass can be used as organic fertilizers. However, the production of kelp is costly due to the limited areas in which it grows in the wild, as well as environmental regulations that limit the scale of its harvesting. We believe that LPC can be a lower-cost, potentially higher-value alternative to kelp. We also believe that LM could be used as a nitrogen source in organic fertilizers. We believe that LPC will be competitive in the specialty turf fertilizer market given its favorable chemical composition and the opportunity it presents to reduce potential environmental pollution as compared to other alternatives.

 

 

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Fortification of Basic Human Food Products

We are developing our technology to address the rising demand for human food, a market of particular relevance in the equatorial regions in which we believe our technology will be well-suited to grow. We believe that LPC can eventually serve the global market for fortification of basic food ingredients for malnourished populations, particularly in developing and emerging countries. Given the rapidly growing populations in regions such as South Asia, Africa and South America, we believe that there is a clear need for an alternative supply of high quality and economical protein to supplement and enhance basic foods, such as breads, tortillas, noodles and crackers.

Specialty Markets for Prepared Foods

In the long term, we believe we can develop a higher protein content product from lemna using alternative separation techniques. This would allow our customer licensees to access specialty markets for prepared foods for human consumption, such as baked goods, meats and frozen foods. Third-party research is continuing to validate our results and enhance our understanding of these properties. While this process change would increase the capital expenditure and operating costs associated with our technology, we anticipate that the increased value of the end product produced would in many cases justify the additional expenses.

Renewable Fuels

We expect that third-party technology will lead to the conversion of Biocrude into drop-in fuels. If the technology is successfully developed in this manner, we anticipate that our customer licensees will have the ability to create products that address the significant and continuing global demand for renewable fuel.

Our Solution and Customer Licensee Approach

We believe that our solution will result in the commercial scale production of renewable products specifically for the feed, food and fuel industries. Our technology platform primarily consists of four components: micro-crop selection and testing, growth and harvesting techniques, processing technology, and control systems. Our technology includes the selection of indigenous micro-crops that demonstrate an optimal profile for a particular geography and environment, which we believe will allow our customer licensees to grow, harvest and process these micro-crops efficiently and profitably. We have developed a scalable and flexible model based on micro-crop growth units of 150 hectare increments. This model is designed to be attractive to a wide range of entities, including agricultural customers with an interest in the sustainable production of feed products, larger operators of renewable fuel production facilities and financial investment groups.

The estimated capital expenditure for a 150 hectare facility as an entry point is $12 million (excluding the cost of land and improvements)—a model that we believe involves manageable costs, risks and build-out times, while also enabling our customer licensees to evaluate the commercial potential of the technology on a larger scale. Due to economies of scale, we believe that a 600 hectare unit would deliver an attractive internal rate of return on our customer licensees’ investment. Ultimately, we expect that our customer licensees will expand their facilities in 150 hectare increments at similar costs in order to complete facilities of up to 5,000 hectares. Depending on economies of scale, we expect that the capital expenditure for a 5,000 hectare facility will be approximately $375 million (excluding the cost of land and improvements). We believe that a license unit of this size will enable our customer licensees to deliver significant volumes of product to market, thereby maximizing internal rates of return on their investments.

 

 

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Our business model requires minimal capital expenditures from us and involves the licensing of our technology and processes to customer licensees for fees and royalties during the life of the license. Our customer licensees will be required to pay the upfront infrastructure costs as well as continued maintenance costs for their licensed facilities.

Since our inception in 2006, we have focused on continuously developing our technology with the objective of enabling our customer licensees to produce renewable feed, food and fuel products at commercial scale. We believe research and development is an ongoing effort and we continue to look for ways to improve our technology and processes so that our customer licensees will be able to scale up our technology efficiently and profitably. We have successfully built and operated a demonstration facility (approximately one hectare) and have extracted small field-scale product quantities for technical validation. We believe that this process of scaling up our technology from the laboratory scale to demonstration scale will allow us to reach commercial scale with our initial customer licensees.

Our Competitive Strengths

Our key competitive strengths are:

 

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Strong economic returns to our customer licensees without the need for government subsidies. We believe that our solution will present our customer licensees with the opportunity to invest profitably in renewable technology designed to meet the significant and growing demand for feed, food and fuel. The profitability of our technology and processes is not dependent on government subsidies; although any subsidies that we or our customer licensees receive will enhance the profitability of our technology and processes.

 

  Ÿ  

Highly scalable and flexible technology, with initial license units providing the basis for larger-scale operations in the future. To facilitate rapid deployment opportunities in the near future, we have developed a highly scalable and flexible model for potential customer licensees. Our solution involves the construction and operation of production facilities based on 150 hectare increments of micro-crop growth bioreactors. We expect each 150 hectare unit will be a profitable module that can be replicated as the components of a larger-scale project of up to 5,000 hectares.

 

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Fully integrated, comprehensive solution that transforms simple, naturally occurring inputs, such as sunlight, water and indigenous micro-crops, into valuable outputs. We will provide our customer licensees with a comprehensive system that contains all components necessary for the creation of renewable products at commercial scale, from selection and testing of micro-crops to growth, harvesting and processing. In addition to a fully integrated technology platform, we expect to provide our customer licensees with extensive facility planning, design and construction/operation management services.

 

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Product compatibility with the existing agriculture infrastructure. Our processes for producing LPC and LM are designed to be compatible with standard processing techniques that can be implemented using existing agricultural equipment and infrastructure. We expect both products to become direct substitutes for existing protein supplies in animal feed applications. Our technology can potentially provide a new source of supply where existing demand or expected growth in demand cannot be met solely by existing sources due to environmental and other constraints.

 

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First mover advantage in providing renewable micro-crop technology to produce products that serve the global animal feed market. We believe that the deployment of our solution will place our customer licensees in a position to enter the global animal feed market as a first-mover in producing animal feed from renewable micro-crops.

 

 

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Experienced management team with a track record of innovative growth, value creation and commercial scaling of businesses. Our senior management team has broad expertise in guiding early-stage development companies to commercialization. Our management team has been involved in various technical and management roles within leading organizations across various industries.

Our Business Strategy

Building on our competitive strengths, our objective is to become the leading global provider of technology and processes for the commercial production of micro-crop biomass for the agriculture and energy markets. Key elements of our strategy include:

 

  Ÿ  

Rapid deployment and support of modular and highly scalable license units. Our customer licensees will be able to assemble our proprietary units from modular, cost-effective bioreactors and other ancillary equipment, which are currently operating at a smaller scale at our fully operational demonstration facility. These modular bioreactors are designed to enable rapid deployment at predictable cost and productivity levels.

 

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Leveraging our capital-light licensing model. Our customer licensees will be required to pay the upfront infrastructure costs as well as continued maintenance costs for their licensed facilities. This business model allows us to make minimal capital expenditures while generating fees and royalties over the term of the license.

 

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Expansion of our customer base on a global scale. We are continuing to expand our marketing efforts internationally. In 2011, we expanded our operations in China to further our focus in the region. We also recently expanded our sales and marketing efforts in both Africa and South America, which represent key locations where we expect to license our technology. In addition, we are establishing relationships and seeking opportunities with investment funds.

 

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Further development of our technology and pursuit of additional applications for our products. We expect to further enhance our technology in order to provide our customer licensees with additional end market applications for our products along with the ability to capture higher economic returns. We expect these efforts to provide our customer licensees with access to markets for human food and renewable fuels.

 

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Assisting our customer licensees in the identification of off-take partners. We will continue academic and commercial testing of our products to confirm their market viability. This third-party validation will assist us and our customer licensees in establishing off-take arrangements in which companies will purchase products produced by our customer licensees.

 

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Creation of brand loyalty. We intend to become recognized as the leading global provider of technology for the commercial production of micro-crop biomass for agriculture and energy markets. We intend to become a recognized provider of green technology solutions.

 

 

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Our Structure

Background

PetroAlgae Inc. is a holding company whose sole asset is its controlling equity interest in its operating subsidiary, PA LLC. We operate and control the business and affairs, and consolidate the financial results, of PA LLC. As of                 , we held             % of the equity interests in PA LLC, with the remainder held by Valens-Calliope (as defined under “—The Exchange Transactions”) and certain of our employees.

PA LLC was originally founded in September 2006 by XL TechGroup, Inc., or XL Tech, as a company focused on developing technologies for the renewable energy market. In August 2008, XL Tech exchanged certain of its assets, including the equity it held in PA LLC, for the outstanding debt of XL Tech that was held by the Laurus-Valens Funds (as defined under “Our Principal Stockholders”). Subsequent to that exchange, the Laurus-Valens Funds transferred the equity they received and certain related debt to PetroTech Holdings Corp., or PetroTech, a holding company controlled by the Laurus-Valens Funds. In December 2008, PetroTech acquired a shell company that was quoted on the OTC Bulletin Board, or the OTCBB, and assigned its interest in PA LLC to this shell company, which it then renamed PetroAlgae Inc.

Our Principal Stockholders

Our principal stockholders consist of private investment entities that are managed by Laurus Capital Management, LLC, or LCM, and Valens Capital Management, LLC, or VCM. We refer to these private investment entities as the Laurus-Valens Funds. At the completion of this offering, the Laurus-Valens Funds will own directly or indirectly approximately     % of our common stock (or     % if the underwriters exercise their option in full) and approximately     % of the equity interests in PA LLC. The Laurus-Valens Funds have invested in micro-cap and small private and publicly traded companies since 2001. For more information about our principal stockholders, see “Principal and Selling Stockholders.”

 

 

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Governance Matters

Prior to the completion of this offering, we will enter into a stockholders agreement with our principal stockholders, or the stockholders agreement. The stockholders agreement will become effective upon completion of this offering. The stockholders agreement will contain a voting agreement that provides, among other things, that:

 

   

our principal stockholders will agree to vote any shares of our common stock they and their affiliates own pro rata with our unaffiliated stockholders (other than in connection with any vote relating to (i) a consolidation or merger of the company or any of its affiliates into or with any other person (other than affiliates of our principal stockholders); or (ii) a sale, lease or transfer of all or substantially all of our assets or capital stock to another person (other than affiliates of our principal stockholders)); and

 

   

our principal stockholders will not vote in favor of the removal of any of our independent directors unless our unaffiliated stockholders approve such removal.

For more information regarding our governance, see “Relationships and Related Party Transactions — Stockholders Agreement.”

The Exchange Transactions

Prior to the acquisition of the shell company, our employees were compensated in part with equity incentives consisting of units in PA LLC. Since that acquisition, our employees have received equity incentives in PetroAlgae Inc. In order to provide liquidity for their equity interests in PA LLC and to facilitate the exchange of all equity interests in PA LLC, we have committed to the following:

 

  Ÿ  

We will enter into an exchange agreement with certain of our employees, Valens U.S. SPV I, LLC, or Valens U.S., and Calliope Capital Corporation, or CCC, which, together with Valens U.S., we refer to as Valens-Calliope. Each of these entities and employees will also be a selling stockholder in this offering. The exchange agreement will give those employees and Valens-Calliope the right to exchange a portion of their units in PA LLC for shares of PetroAlgae Inc. common stock that they will then sell in this offering, subject to customary conversion rate adjustments for stock splits, stock dividends and reclassifications.

 

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We will set aside $         from this offering to redeem up to              units of PA LLC held by certain of our employees who are not party to the exchange agreement.

 

  Ÿ  

No sooner than              months after the completion of this offering, we will file a registration statement that will cover the exchange from time to time of the aggregate number of shares of PetroAlgae Inc. common stock that will be issuable in exchange for the remaining units in PA LLC held by Valens-Calliope and our employees.

We have reserved              million shares of common stock for issuance to cover all exchanges of PA LLC units for shares of our common stock by our employees. We have reserved a further              million shares of common stock for issuance to cover all such exchanges by Valens-Calliope.

 

 

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Our Organizational Structure

The following diagram depicts our organizational structure immediately following the consummation of this offering:

LOGO

 

(1) The Laurus-Valens Funds hold their interests in PetroAlgae Inc. through PetroTech.
(2) The Pre-IPO Investors consist of acquirors of our common stock pursuant to private placements, over-the-counter trading or the 2008 shell company transaction and which are not affiliated with the Laurus-Valens Funds.

The following diagram depicts our organizational structure following the consummation of this offering and assuming that all of the equity interests of PA LLC are exchanged as described in “—The Exchange Transactions”:

LOGO

 

 

(1) The Laurus-Valens Funds hold their interests in PetroAlgae Inc. through PetroTech.
(2) The Pre-IPO Investors consist of acquirors of our common stock pursuant to private placements, over-the-counter trading or the 2008 shell company transaction and which are not affiliated with the Laurus-Valens Funds.

 

 

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Risk Factors

Our business is subject to numerous risks, as more fully described in the section entitled “Risk Factors” beginning on page 15 and elsewhere in this prospectus. These risks could materially and adversely impact our business, financial condition, operating results and cash flow, which could cause the trading price of our common stock to decline and could result in a partial or total loss of your investment. You should carefully consider such risks before deciding to invest in our common stock.

Our Corporate Information

PetroAlgae Inc. became a Delaware corporation on August 12, 2008 upon a change of domicile by its predecessor, a California corporation originally incorporated on April 15, 1988. Our principal executive office is located at 1901 S. Harbor City Blvd., Suite 600, Melbourne, FL 32901 and our telephone number is (321) 409-7500. Our website address is www.petroalgae.com. The information contained on, or that can be accessed through, our website is not part of, and is not incorporated into, this prospectus. We are currently a reporting company under Section 13 of the Securities Exchange Act of 1934, as amended, or the Exchange Act. “PetroAlgae”, the “PetroAlgae logo” and other trademarks or service marks of PetroAlgae Inc. appearing in this prospectus are the property of PetroAlgae Inc. This prospectus contains additional trade names, trademarks and service marks of others, which are the property of their respective owners and the inclusion of such trade names, trademarks or service marks in this prospectus does not signify a relationship with, or endorsement or sponsorship of us by, these other companies.

Industry and Market Data

Market data and industry statistics and forecasts used throughout this prospectus are based on independent industry publications, reports by market research firms and other published independent sources. Some data and other information are also based on our good faith estimates, which are derived from our review of internal surveys and independent sources. Certain information contained in this prospectus is based on results of studies conducted by the University of Idaho, the University of Minnesota, Purdue University, Kansas State University and Craft Technologies. We commissioned each of the aforementioned studies. Furthermore, to our knowledge, each of the studies cited in this prospectus represent the most recent information with respect to the subject matter of such study.

 

 

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THE OFFERING

 

Common stock offered by us

             shares.

 

Common stock offered by the selling stockholders

             shares.

 

Common stock to be outstanding immediately after this offering(1)

             shares.

 

Common stock to be outstanding immediately after this offering, as adjusted(2)

             shares.

 

Voting rights

Each share of our common stock entitles its holder to one vote on all matters to be voted on by stockholders generally. See “Description of Capital Stock—Common Stock.”

 

Use of proceeds

We estimate that the net proceeds to us from this offering will be approximately $             (based on the midpoint of the range listed on the cover page of this prospectus, and after deducting estimated underwriting discounts and commissions and estimated offering expenses payable by us).

 

  We will set aside $             of the net proceeds to redeem up to                  units of PA LLC held by certain of our employees who are not otherwise selling in this offering. We intend to use the remainder of the net proceeds from this offering for working capital and other general corporate purposes.

 

  We will not receive any of the proceeds from the sale of shares by the selling stockholders. See “Use of Proceeds.”

 

Risk factors

See “Risk Factors” and other information included in this prospectus for a discussion of factors you should carefully consider before deciding to invest in shares of our common stock.

 

OTCQB symbol

“PALG”.

 

Proposed              symbol

“            ”.

 

(1) The number of shares of our common stock that will be outstanding immediately after this offering is based on              shares of PetroAlgae common stock outstanding as of              and excludes:

 

  Ÿ  

             shares of our common stock issuable upon the exercise of options outstanding              at a weighted average exercise price of $             per share;

 

  Ÿ  

             shares of our common stock issuable upon the exercise of warrants outstanding              at a weighted average exercise price of $             per share;

 

 

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  Ÿ  

             shares of our common stock reserved for issuance under the 2009 Equity Compensation Plan; and

 

  Ÿ  

any exercise by the underwriters of their right to purchase up to an additional              shares of our common stock from            .

 

(2) The number of shares of our common stock that will be outstanding immediately after this offering, as adjusted, is based on              shares of PetroAlgae common stock outstanding as of              and includes:

 

  Ÿ  

             shares of our common stock offered by us in this offering;

 

  Ÿ  

             shares of our common stock reserved for issuance to cover exchanges by our employees of their PA LLC units for common stock of PetroAlgae Inc.; and

 

  Ÿ  

             shares of our common stock reserved for issuance to cover exchanges by Valens-Calliope of their PA LLC units for common stock of PetroAlgae Inc.

and excludes:

 

  Ÿ  

             shares of our common stock issuable upon the exercise of options outstanding at              at a weighted average exercise price of $             per share;

 

  Ÿ  

             shares of our common stock issuable upon the exercise of warrants outstanding at              at a weighted average exercise price of $             per share;

 

  Ÿ  

             shares of our common stock reserved for issuance under the 2009 Equity Compensation Plan; and

 

  Ÿ  

any exercise by the underwriters of their right to purchase up to an additional              shares of our common stock from             .

 

 

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SUMMARY CONSOLIDATED FINANCIAL DATA

The following summary consolidated financial data for the years ended December 31, 2007, 2008, 2009 and 2010 are derived from our audited consolidated financial statements. The summary audited consolidated financial data for the period beginning September 22, 2006 and ending December 31, 2010 is derived from our audited consolidated financial statements for such period that are included elsewhere in this prospectus. The summary unaudited consolidated interim financial data for the nine months ended September 30, 2010 and 2011 and as of September 30, 2011 are derived from our unaudited consolidated interim financial statements for such periods and dates that are included elsewhere in this prospectus. The unaudited consolidated interim financial statements were prepared on a basis consistent with our audited consolidated financial statements and include, in the opinion of management, all adjustments, consisting only of normal recurring adjustments, necessary for the fair presentation of the financial information contained in those statements. The historical results presented below are not necessarily indicative of financial results to be achieved in future periods. Prospective investors should read these summary consolidated financial data together with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our consolidated financial statements and the related notes included elsewhere in this prospectus.

 

                            For the Period
From
September 22,
2006
(Inception)
Through
December 31,
    (Unaudited)
Nine Months
Ended
September 30,
    Pro Forma(1)  
    Years Ended December 31,         (Unaudited)
Year Ended
December 31,
    (Unaudited)
Nine Months
Ended
September 30,
 
    2007     2008     2009     2010     2010     2010     2011     2010     2011  
   

(in thousands, except for share and per share data)

 

Consolidated Statements of Operations Data:

                 

Revenue

  $      $      $      $      $      $      $      $      $   

Costs and expenses:

                 

Selling, general and administrative

    2,984        8,251        17,401        21,850        50,666        9,447        8,074        21,850        8,074   

Research and development

    4,863        9,866        15,085        17,424        48,469        11,184        8,463        17,424        8,463   

Interest expense—related party

    44        1,764        3,198        4,077        9,483        2,912        4,646        2,860        3,736   

Depreciation

    55        269        1,138        1,128        2,591        773        669        1,128        669   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total costs and expenses

    8,346        20,150        36,822        44,479        111,209        24,316        21,852        43,262        20,942   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net loss before non-controlling interest

    (8,346     (20,150     (36,822     (44,479     (111,209     (24,316     (21,852     (43,262     (20,942

Non-controlling interest

           162        6,554        6,469        13,186        3,842        2,797        6,285        2,681   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net loss attributable to PetroAlgae Inc.

  $ (8,346   $ (19,988   $ (30,268   $ (38,010   $ (98,023   $ (20,474   $ (19,055   $ (36,977   $ (18,261
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Basic and diluted common shares outstanding

    100,000,000        100,362,021        104,866,065        106,731,469          106,664,896        106,920,730        108,719,586        108,908,847   
 

 

 

   

 

 

   

 

 

   

 

 

     

 

 

   

 

 

   

 

 

   

 

 

 

Basic and diluted loss per share

  $ (0.08   $ (0.20   $ (0.29   $ (0.36     $ (0.19   $ (0.18   $ (0.34   $ (0.17
 

 

 

   

 

 

   

 

 

   

 

 

     

 

 

   

 

 

   

 

 

   

 

 

 

 

 

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     As of September 30, 2011  
     Actual     Pro
Forma(1)
    Pro Forma As
Adjusted(1)(2)
 
     (Unaudited)  
     (in thousands)  

Consolidated Balance Sheet Data:

      

Cash

   $ 6,715      $ 6,715      $                

Property and equipment, net

     1,358        1,358     

Total assets

     8,324        8,324     

Current liabilities (excluding notes payable)

     12,232        9,310     

Notes payable—related party (current)

     72,053        62,053     

Total stockholders’ equity (deficit)

     (75,993     (63,071  

 

(1) On a pro forma basis to give effect to the conversion (as of January 1, 2010 for statements of operations data and as of September 30, 2011 for balance sheet data) of all of our outstanding convertible debt of $10 million and accrued interest into common shares at a conversion price of $5.43 per share.
  Ÿ  

On the consolidated statements of operations:

  Ÿ  

$1.2 million and $0.9 million of interest expense was reversed for the year ended December 31, 2010 and the nine months ended September 30, 2011, respectively; and

  Ÿ  

net loss attributable to non-controlling interest of $0.2 million and $0.1 million was reversed for the year ended December 31, 2010 and the nine months ended September 30, 2011, respectively.

  Ÿ  

On the consolidated balance sheet:

  Ÿ  

the sum of accrued interest and notes payable – related party of $12.9 million was reclassified to reduce total stockholders’ deficit as of September 30, 2011.

(2) On a pro forma as adjusted basis to give further effect to:
  Ÿ  

the sale by us of shares of common stock in this offering at an assumed initial public offering price of $             per share, the midpoint of the range listed on the cover page of this prospectus, and our receipt of the estimated net proceeds from that sale after deducting the estimated underwriting discounts and commissions and estimated offering expenses payable by us;

  Ÿ  

the exchange of             million shares of common stock reserved for issuance prior to the closing of this offering and that are issuable upon the exchange of units of PA LLC for common shares of PetroAlgae; and

  Ÿ  

our use of approximately $             million of the net proceeds of this offering to redeem certain of the equity units of PA LLC held by our employees.

 

 

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RISK FACTORS

Investing in our common stock involves a high degree of risk. You should carefully consider the following risk factors, as well as the other information in this prospectus, before deciding whether to invest in our common stock. Our business, prospects, financial condition or operating results could be materially adversely affected by any of these risks. The trading price of our common stock could decline as a result of any of these risks, and you could lose part or all of your investment in our common stock. When deciding whether to invest in our common stock, you should also refer to the other information in this prospectus, including our consolidated financial statements and related notes and the “Management’s Discussion and Analysis of Financial Condition and Results of Operations” section of this prospectus. You should read the section entitled “Special Note Regarding Forward-Looking Statements” immediately following these risk factors for a discussion of what types of statements are forward-looking statements, as well as the significance of such statements in the context of this prospectus.

Risks Related to Our Business

We have a limited operating history.

We are a development stage company. As a result, we have no significant history of revenues, operating or net income, cash flows or the other financial performance metrics that will affect the future market price of our common stock. Any investment you make in our common stock will necessarily be speculative and based largely on your own views as to the future prospects for our business. If we are unable to generate sufficient revenues or profits, we may be unable to continue operating and you may lose your entire investment in our common stock.

In addition, because of this limited operating history, investors and research analysts could have more difficulty valuing our common stock, which could lead to significant variability in the value ascribed to our common stock by market participants. This, in turn, could lead to a high degree of volatility in the market price of our common stock, which could have adverse effects on our investors and on our ability to conduct financing activities, determine dividend policy and price any stock options we grant for compensation or other purposes.

We have a history of operating losses and our auditors have indicated that there is a substantial doubt about our ability to continue as a going concern.

To date, we have not been profitable and have incurred significant losses and cash flow deficits. For the fiscal years ended December 31, 2010, 2009, and 2008, we reported net losses before non-controlling interest of $44.5 million, $36.8 million, $20.2 million, respectively, and negative cash flow from operating activities of $22.8 million, $27.6 million, and $11.8 million, respectively. For the nine months ended September 30, 2011, we reported net losses of $19.1 million and negative cash flow from operating activities of $13.4 million. As of September 30, 2011, we had an aggregate accumulated deficit of $117.1 million. We anticipate that we will continue to report losses and negative cash flow for the next several years.

As a result of these net losses and cash flow deficits and other factors, our independent auditors issued an audit opinion with respect to our consolidated financial statements for the three years ended December 31, 2010 that indicated that there is a substantial doubt about our ability to continue as a going concern. Our financial statements do not include any adjustments that might result from the outcome of this uncertainty. These adjustments would likely include substantial impairment of the carrying amount of our assets and potential contingent liabilities that may arise if we are unable to fulfill various operational commitments. In addition, the value of our securities, including common stock issued in this offering, would be greatly impaired. Our ability to continue as a going concern is

 

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dependent upon generating sufficient cash flow from operations and obtaining additional capital and financing, including funds to be raised in this offering. If our ability to generate cash flow from operations is delayed or reduced and we are unable to raise additional funding from other sources, we may be unable to continue in business even if this offering is successful. For further discussion about our ability to continue as a going concern and our plan for future liquidity, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Ability to Continue as a Going Concern.”

We expect to rely on a small number of early-adopter customer licensees for substantially all of our revenue during our next several years of operation.

We expect to be reliant on a small number of customer licensees for substantially all of our revenue. During the next several years, our business will depend on the successful operation of the license units to which our initial contracts will relate.

Our initial contract is, and we expect that our additional early contracts will be, subject to significant conditionality. These contracts may be terminated by customer licensees if these conditions are not met. See “—Our initial contracts will be conditioned on pilot-scale facilities built by our customer licensees meeting certain levels of productivity, and the failure to meet those levels may lead to the termination of these contracts, which will materially adversely affect our ability to generate revenue.” In addition, these contracts are generally subject to termination in the event that we fail to satisfy our obligations under such contracts. Although we believe that we have satisfied, and intend to continue to satisfy, these obligations, there can be no assurance that we will be able to continue to do so in the future.

Furthermore, there is no assurance that our customer licensees will be able to successfully commercialize and distribute LPC, LM or Biocrude created using our technology. If our customer licensees are unable to sell the products that they produce with our technology, they may seek to terminate our contracts or renegotiate the terms. If any of these contracts are terminated or renegotiated on less favorable terms, if contracts are terminated for failure to meet conditions or if any of our customer licensees fail to meet their payment obligations to us, our ability to generate revenues will be materially adversely affected, and this could have a material adverse effect on our business, financial condition and results of operations.

Our dependence on certain turnkey contracts subjects us to certain legal and financial terms that could adversely affect us.

We expect that some of the contracts with our initial early-adopter customer licensees will provide for the build-out of a turnkey license unit of 150 hectares after the successful completion of the testing phase of our technology. This means that we will direct the general contractor of such units and we will be required to deliver the unit at a fixed cost. We will receive payment for the build-out of the license unit on a progress basis as the license unit is constructed. The difference in the amounts and timing of our payments to contractors and suppliers relative to payments we receive from our customer licensees exposes us to liquidity risk and could leave us vulnerable in the event we encounter challenges in building the facility or bringing it online, delays in achieving commercial viability with our production process, disputes with our customer licensees or other unanticipated events that may occur prior to the time we receive payment from our customer licensees. Because our customer licensees’ payments will be capped, we will bear the responsibility for construction costs in excess of those anticipated, which could cause us to suffer significant losses on these license units.

 

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Our success depends on future royalties we expect will be paid to us by our customer licensees, and we face the risks inherent in a royalty-based business model.

We are a licensing business without a substantial amount of tangible assets, and our long-term success depends on future royalties paid to us by customer licensees. The amount of royalty payments we expect to receive will be primarily based upon the revenues generated by our customer licensees’ operations, so we will be dependent on the successful operations of our customer licensees for a significant portion of our revenues. Furthermore, we expect that the terms of some of our early-adopter customer license contracts will provide for royalty payments in lieu of license fees, which will cause us to recognize revenue from these contracts only once the license units have been built and are operational and the end products are being sold by the customer licensee. We face risks inherent in a royalty-based business model, many of which are outside of our control, including those arising from our reliance on the management and operating capabilities of our customer licensees and the cyclicality of supply and demand for end-products produced using our technology. Should our customer licensees fail to achieve sufficient profitability in their operations, our royalty payments would be diminished and our business, financial condition and results of operations could be materially adversely affected.

Our initial contracts are or will be subject to significant conditionality, including that the pilot-scale facilities built by our customer licensees achieve certain minimum levels of projected investment return, and the failure to meet these conditions may lead to the termination of these contracts.

Our initial contract is, and we expect that our additional early contract will be, subject to significant conditionality. For example, our initial contract may be terminated if our customer licensee deems the performance of its pilot-scale facility to be unsatisfactory. See “Business—Our Customer Licensees—AIQ.” In the contracts that we are currently negotiating, our prospective customer licensees will be permitted to terminate their agreements if projected investment returns, based upon the performance of their pilot-scale facilities and other factors, do not meet minimum investment return requirements. We generally will not receive any revenues under these contracts unless such returns are met during the test periods prescribed in each such contract. We cannot provide any assurances that any or all of our customer licensees’ pilot-scale facilities will meet the minimum investment returns required under these contracts. If a pilot-scale facility does not meet the minimum investment return requirements, the relevant contract may be terminated by the customer licensee, which in turn could have a material adverse effect on our business, financial condition and results of operations and our ability to generate revenue.

Our proposed licensing terms may not be accepted by prospective customer licensees and, even if accepted, there can be no assurance that customer licensees will meet their payment obligations under these licensing terms.

Prospective customer licensees may not accept our planned license agreement model. For example, prospective customer licensees may be unwilling to pay the proposed licensing fees prior to or during the construction of our micro-crop production system or prior to full commercial deployment of the system. We expect that our initial contracts will generally be royalty-based and will not involve any significant payment of license fees, and there can be no assurance that future contracts will involve significant license fees. Therefore, even if we are successful in attracting new customer licensees for our technology, we may not realize revenue from such customer licensees in the form or time frame we currently anticipate. Furthermore, there is no guarantee that customer licensees will make payments in the time frame to which they agree. If prospective customer licensees are unwilling or unable to pay as anticipated, the timing of our revenues and incoming cash flows could be reduced or delayed, which could have a material adverse effect on our business, financial condition and results of operations.

 

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We may be unable to acquire and retain customer licensees.

Our main source of revenue will be in the form of licensing fees and royalties from our customer licensees. Therefore, obtaining a significant number of customer licensees is critical for our growth and operation. Because our technology has not previously been deployed in the marketplace, it is uncertain whether it will be accepted by prospective customer licensees and there is a risk that we will be unable to acquire and retain licensees due to a number of factors, including our proposed licensing fee and royalty structure, capital expenditure requirements or questions surrounding commercial feasibility of our technology. For example, the projected investment returns of our micro-crop production system and the processes and methodologies used to operate the system may not yield a result that is commercially attractive to prospective customer licensees (compared to competitive products or otherwise). Our micro-crop production system requires our customer licensees to incur large fixed capital costs, which could render the system cost prohibitive for prospective customer licensees. A failure to secure customer licensees in a timely manner could have a material adverse effect on our business, financial condition and results of operations.

We have yet to construct our technology on a commercial scale, and may be unable to solve technical and engineering challenges that would prevent our technology from being economically attractive to prospective customer licensees.

Although we have successfully built a fully operational demonstration facility (approximately one hectare) and have extracted small field-scale quantities of LPC, LM and Biocrude for technical validation, we have not demonstrated that our technology is viable on a commercial scale, which we define to mean an operation consisting of at least 150 hectares. All of the tests conducted to date by us with respect to our technologies have been performed on limited quantities of micro-crops, and we cannot provide any assurances that the same or similar results could be obtained at competitive cost on a large-scale commercial basis. We have never utilized this technology under the conditions or in the volumes that will be required to be profitable and cannot predict all of the difficulties that may arise. While our bioreactors are modular in design, a single commercial-scale facility would be substantially larger than our demonstration facility, and the implementation of our technology on that scale will require further research, development, design and testing. Such an undertaking involves significant uncertainties, and consequently the construction of a commercial-scale facility may face delays, failures or unexpected costs. Furthermore, we may not be able to successfully design a scalable, cost-effective system for the growth and harvesting of micro-crops.

In addition, once a customer licensee begins to scale up and replicate such a system, unforeseen factors and issues may arise which make any such system uneconomical, thus causing additional delays or outright failure. The production of LPC and LM from micro-crops involves complex outdoor aquatic systems with inherent risks, including weather, disease, and contamination. As a result, the operations of our customer licensees may be adversely affected from time to time by climatic conditions, such as severe storms, flooding, dry spells and changes in air and water temperature or salinity, and may also be adversely affected by pollution and disease. Any of these or other factors could cause production at commercial-scale operations to be significantly below those we project based on results we have achieved at our demonstration facility. Because we expect to rely on license fees and royalties for our revenues, any operational difficulties experienced by our customer licensees would have an adverse effect on our revenues and profitability, and such effects could be material.

If we encounter significant engineering or other obstacles in implementing our technology at commercial scale, or if our customer licensees experience significant operational difficulties, our business, financial condition, and results of operations could be materially adversely affected.

 

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The market may not accept the end-products produced by our technology.

The biomass produced by our micro-crop production system produces several end-products: principally LPC, LM and Biocrude. The commercial viability of our technology largely depends on the ability of our customer licensees to sell these end-products into existing markets.

It has yet to be proven that potential buyers for the specific end-products produced by our technology, such as feed companies, would ultimately purchase the end-products produced by our customer licensees. For example, market acceptance of our LPC and LM will be a function, among others, of digestibility and palatability (the assessment of which will require additional laboratory and field study). Should these studies not proceed favorably, the market for our LPC and LM may not materialize or could be materially diminished. Failure to establish such a market or any significant reduction in a customer licensee’s profitability would decrease the amount of any royalties we would otherwise receive and may result in their failing to pay us expected licensing fees. Any of these events may have a material adverse effect on our business, financial condition and results of operations.

The revenue and returns we believe our customer licensees will realize from our technology will be highly dependent on the market price of the end-products produced using our technology.

The economic viability of our technology depends on the ability of our customer licensees to generate sufficient revenues from the sale of LPC, LM and other potential end-products of our technology. These revenues, and the internal rates of return our customer licensees can expect from their investment in our technology, are sensitive to the market prices of these products. Should our customer licensees be unable to obtain an adequate price for these products, their profits would be lower than expected and they might incur losses.

If our customer licensees cannot operate at a reasonable level of profit or incur losses, they might cease operations, which would result in our losing license fees and royalty payments. In such a circumstance, it is also likely that we would face significant difficulties attracting new customer licensees. Either or both outcomes would likely have a materially adverse effect on our business, financial condition and results of operations.

The end-products produced by our technology are subject to industry and regulatory testing.

The end-products produced by our technology generally require industry or regulatory testing in the countries in which they are produced or sold. For example, LPC requires regulatory approvals before it can be used in animal feed or for human consumption. To date, we have obtained approval for the use of LPC in animal feed only in Indonesia. Regulatory approvals in other jurisdictions will be essential to the commercial viability of our technology. In addition, we have not yet submitted LPC’s application for human consumption for regulatory approval in any jurisdiction. Such approvals could take several years or longer to obtain, if they can be obtained at all. See “Business—Regulatory.”

Should the end-products produced by our technology fail to meet industry or regulatory requirements, there would be an adverse effect on the ability of our customer licensees to market the products of their micro-crop operations, which would adversely affect their profitability. Since we expect to rely on licensing fees and royalties for the substantial majority of our revenues, such events would also materially adversely affect our business, financial condition and results of operations. See “Business—Regulatory.”

 

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The assumptions underlying the projected revenues and profitability of our license units that we develop in conjunction with our customer licensees are inherently uncertain and are subject to significant business, economic, financial, regulatory and competitive risks and uncertainties that could cause our customer licensees’ actual results to differ materially from those projected.

The projected revenues and returns on investment of our license units that we develop in conjunction with our customer licensees are based on assumptions relating to construction costs and other capital costs associated with building a unit, operating expenses and productivity, end-product price ranges and numerous other assumptions, all of which are inherently uncertain and are subject to significant business, economic, meteorological, regulatory and competitive risks and uncertainties that could cause actual results to differ materially from those projected. If our license units do not achieve the projected results, our customer licensees may not generate revenues or profits sufficient for them to continue operating license units or the revenues that we receive from such license units may be significantly less than we anticipate. Any of the foregoing could have a material adverse effect on our business, financial condition and results of operations.

If a competitor were to achieve a technological breakthrough, our financial condition, results of operations and business could be negatively impacted.

There currently exist a number of businesses that are pursuing the use of algae, bacteria and other micro-crops and other methods for creating biomass, food and feed products, and alternative fuels. Should a competitor achieve a research and development, technological or biological breakthrough with significantly lower production costs, or if the costs of similar competing products were to fall substantially, we may have difficulty attracting customer licensees. In addition, competition from other technologies considered “green technologies” could decrease the demand for the end-products produced by our technology. Furthermore, competitors may have access to larger resources (capital or otherwise) that provide them with an advantage in the marketplace, which could result in a negative impact on our business, financial condition and results of operations.

Any competing technology that produces biomass of similar quality and on a more efficient cost basis than ours could render our technology obsolete. In addition, because we do not have any issued patents, we may not be able to preclude development of even directly competing technologies using the same methods, materials and procedures as we use to achieve our results. Any of these competitive forces may inhibit or materially adversely affect our ability to attract and retain customer licensees, or to obtain royalties or other fees from our customer licensees. This could have a material adverse effect on our financial condition, results of operations and business.

If we fail to establish, maintain and enforce intellectual property rights with respect to our technology, our financial condition, results of operations and business could be negatively impacted.

Our ability to establish, maintain and enforce intellectual property rights with respect to the technology that we license to our customer licensees will be a significant factor in determining our future financial and operating performance. We seek to protect our intellectual property rights by relying on a combination of patent, trade secret and copyright laws. We also use confidentiality and other provisions in our agreements that restrict access to and disclosure of our confidential know-how and trade secrets.

We have filed patent applications with respect to many aspects of our technologies, including those relating to our bioreactors, growth management systems and downstream processing technologies. However, we cannot provide any assurance that any of these applications will ultimately

 

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result in issued patents or, if patents are issued, that they will provide sufficient protections for our technology against competitors. See “—Although we have filed patent applications for some of our core technologies, we do not currently hold any issued patents and we may face delays and difficulties in obtaining these patents, or we may not be able to obtain such patents at all.”

Outside of these patent applications, we seek to protect our technology as trade secrets and technical know-how. However, trade secrets and technical know-how are difficult to maintain and do not provide the same legal protections provided by patents. In particular, only patents will allow us to prohibit others from using independently developed technology that is similar. If competitors develop knowledge substantially equivalent or superior to our trade secrets and technical know-how, or gain access to our knowledge through other means such as observation of our technology that embody trade secrets at customer sites which we do not control, the value of our trade secrets and technical know-how would be diminished.

While we strive to maintain systems and procedures to protect the confidentiality and security of our trade secrets and technical know-how, these systems and procedures may fail to provide an adequate degree of protection. For example, although we generally enter into agreements with our employees, consultants, advisors, customer licensees and strategic partners restricting the disclosure and use of trade secrets, technical know-how and confidential information, we cannot provide any assurance that these agreements will be sufficient to prevent unauthorized use or disclosure. In addition, some of the technology deployed at our customer sites which we do not control, may be readily observable by third parties who are not under contractual obligations of non-disclosure, which may limit or compromise our ability to continue to protect such technology as a trade secret.

Although we seek to secure intellectual property rights with respect to our technology where such rights are available, certain aspects of our technology cannot be protected as intellectual property. For example, unlike certain other companies operating in the alternative energy or biofuel industry, our technology does not involve the creation or use of manufactured or genetically engineered organisms. The micro-crops that our processes ultimately convert to LPC, LM and Biocrude are naturally-occurring species indigenous to the environments in which our customer licensees operate. Since we do not have, and cannot obtain, intellectual property rights with respect to these species, and consequently other companies are free to develop competing technologies to grow these organisms, it is important that we secure and protect our intellectual property rights in the technology that we license to customer licensees, including our processes and system for growing micro-crops at an optimal rate. If we fail to secure and protect these rights, other companies will be able to freely copy or otherwise reproduce our technology, which may in turn cause us to lose customer licensees and prospective customer licensees to those competitors.

While we are not currently aware of any infringement or other violation of our intellectual property rights, monitoring and policing unauthorized use and disclosure of intellectual property is difficult. If we learned that a third party was in fact infringing or otherwise violating our intellectual property, we may need to enforce our intellectual property rights through litigation. Litigation relating to our intellectual property may not prove successful and might result in substantial costs and diversion of resources and management attention.

From our customer licensee’s standpoint, the strength of the intellectual property under which we grant licenses can be a critical determinant of the value of these licenses. If we are unable to secure, protect and enforce our intellectual property, it may become more difficult for us to attract new customer licensees. Any such development could have a material adverse effect on our business, financial condition and results of operations.

 

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Although we have filed patent applications for some of our core technologies, we do not currently hold any issued patents and we may face delays and difficulties in obtaining these patents, or we may not be able to obtain such patents at all.

Patents are a key element of our intellectual property strategy. We have currently filed patent applications for six families of technologies, both in the United States and in foreign jurisdictions. These pending patent applications relate to, among other aspects of our technology, the design of our bioreactors, the physical and chemical treatment processes for biomass, our growth algorithms, multi-spectral cameras and imaging algorithms, the use of our processes to make Biocrude, LPC and LM, and our enterprise management system. Our patent applications are in the early stages and we have not received substantive feedback from relevant patent offices regarding the viability of our patent applications. It may take two or more years for any patents to issue from our applications, we cannot provide any assurance that any patents will ultimately be issued or that any patents that do ultimately issue will issue in a form that will adequately protect our commercial advantage.

Our ability to obtain patent protection for our technologies is uncertain due to a number of factors, including that we may not have been the first to make the inventions covered by our pending patent applications or to file patent applications for these inventions. We have not conducted any formal analysis of the prior art in the areas in which we have filed our patent applications, and the existence of any such prior art would bring the novelty of our technologies into question and could cause the pending patent applications to be rejected.

Further, changes in U.S. and foreign patent law may also impact our ability to successfully prosecute our patent applications. For example, the United States Congress and other foreign legislative bodies may amend their respective patent laws in a manner that makes obtaining patents more difficult or costly. Courts may also render decisions that alter the application of patent laws and detrimentally affect our ability to obtain patent protection.

Even if patents do ultimately issue from our patent applications, these patents may not provide meaningful protection or commercial advantage. Patents only provide protection for a 20-year period starting from the filing date and the longer a patent application takes to issue the less time there is to enforce it. Further, the claims under any patents that issue from our applications may not be broad enough to prevent others from developing technologies that are similar or that achieve similar results to ours. It is also possible that the intellectual property rights of others will bar us from licensing our technology and bar us or our customer licensees from exploiting any patents that issue from our pending applications. Numerous U.S. and foreign issued patents and pending patent applications owned by others exist in the fields in which we have developed and are developing our technology. These patents and patent applications might have priority over our patent applications and could subject our patent applications to invalidation. Finally, in addition to those who may claim priority, any patents that issue from our applications may also be challenged by our competitors on the basis that they are otherwise invalid or unenforceable.

We may be unable to fully enforce our intellectual property in certain countries.

Based on our current negotiations with prospective customer licensees, we expect that many of our customer licensees will be in certain countries, including China and Indonesia, where we may have difficulty enforcing our intellectual property rights due to the general nature of the intellectual property enforcement mechanisms that are in place in such countries. These jurisdictions may have weaker statutory protections for intellectual property, or judicial or administrative regimes that make enforcement of these protections more difficult than in the United States. As a result, we might not be able to pursue adequate remedies in the event that our intellectual property rights are violated. In particular, we might be unable to effectively prevent the continuing infringement of our intellectual property rights.

 

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To the extent that any material infringement of our intellectual property occurs for which we are unable to obtain a remedy, we are likely to suffer a loss of potential revenues, since we will not receive license fees or royalties for such infringing uses, and other existing and prospective customer licensees might become hesitant to pay license fees for a technology being used freely by their competitors in the marketplace. If the infringing uses became widespread, this could have a material adverse effect on our business, financial condition and results of operations.

We may face claims that we are violating the intellectual property rights of others.

We may face claims, including from direct competitors, other energy companies, scientists or research universities, asserting that our technology or the commercial use of such technology by our customer licensees or partners infringes or otherwise violates the intellectual property rights of others. We have not conducted infringement, freedom to operate or landscape analyses, and as a result we cannot be certain that our technologies and processes do not violate the intellectual property rights of others. We expect that we may increasingly be subject to such claims as we begin to earn revenues and our market profile grows.

We may also face infringement claims from the employees, consultants, agents and outside organizations we have engaged to develop our technology. While we have sought to protect ourselves against such claims through contractual means, we cannot provide any assurance that such contractual provisions are adequate, and any of these parties might claim full or partial ownership of the intellectual property in the technology that they were engaged to develop for us.

If we were found to be infringing or otherwise violating the intellectual property rights of others, we could face significant costs to implement work-around methods, and we cannot provide any assurance that any such work-around would be available or technically equivalent to our current technology. In such cases, we might need to license a third party’s intellectual property, although any required license might not be available to us on acceptable terms, or at all. If we are unable to work around such infringement or obtain a license on acceptable terms, we might face substantial monetary judgments against us or an injunction against continuing to license our technology, which might cause us to cease operations.

In addition, even if we are not infringing or otherwise violating the intellectual property rights of others, we could nonetheless incur substantial costs in defending ourselves in suits brought against us for alleged infringement. Also, if our license agreements provide that we will defend and indemnify our customer licensees for claims against them relating to any alleged infringement of the intellectual property rights of third parties in connection with such customer licensees’ use of our technologies, we may incur substantial costs defending and indemnifying our customer licensees to the extent they are subject to these types of claims. Such suits, even if without merit, would likely require our management team to dedicate substantial time to addressing the issues presented. Any party bringing claims might have greater resources than we do, which could potentially lead to our settling claims against which we might otherwise prevail on the merits.

Any claims brought against us or our customer licensees alleging that we have violated the intellectual property of others could have a material adverse effect on our business, financial condition and results of operations.

 

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We expect to rely on third parties, such as academic institutions and agriculture and energy companies.

We expect to rely on third parties, such as academic institutions and agriculture and energy companies, to aid in the development and marketing of our technology and processes. Should these third parties reduce their commitment to us or terminate their relationship with us, pursue competing relationships or attempt to develop or acquire products or services that compete with the end-products produced using our technology, such action could have a material adverse effect on our business, financial condition and results of operations.

We will have to devote significant management resources to our compliance with the requirements imposed by Section 404 of the Sarbanes-Oxley Act of 2002, which could harm our growth.

Pursuant to Section 404 of the Sarbanes-Oxley Act of 2002, or the Sarbanes-Oxley Act, and the rules and regulations promulgated by the Securities and Exchange Commission, or the SEC, to implement Section 404, we are required to include in our Annual Reports on Form 10-K a report by our management regarding the effectiveness of our internal control over financial reporting. The report must include, among other things, an assessment of the effectiveness of our internal control over financial reporting as of the end of our fiscal year, including a statement as to whether or not our internal control over financial reporting is effective. The Dodd-Frank Wall Street Reform and Consumer Protection Act exempts non-accelerated filers from complying with the requirement set forth in Section 404(b) of the Sarbanes-Oxley Act, which requires that reporting companies include in their annual reports an independent auditor’s attestation report on the effectiveness of the reporting company’s internal control over financial reporting. For the fiscal year ended December 31, 2011, we will not be an accelerated filer and will therefore be exempt from the requirements of Section 404(b) of the Sarbanes-Oxley Act. However, we expect that following the completion of this offering we will become an accelerated filer and will be required to comply with the requirements of Section 404(b) of the Sarbanes-Oxley Act, which will increase the diversion of our management’s limited resources and attention.

If we fail to manage future growth effectively, our business could be harmed.

We expect to experience rapid growth as we commercialize our technology. This growth will likely place significant demands on our management and on our operational and financial infrastructure. To manage our growth effectively, we must continue to improve and enhance our managerial, operational and financial controls, hire sufficient numbers of capable employees and upgrade our infrastructure. We must also manage an increasing number of new and existing relationships with customer licensees, suppliers, business partners and other third parties. These activities will require significant expenditures and allocation of valuable management resources. If we fail to maintain the efficiency of our organization as we grow, our revenues and profitability may be harmed, and we might be unable to achieve our business objectives.

We may be unable to recruit and retain the necessary personnel to support our future growth.

We currently rely on key individuals in the management and operation of our business. In order to continue the research and design of our micro-crop production system and to move to larger commercial scaling and deployment, it will be necessary for us to recruit a significant number of additional qualified individuals, including experienced management and specific technical experts. Any inability on our part to retain key employees or obtain the appropriate resources through hiring, outsourcing or through other contractors could delay or impair our ability to achieve successful results.

 

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Most of our planned production capacity will be in equatorial regions around the world, which will limit the number of prospective customer licensees willing to license our technology, and our business will be adversely affected if we do not operate effectively in those regions.

The economic viability of our technology depends on geographical proximity to the equator, and the operations of our customer licensees generally should be within approximately 15 degrees of latitude from the equator for optimal performance. As a result, prospective customer licensees that do not have access to these regions are unlikely to license our technology. Furthermore, we will be subject to risks associated with the concentration of our customer licensees’ operations in these regions. The occurrence of prolonged increases in temperature due to climate change or natural disasters, such as earthquakes or floods, localized extended outages of critical utilities or transportation systems or political, social or economic disruptions in these regions, could cause a significant interruption in the output and sales realized by our customer licensees. Such interruptions could have a material adverse effect on our business, financial condition and results of operations.

We face risks associated with our international operations, including unfavorable regulatory, political and tax conditions, which could harm our business.

We face risks associated with the international licensing activities we have engaged in and expect to engage in, including possible unfavorable regulatory, political and tax conditions, any of which could harm our business. We expect that our future customer licensees will be based in various jurisdictions around the world, each of which is subject to the legal, political, regulatory and social requirements and economic conditions in these jurisdictions. In particular, the legal systems in these jurisdictions, particularly with respect to commercial matters and property rights, may be less developed than in the United States or more uncertain in their application. Laws can be subject to varying or unpredictable interpretations, and prior court decisions may have limited or no precedential value. In addition, our ability to enforce our contractual rights in foreign jurisdictions might be limited, especially in relation to our customer licensees that are instrumentalities of foreign governments.

Our business relationships with international customer licensees are subject to foreign government taxes, regulations and permit requirements, and foreign tax and other laws. Our international licensee relationships are also subject to United States and foreign government trade restrictions, tariffs and price or exchange controls; the U.S. Foreign Corrupt Practices Act of 1977, as amended; preferences of foreign nations for domestic technologies; changes in diplomatic and trade relationships; political instability, natural disasters, war or events of terrorism; and the strength of international economies. Because we will rely on license fees and royalties from our customer licensees’ operations, any negative impact these factors have on our customer licensees could also have a material adverse effect on our business, financial condition and results of operations.

We expect to be exposed to fluctuations in foreign exchange rates.

We expect that substantially all of our revenues will be from customer licensees located outside the United States and that, over the long term, at least a substantial majority of our revenues will come from non-U.S. customer licensees. Under the license agreements that we expect to enter into in the future with non-U.S. customer licensees, all or a portion of our license and royalty fee revenue may be denominated in currencies other than the U.S. dollar. Many of our costs, however, including most of the costs of our employees who we expect to support the operations of our customer licensees, and our research and development costs, will be denominated in U.S. dollars. We expect that fluctuations in the value of these revenues and expenses as measured in U.S. dollars will affect our results of operations, and adverse currency exchange rate fluctuations may have a material impact on our future financial results. In particular, to the extent that the U.S. dollar appreciates in value relative to the currencies in which we receive revenue, our revenues will be lower in U.S. dollar terms, while many of our expenses will remain at the same level, resulting in a net negative impact on our profitability.

 

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Our quarterly operating results may fluctuate in the future, which may cause our stock price to decline.

Our quarterly operating results may fluctuate as a result of a variety of factors, many of which are outside of our control. Our fluctuations may be amplified by the uncertainty in timing of a relatively small number of large transactions we anticipate that we will consummate. Fluctuations in our quarterly operating results could cause our stock price to decline rapidly, may lead analysts to change their long-term model for valuing our common stock, could cause us to face short-term liquidity issues, may impact our ability to retain or attract key personnel, or cause other unanticipated issues. If our quarterly operating results fail to meet or exceed the expectations of research analysts or investors, the price of our common stock could decline substantially. We believe that our quarterly revenue and operating results may vary significantly in the future and that period-to-period comparisons of our operating results may not be meaningful. The results of any quarterly or annual periods should not be relied upon as indications of our future operating performance.

Risks Related to this Offering and Ownership of Our Common Stock

Following this offering, we will be controlled by our principal stockholders. As a result, our principal stockholders will be able to exert significant influence over matters requiring stockholder approval.

Following this offering, our principal stockholders will directly or through a single holding company own approximately      % of our common stock (or      % if the underwriters exercise their option in full) at the completion of this offering. Accordingly, our principal stockholders will have substantial influence over the outcome of certain corporate actions requiring stockholder approval, including the approval of significant corporate transactions, and it may in some instances exercise this influence in a manner that advances its best interests and not necessarily those of other stockholders. Although our principal stockholders will enter into the stockholders agreement requiring it to vote its stock in accordance with our unaffiliated stockholders’ vote in most cases, this requirement does not apply to merger or asset sales with entities that are not affiliated with our principal stockholders. Accordingly, our principal stockholders may vote its stock in a manner that has the effect of delaying, preventing or deterring a change in control of our company, which could deprive you of the opportunity to receive a premium for your common stock as part of a sale, could adversely affect the market price of our common stock and could impede our growth. See “Relationships and Related Party Transactions—Stockholders Agreement” and “Management—Structure of the Board of Directors.”

Anti-takeover provisions in our charter documents and under Delaware law could make an acquisition of us more difficult, limit attempts by our stockholders to replace or remove our current management and limit the market price of our common stock.

Provisions in our amended and restated certificate of incorporation and amended and restated bylaws, which we will adopt prior to the completion of this offering, may have the effect of delaying or preventing a change of control or changes in our management. Our amended and restated certificate of incorporation and amended and restated bylaws will include provisions that:

 

  Ÿ  

authorize our board of directors to issue, without further action by the stockholders, up to              shares of undesignated preferred stock;

 

  Ÿ  

require that any action to be taken by our stockholders be effected at a duly called annual or special meeting and not by written consent;

 

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establish an advance notice procedure for stockholder proposals to be brought before an annual meeting, including proposed nominations of persons for election to our board of directors;

 

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  Ÿ  

establish that our board of directors is divided into three classes, with each class serving three-year staggered terms;

 

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provide that our directors may be removed only for cause; and

 

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provide that vacancies on our board of directors may be filled only by a majority of directors then in office, even though less than a quorum.

These provisions may frustrate or prevent any attempts by our stockholders to replace or remove our management by making it more difficult and time consuming for stockholders to replace members of our board of directors, which is responsible for appointing the members of our management. In addition, because we are incorporated in Delaware, we are governed by the provisions of Section 203 of the General Corporation Law of the State of Delaware, or DGCL, which generally prohibits a Delaware corporation from engaging in any of a broad range of business combinations with any “interested” stockholder (any stockholder with 15% or more of our capital stock) for a period of three years following the date on which the stockholder became an “interested” stockholder.

We became a public company through our acquisition of a public shell company pursuant to which we assumed all known and unknown potential liabilities of our predecessor entity.

We became a public company through the acquisition of a public shell company that did not have significant operations or assets at the time of the transaction, but previously operated as a company developing medical imaging technologies prior to declaring bankruptcy and subsequently undergoing bankruptcy liquidation in 1998. Although the bankruptcy decree discharged pre-existing liabilities, we may still be exposed to undisclosed liabilities related to the prior operations of the shell company and we could incur losses, damages or other costs as a result of such exposure. These losses, damages and costs from such undisclosed liabilities could be significant, and could have a material adverse effect on our business, financial condition and results of operations.

A total of                     , or     %, of our total outstanding shares after the offering are restricted from immediate resale, but may be sold on a stock exchange in the near future. The large number of shares eligible for public sale or subject to rights requiring us to register them for public sale could depress the market price of our common stock.

The market price of our common stock could decline as a result of sales of a large number of shares of our common stock in the market after this offering, and the perception that these sales could occur may also depress the market price of our common stock. We will have              shares of common stock outstanding after this offering, assuming no exercise of the underwriters’ option. Of these shares, the              shares sold in this offering will be freely tradable in the United States, except for any shares purchased by our “affiliates” as defined in Rule 144, or Rule 144, under the Securities Act of 1933, as amended, or the Securities Act. The holders of shares of outstanding common stock have agreed with the underwriters, subject to certain exceptions, not to dispose of or hedge any of their common stock during the 180-day period beginning on the date of this prospectus, except with the prior written consent of Goldman, Sachs & Co., Citigroup Global Markets Inc. and UBS Securities LLC. After the expiration of the 180-day restricted period, these shares may be sold in the public market in the United States, subject to prior registration in the United States, if required, or reliance upon an exemption from U.S. registration, including as provided for by Rule 144 (subject, in the case of shares held by affiliates or control persons, to compliance with the volume and manner of sale restrictions prescribed thereby).

Shares that were outstanding prior to this offering and which are not subject to lock-up agreements, other than those shares held by our affiliates, will be freely tradable in the United States provided any holding period under Rule 144 has expired with respect to such shares, subject, in the case of shares held by our affiliates, to the volume and manner of sale restrictions imposed by Rule 144.

 

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No sooner than                      months following the completion of this offering, we will file a registration statement with the SEC covering the exchange from time to time of an aggregate of              shares of our common stock issuable upon exchange of the outstanding limited liability company interests in PA LLC held by our employees or by Valens-Calliope. Any shares issued upon such exchange would be freely tradable by any exchanging holder subject, in the case of exchanging holders who are our affiliates, to the volume and manner of sale restrictions imposed by Rule 144. See “Shares Eligible for Future Sale—Rule 144.”

Sales of our common stock by our stockholders may make it more difficult for us to sell equity securities in the future at a time and at a price that we deem appropriate. These sales also could cause our stock price to fall and make it more difficult for you to sell shares of our common stock.

An active, liquid and orderly trading market for our common stock may not develop, our share price may be volatile, and you may be unable to sell your shares at or above the offering price.

Prior to this offering, there has been a limited public market for our common stock. We cannot predict the extent to which an expanded trading market will develop or how liquid that market might become. The initial public offering price for our shares will be determined by negotiations between us and representatives of the underwriters and may not be indicative of prices that will prevail in the trading market. In particular, because we do not have any significant operating history, valuation of our common stock might be more difficult than for companies with a substantial financial record. This might cause significant volatility in the market price of our common stock. The market price of shares of our common stock may also be subject to wide fluctuations in response to the many risk factors listed in this section and other factors beyond our control, including:

 

  Ÿ  

actual or anticipated fluctuations in our key operating metrics, financial condition and operating results;

 

  Ÿ  

issuance of new or updated research or reports by securities analysts;

 

  Ÿ  

our announcement of actual results for a fiscal period that are higher or lower than projected or expected results, or our announcement of revenue or earnings guidance that is higher or lower than expected;

 

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fluctuations in the valuation of companies perceived by investors to be comparable to us;

 

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share price and volume fluctuations attributable to inconsistent trading volume levels of our shares;

 

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sales or expected sales of additional common stock;

 

  Ÿ  

announcements from, or operating results of, our competitors; or

 

  Ÿ  

general economic and market conditions.

Furthermore, the stock markets have experienced extreme price and volume fluctuations that have affected and continue to affect the market prices of equity securities of many companies. These fluctuations often have been unrelated or disproportionate to the operating performance of those companies. These broad market and industry fluctuations, as well as general economic, political and market conditions, such as recessions, interest rate changes or international currency fluctuations, may cause our common stock price to decline. If our common stock price after this offering does not exceed the initial public offering price, you will not realize any return on your investment in our common stock and may lose some or all of your investment. In the past, companies that have experienced volatility in the market price of their stock have been subject to securities class action litigation. We may be the target of this type of litigation in the future. Securities litigation against us could result in substantial costs and divert our management’s attention from other business concerns.

 

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We do not currently intend to pay dividends on our common stock and, consequently, your ability to achieve a return on your investment will depend solely on appreciation in the price of our common stock.

We have never declared or paid any cash dividends on our common stock and do not intend to do so for the foreseeable future. We currently intend to invest our future earnings, if any, to fund our growth. Therefore, you are not likely to receive any dividends on your common stock for the foreseeable future, and the success of an investment in shares of our common stock will depend upon any future appreciation in their value. There is no guarantee that shares of our common stock will appreciate in value or even maintain the price at which our stockholders have purchased their shares.

You will experience immediate and substantial dilution.

The initial public offering price will be substantially higher than the pro forma net tangible book value of each outstanding share of our common stock immediately after this offering. If you purchase our common stock in this offering, you will suffer immediate and substantial dilution. If previously granted warrants or options are exercised, you will experience additional dilution. As of             , warrants to purchase              shares of our common stock at a weighted-average exercise price of $             per share and options to purchase              shares of our common stock at a weighted-average exercise price of $             were outstanding. For more information refer to the section of this prospectus entitled “Dilution.”

 

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SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS

This prospectus, including the sections entitled “Prospectus Summary,” “Risk Factors,” “Use of Proceeds,” “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” and “Business” contains forward-looking statements. All statements other than statements of historical facts contained in this prospectus, including statements regarding our future results of operations and financial position, business strategy and plans and our objectives for future operations, are forward-looking statements. The words “believe,” “may,” “will,” “estimate,” “continue,” “anticipate,” “intend,” “expect” and similar expressions are intended to identify forward-looking statements. We have based these forward-looking statements largely on our current expectations and projections about future events and financial trends that we believe may affect our financial condition, results of operations, business strategy, short term and long-term business operations and objectives, and financial needs. These forward-looking statements are subject to a number of risks, uncertainties and assumptions, including those described in “Risk Factors.” Moreover, we operate in a very competitive and rapidly changing environment. New risks emerge from time to time. It is not possible for our management to predict all risks, nor can we assess the impact of all factors on our business or the extent to which any factor, or combination of factors, may cause actual results to differ materially from those contained in any forward-looking statements we may make. In light of these risks, uncertainties and assumptions, the forward-looking events and circumstances discussed in this prospectus may not occur and actual results could differ materially and adversely from those anticipated or implied in the forward-looking statements.

You should not rely upon forward-looking statements as predictions of future events. Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee that the future results, levels of activity, performance or events and circumstances reflected in the forward-looking statements will be achieved or occur. We undertake no obligation to update publicly any forward-looking statements for any reason after the date of this prospectus to conform these statements to actual results or to changes in our expectations.

You should read this prospectus and the documents that we reference in this prospectus and have filed with the SEC as exhibits to the registration statement of which this prospectus is a part with the understanding that our actual future results, levels of activity, performance and events and circumstances may be materially different from what we expect.

 

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USE OF PROCEEDS

We estimate that the net proceeds we will receive from this offering will be approximately $             million, assuming an initial public offering price of $             per share, which is the midpoint of the range listed on the cover page of this prospectus, and after deducting estimated underwriting discounts and commissions and estimated offering expenses payable by us. We will not receive any of the proceeds from the sale of shares by the selling stockholders, although we will bear the costs, other than underwriting discounts and commissions, associated with those sales.

A $1.00 increase (decrease) in the assumed initial public offering price of $             per share, which is the midpoint of the range listed on the cover page of this prospectus, would increase (decrease) the net proceeds to us from this offering by $             million, assuming the number of shares offered by us, as set forth on the cover page of this prospectus, remains the same and after deducting the estimated underwriting discounts and commissions and estimated expenses payable by us.

We will set aside $             of the proceeds to redeem up to              units of PA LLC held by certain of our employees who are not otherwise selling in this offering. We intend to use the remainder of the net proceeds from this offering for working capital and other general corporate purposes, including expanding our development, operations, demonstration facility, and marketing and sales departments.

Our management will have broad discretion in the application of the net proceeds of this offering. The amount we actually spend for the purposes described above will depend, in part, on the timing and amount of our future revenues and our future expenses. Investors will be relying on the judgment of our management regarding the application of the net proceeds of this offering. Pending these uses, we plan to invest these net proceeds in short-term, interest bearing obligations, investment grade instruments, certificates of deposit or direct or guaranteed obligations of the United States. The goal with respect to the investment of these net proceeds is capital preservation and liquidity so that such funds are readily available to fund our operations.

 

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DIVIDEND POLICY

We have never declared or paid dividends on our capital stock. We currently intend to retain all available funds and any future earnings to support operations and to finance the growth and development of our business. We do not intend to declare or pay cash dividends on our common stock in the foreseeable future. Any future determination to pay dividends will be made at the discretion of our board of directors subject to applicable laws, and will depend upon our results of operations, financial condition, contractual restrictions, capital requirements and other factors that our board of directors may deem relevant.

 

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MARKET INFORMATION

Our common stock is currently quoted on the OTCQB under the symbol “PALG”. There is a very limited public market for our common stock on the OTCQB. As a result, our common stock has experienced significant price fluctuations and volatility based on discrete trades of very modest volume.

The following table sets forth, for the periods indicated, the reported high and low sales prices of our common stock on the OTCQB. These quotations reflect inter-dealer prices, without retail mark-ups, mark-downs or commissions, involving our common stock during each calendar quarter, and may not represent actual transactions. The table also shows the average monthly trading volume for the periods indicated.

 

     Sales Price      Average
Monthly
Trading
Volume
 
     High      Low     

Fiscal 2011:

        

Fourth Quarter (through November 30, 2011)

   $ 13.50       $ 3.50         1,732   

Third Quarter

   $ 25.00       $ 5.50         8,696   

Second Quarter

   $ 25.00       $ 14.00         10,554   

First Quarter

   $ 101.00       $ 8.80         16,482   

Fiscal 2010:

        

Fourth Quarter

   $ 25.00       $ 6.01         8,596   

Third Quarter

   $ 26.00       $ 0.10         3,664   

Second Quarter

   $ 20.00       $ 3.00         1,853   

First Quarter

   $ 25.00       $ 11.60         2,326   

Fiscal 2009:

        

Fourth Quarter

   $ 24.95       $ 15.00         4,654   

Third Quarter

   $ 40.00       $ 8.00         6,241   

Second Quarter

   $ 11.00       $ 2.65         5,756   

First Quarter

   $ 10.00       $ 2.00         94,704   

Fiscal 2008:

        

Fourth Quarter

   $ 7.00       $ 0.25         41,676   

On November 30, the last reported sale price of our common stock on the OTCQB was $5.50 per common share. We have applied to have our common stock listed on              under the symbol “            ”.

 

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CAPITALIZATION

The following table sets forth our capitalization as of September 30, 2011:

 

  Ÿ  

on a pro forma basis to give further effect to the conversion of all of our outstanding convertible debt, including accrued interest, into 2,379,768 shares of common stock based on a conversion price of $5.43 per share.

 

  Ÿ  

on a pro forma as adjusted basis to give further effect to:

 

  ¡   

the sale by us of shares of common stock in this offering at an assumed initial public offering price of $             per share, the midpoint of the range listed on the cover page of this prospectus, and our receipt of the estimated net proceeds from that sale after deducting the estimated underwriting discounts and commissions and estimated offering expenses payable by us;

 

  ¡   

the exchange of              shares of common stock reserved for issuance prior to the closing of this offering and that are issuable upon the exchange of units of PA LLC for common shares of PetroAlgae; and

 

  ¡   

our use of approximately $             of the net proceeds of this offering to redeem certain of the equity units of PA LLC held by our employees.

The pro forma as adjusted information set forth in the table below is illustrative only and will adjust based on the actual initial public offering price and other terms of this offering determined at pricing.

You should read this table with the sections of this prospectus entitled “Selected Consolidated Financial Data,” “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our consolidated financial statements and related notes that are included elsewhere in this prospectus.

 

     As of September 30, 2011
     Actual     Pro Forma     Pro Forma
as Adjusted
     (Unaudited)      

Current Liabilities (excluding notes payable)

   $ 12,232      $ 9,310     

Notes payable—related party (current)

   $ 72,053      $ 62,053     

Stockholders’ equity (deficit):

      

Common stock, par value $0.001; 300,000,000 shares authorized; 106,920,730 shares issued and outstanding, actual; 109,300,498 shares issued and outstanding, pro forma;             shares issued and outstanding, pro forma as adjusted

   $ 107      $ 109     

Additional paid-in capital

   $ 39,082      $ 52,002     

Accumulated deficit

   $ (117,078   $ (117,078  

Non-controlling interest

   $ 1,896      $ 1,896     

Total stockholders’ equity (deficit)

   $ (75,993   $ (63,071  

Total capitalization

   $ (3,940   $ (1,018  

The number of shares of our common stock set forth in the table above excludes:

 

  Ÿ  

1,700,750 shares of common stock issuable upon the exercise of options outstanding at September 30, 2011 at a weighted average exercise price of $5.50 per share;

 

  Ÿ  

2,592,143 shares of common stock issuable upon the exercise of warrants outstanding at September 30, 2011, at a weighted average exercise price of $15.00 per share; and

 

  Ÿ  

shares of common stock reserved for future issuance under our stock-based compensation plans, consisting of 4,000,000 shares of common stock reserved for issuance under the 2009 Plan.

 

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DILUTION

As of             , we had a negative net tangible book value of approximately $                     or $                     per share of our common stock, based upon                      shares of our common stock outstanding on such date.

Our pro forma as adjusted net tangible book value as of                      was $                    , or $                     per share of our common stock. Pro forma as adjusted net tangible book value per share represents the amount of our total tangible assets reduced by the amount of our total liabilities and divided by the sum of:

 

  (i) the              shares of our common stock that will be outstanding following this offering; and

 

  (ii) the              shares of our common stock that are issuable following this offering upon the exchange of units of PA LLC for shares of our common stock.

Dilution in pro forma as adjusted net tangible book value per share to new investors in this offering represents the difference between the amount per share paid by purchasers of              shares of our common stock in this offering and the pro forma as adjusted net tangible book value per share of our common stock immediately after the completion of this offering. After giving effect to the sale of the shares of our common stock offered by us in this offering at an assumed initial public offering price of $             per share, the mid-point of the range set forth on the cover page of this prospectus, and after deducting the estimated underwriting discounts and estimated offering expenses payable by us, our pro forma as adjusted net tangible book value as of              would have been $            , or $             per share of our common stock. This represents an immediate increase in pro forma as adjusted net tangible book value of $             per share to existing stockholders and an immediate dilution of $             per share to new investors in our common stock. The following table illustrates this dilution on a per share basis.

 

Assumed initial public offering price per share

   $                

Pro forma as adjusted net tangible book value per share as of                     , before giving effect to this offering

   $     

Increase in pro forma as adjusted net tangible book value per share attributed to new investors purchasing shares in this offering

   $     
  

 

 

 

Pro forma as adjusted net tangible book value per share after giving effect to this offering

   $     
  

 

 

 

Dilution per share to new investors in this offering

   $     
  

 

 

 

A $1.00 increase or decrease in the assumed initial public offering price of $             per share would increase or decrease our pro forma as adjusted net tangible book value per share after this offering by $             per share and the dilution in pro forma as adjusted net tangible book value to new investors by $             per share, assuming the number of shares offered by us, as set forth on the cover of this prospectus, remains the same and after deducting the estimated underwriting discounts and commissions and estimated offering expenses payable by us.

If the underwriters exercise their option to purchase additional shares of our common stock in full, based on an assumed initial public offering price of $             per share, the pro forma as adjusted net tangible book value per share after this offering would be $             per share, and the dilution in pro forma as adjusted net tangible book value per share to new investors in this offering would be $             per share.

The following table summarizes, on a pro forma as adjusted basis as of              and after giving effect to the offering, based on the assumed initial public offering price per share of $            , the midpoint of the range set forth on the cover of this prospectus.

 

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The differences between existing stockholders and new investors with respect to the number of shares of our common stock purchased from us, the total consideration paid to us and the average price per share paid:

 

     Shares
Purchased
    Total Consideration        
     Number    Percent     Amount
(in thousands)
     Percent     Average
Price Per
Share
 

Existing stockholders

               $                             $                

New public investors

            
  

 

  

 

 

   

 

 

    

 

 

   

Total

        100   $           100  
  

 

  

 

 

   

 

 

    

 

 

   

A $1.00 increase or decrease in the assumed initial public offering price of $             per share would increase or decrease, respectively, total consideration paid by new investors and total consideration paid by all stockholders by approximately $            , assuming that the number of shares offered by us, as set forth on the cover page of this prospectus, remains the same.

If the underwriters exercise their option in full to acquire additional shares, our existing stockholders would own     % and our new investors would own     % of the total number of shares of our common stock outstanding upon the closing of this offering.

As of                             , warrants to purchase                      shares of our common stock at a weighted-average exercise price of $             per share and options to purchase                  shares of our common stock at a weighted-average exercise price of $             were outstanding.

 

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SELECTED CONSOLIDATED FINANCIAL DATA

The following selected consolidated financial data as of and for the years ended December 31, 2007, 2008, 2009 and 2010 are derived from our audited consolidated financial statements. The selected audited consolidated financial data for the period beginning September 22, 2006 and ending December 31, 2010 is derived from our audited consolidated financial statements for such period that are included elsewhere in this prospectus. The selected unaudited consolidated interim financial data for the nine months ended September 30, 2010 and 2011 and as of September 30, 2011 are derived from our unaudited consolidated interim financial statements for such periods and dates that are included elsewhere in this prospectus. The unaudited consolidated financial statements were prepared on a basis consistent with our audited consolidated interim financial statements and include, in the opinion of management, all adjustments, consisting only of normal recurring adjustments, necessary for the fair presentation of the financial information contained in those statements. The historical results presented below are not necessarily indicative of financial results to be achieved in future periods. Prospective investors should read these selected consolidated financial data together with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our consolidated financial statements and the related notes included elsewhere in this prospectus.

 

    Years Ended December 31,     For the Period
From
September 22,
2006
(Inception)
Through
December 31
    Nine Months Ended
September 30,
 
    2007     2008     2009     2010     2010     2010     2011  
   

(in thousands, except for share and per share data)

 
                                  (Unaudited)  

Consolidated Statements of Operations Data:

             

Revenue

  $      $      $      $      $      $      $   

Costs and expenses:

             

Selling, general and administrative

    2,984        8,251        17,401        21,850        50,666        9,447        8,074   

Research and development

    4,863        9,866        15,085        17,424        48,469        11,184        8,463   

Interest expense—related party

    444        1,764        3,198        4,077        9,483        2,912        4,646   

Depreciation

    55        269        1,138        1,128        2,591        773        669   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total costs and expenses

    8,346        20,150        36,822        44,479        111,209        24,316        21,852   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net loss before non-controlling interest

    (8,346     (20,150     (36,822     (44,479     (111,209     (24,316     (21,852

Non-controlling interest

           162        6,554        6,469        13,186        3,842        2,797   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net loss attributable to PetroAlgae Inc.

  $ (8,346   $ (19,988   $ (30,268   $ (38,010   $ (98,023   $ (20,474   $ (19,055
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Basic and diluted common shares outstanding

    100,000,000        100,362,021        104,866,065        106,731,469          106,664,896        106,920,730   
 

 

 

   

 

 

   

 

 

   

 

 

     

 

 

   

 

 

 

Basic and diluted loss per share

  $ (0.08   $ (0.20   $ (0.29   $ (0.36     $ (0.19   $ (0.18
 

 

 

   

 

 

   

 

 

   

 

 

     

 

 

   

 

 

 

 

     As of December 31,     As of
September 30,
 
     2007     2008     2009     2010     2011  
    

(in thousands, except for share data)

 
                 (Unaudited)  

Consolidated Balance Sheet Data:

          

Total assets

   $ 720      $ 11,598      $ 8,592      $ 6,325      $ 8,323   

Total liabilities

   $ 9,712      $ 26,803      $ 48,912      $ 62,829      $ 84,316   

Total stockholders’ deficit

   $ (8,992   $ (15,205   $ (40,320   $ (56,504   $ (75,993

Total common shares outstanding

     100,000,000        104,274,189        106,229,356        106,933,230        106,920,730   

 

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MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL

CONDITION AND RESULTS OF OPERATIONS

The following discussion and analysis of our financial condition and results of operations should be read in conjunction with “Prospectus Summary—Summary Consolidated Financial Data,” “Selected Consolidated Financial Data” and our consolidated financial statements that are included elsewhere in this prospectus. In addition to historical data, this discussion contains forward-looking statements about our business, operations and financial performance based on current expectations that involve risks, uncertainties and assumptions. Our actual results may differ materially from those discussed in the forward-looking statements as a result of various factors, including, but not limited to, those discussed in the sections entitled “Risk Factors” and “Special Note Regarding Forward-Looking Statements” included elsewhere in this prospectus.

Overview

Our Business

We provide renewable technology and solutions to address the global demand for new economical sources of feed, food and fuel.

Our objective is to be the leading global provider of technology and processes for the commercial production of micro-crop biomass for agriculture and energy markets. We seek to license renewable technology to meet the significant and growing demand for agricultural products and energy in both emerging and developed economies. We believe that our solution will deliver to our customer licensees strong and consistent economic returns as a consequence of continuous, predictable, year-round operations without the need for government subsidies. We also expect our solution to provide social benefits, through job creation and community investment, as well as significant environmental advantages, through sustainable production that absorbs atmospheric carbon dioxide and does not compete with the existing food supply, require arable land, or pollute soil or water.

We have developed proprietary technology, consisting of integrated environmental management systems, which we believe will allow our customer licensees to grow aquatic micro-crops at accelerated rates. This solution utilizes locally available micro-crops and commercially available processing equipment to produce biomass-based products that can be sold directly into agriculture and energy markets.

Our strategy is to license and provide management support for production facilities in equatorial regions around the world. Our solution is scalable and flexible, which we believe will allow our customer licensees to expand facility capacity and increase production to meet market demand. We intend to generate revenue from licensing fees and royalties primarily from customer licensees that are engaged in the global agriculture and energy markets, as well as from investment groups. Our licensing approach is designed to minimize our capital expenditures, because our customer licensees will be expected to invest in the development and construction of the production facilities.

Our proprietary technology uses indigenous micro-crops (from the Lemnaceae family) that are not genetically modified and demonstrate an optimal growth profile for a particular geography and environment. These micro-crops will then be grown, harvested and processed in a manner that we believe will optimize the production of our micro-crop biomass. To date, the operations at our demonstration facility have deepened our understanding of the variables relating to the micro-crop productivity of our technology. Based on this work, as well as additional modeling, we believe that these micro-crops can be grown and harvested on a commercial scale. Our processes use industry-standard agricultural and food processing equipment in specialized configurations to produce products with consistent quality. During our process, the micro-crops are pressed to separate the pulp from the liquid. The liquid is further processed to create our Lemna Protein Concentrate, or LPC, while the pulp

 

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is converted to create our Lemna Meal, or LM, and Biocrude product. Our Biocrude product requires further third-party conversion to facilitate the production of renewable fuels. These products can then be used locally or shipped to end customer licensees.

 

We expect to generate our revenues from license fees and royalties that we will earn from license agreements, pursuant to which our customer licensees will license from us the right to build and operate the bioreactors and associated processing facilities that make up our technology platform.

Our Development

We have achieved a number of significant milestones since we were founded in September 2006. Our focus has been on the creation and development of growth and harvesting technologies for the commercial-scale production of micro-crop biomass that could be processed for sale into existing agriculture and energy markets. To do this, we committed significant resources to our research and development efforts, including completing a fully operational demonstration facility in June 2009 to test, refine and exhibit our technology and processes. Since the completion of our demonstration facility, we have conducted extensive internal and third-party testing (both customer and academic) of our products to validate their commercial viability. Although we continue to test and refine our technology and processes, we are now also focused on building our customer pipeline and entering into license agreements with prospective customer licensees.

Our key milestones to date are as follows:

 

  Ÿ  

In 2006, we began the research and development of our growth and harvesting technologies. Our efforts focused on experimentation and testing, developing processes and equipment, and building the infrastructure and databases necessary to support our technology.

 

  Ÿ  

During 2007 and 2008, we developed our proprietary growth algorithms—the complex mathematical formulas we use to determine the correct harvesting density and sunlight exposure of the biomass.

 

  Ÿ  

In 2009, we completed our fully operational demonstration facility and established our business development team. This facility consists of a large bioreactor (approximately one hectare) and three smaller bioreactors that display our technology and processes.

 

  Ÿ  

In November 2009, the Indonesian Ministry of Agriculture approved our LPC product as an approved raw material for use in animal feed.

 

  Ÿ  

In May 2011, we entered into an agreement for the construction of a pilot-scale bioreactor in the Republic of Suriname. The construction of this bioreactor was completed in October 2011 and testing is ongoing.

 

  Ÿ  

In October 2011, we entered into a license agreement with Asesorias e Inversiones Quilicura S.A., or AIQ, a customer licensee in South America, with initial construction of a pilot-scale bioreactor having begun in September 2011.

 

  Ÿ  

In November 2011, China Energy Conservation and Environment Protection Group—CHONGQING INDUSTRY CO. LTD, or CECEP, a prospective Chinese customer licensee with which we are currently negotiating a license agreement, began construction of a pilot-scale bioreactor.

Our Sales Cycle

Our sales and marketing process involves identifying prospective customer licensees and introducing them to our processes and products. We provide each prospective customer licensee with an economic analysis that provides an understanding of expected investment returns, and customer-specific deployment considerations. In addition, we permit prospective customer licensees to visit our demonstration facility. We also evaluate the financial capacity of prospective customer licensees in

 

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light of the capital expenditure required to construct our licensed facilities. Once these steps are complete, we and the prospective customer licensee seek to develop, sign and execute a license agreement, which is often phased, for the construction and operation of facilities in appropriate equatorial regions.

Financial Operations Overview

Revenue

We expect that the license agreements we enter into with our customer licensees will generally provide for the payment of license fees during the construction of our license units and ongoing royalty payments over the term of the license agreement as the licensed unit becomes operational. We may also earn other types of revenues. For a discussion of our revenue recognition policy, please see “—Critical Accounting Policies and Management Estimates—Revenue Recognition.”

We expect that our revenues will consist of the following:

License Fees.    The timing and amount of the license fees we earn will be specific to each license agreement, but they may consist of equal periodic payments over a period of several years or more tailored provisions, including up-front payments at the time a license agreement is signed or payments due upon the achievement of certain specified technical or operational milestones. Some of our license agreements will provide for higher royalty payments in lieu of license fees.

Royalties.    The timing and amount of royalty payments we receive will also be specific to a particular license agreement, but will generally be based on a fixed percentage of the gross revenues generated by our customer licensees. Our license agreements will include a transfer pricing mechanism, which will establish the amount of royalties to be paid by a customer licensee if it consumes the end-products in its own operations or sells the end-products at prices not set by the market.

Construction Revenue.    To facilitate the capture of early customer licensees, we may agree to build the first portion of our customer licensees’ facilities for a fixed price. In general, revenues will be reported as construction progresses.

Other Revenues.    We may also recognize revenue from various other sources, including customer support fees.

Factors Affecting our Revenue

We expect the following to be among the factors that will affect our revenue:

Entry into License Agreements.    Our revenues will be almost entirely dependent on the number and terms of license agreements we enter into. Since we expect our sales cycles to be long, we believe that we will have a degree of visibility into our prospective pipeline for new license agreements.

Product Pricing.    The market prices of the products produced by our technology will play an important role in determining future revenues. Since our royalty revenue will be based on the sales proceeds our customer licensees earn from such products, changes in the market prices of these products will directly impact those revenues. In addition, since long-term price trends in these markets will determine in part the return on investment our customer licensees earn from our technology, our technology will tend to be more attractive to our customer licensees if those prices are expected to trend upward or remain at high levels.

License Agreement Structure.    We expect to tailor our license agreements to specific opportunities available. This may result in differences in the amount of fees paid and the timing of the payment of such fees. In addition to having effects on the timing of cash payments we receive, the structure of a license agreement will also have a significant effect on our ability to recognize revenue over the term of the contract. Since our license fee revenues will generally be recognized over the period of construction, a contract structure that provides for an uneven distribution of payments over that period might result in deferred revenues.

 

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Costs and Expenses

Our costs and expenses are expected to consist of the following:

Cost of Revenue.    Cost of revenue will consist primarily of the costs associated with providing our customer licensees with the technical expertise necessary to assist in the deployment of the license units and ongoing support to optimize their operations. We expect the cost of personnel-related expenses to be the most significant component of these expenses, and we expect to continue to hire new employees, including employees in the jurisdictions in which our customer licensees will operate, in order to support our anticipated growth. These costs will be reported as costs of revenue over the period of the associated revenue recognition. We expect that costs related to customer deployment and support will include primarily employment-related costs for our personnel; travel-related expenses such as airfare, meals and lodging; and the cost of third-party experts that we will retain for technical, logistical and legal support, when necessary. With respect to turnkey agreements, we would recognize the cost of construction and equipment as a cost of revenue.

Selling, General and Administrative.    Selling, general and administrative expenses consist primarily of personnel-related expenses, including consulting and overhead expenses, related to our executive, legal, finance, human resources and information technology functions. These expenses also include costs related to our sales function, including our marketing, public relations and regulatory costs. We expect selling, general and administrative expenses to increase as we incur additional listed company expenses, including increased accounting and legal costs, costs related to compliance with securities, corporate governance and other regulations, investor relations and higher insurance premiums. We also expect that the compensation costs associated with the marketing of our technology will increase. In addition, we expect to incur additional costs as we hire personnel and enhance our infrastructure to support the anticipated growth of our business.

Research and Development.    Research and development expenses consist primarily of the costs of personnel engaged in the construction and operation of our demonstration facility, laboratory testing and experimentation, and product development. Research and development expenses also include the associated materials and equipment, supplies and related overheads associated with these functions. In addition, expenses include costs relating to the research, testing and build-out of various aspects of our technology and processes and costs relating to the testing of the products produced by our technology. We intend to continue to invest in research and development, including hiring additional technical personnel and using outside consultants for various research and development efforts.

Interest Expense—Related Party.    We recognize interest expense on our debt obligations. To date, our debt financing has been provided exclusively by our principal stockholders.

Depreciation Expense.    We capitalize assets used in our business that have an expected useful life that is longer than one year. Since many of our asset purchases relate to research and process testing and therefore have a useful life of less than one year, most of our expenditures on these items have not been capitalized. We depreciate capitalized property and equipment over estimated useful lives that generally range from two to seven years. As we grow our business, capitalized assets and depreciation expense will likely increase as we expand customer support and research and development facilities. Since, under the license agreements we expect to enter into, our customer licensees will purchase the materials associated with the construction of their license units, the significant associated capital expense and the related depreciation of those assets will not affect our financial results.

Income Taxes.    Since our inception, we have incurred losses and have not recorded any U.S. federal, state or non-U.S. income tax. After the utilization of net operating loss and research and

 

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development tax credit carryforwards, we will pay U.S. federal and state or non-U.S. income tax on any profits we generate. We will also be subject to withholding of foreign taxes associated with income we generate from non-U.S. sources, which we expect to constitute a substantial majority of our revenues.

Non-controlling Interest.    We do not wholly own PA LLC, our sole operating subsidiary. As of September 30, 2011, minority holders owned approximately 13% of PA LLC. Non-controlling interest represents the proportion of our net income (or loss) attributable to the minority holders and proportionally reduces the amount of reported earnings (or loss) in each period. We expect the current minority holdings to decrease over time as holders of PA LLC interests exchange those interests for shares of our common stock. As a result, the proportional reduction to our earnings will decrease, and the number of our shares outstanding will increase. See “Prospectus Summary—Our Structure.”

Factors Affecting our Costs and Expenses

We expect the following to be among the factors that will affect our costs and expenses:

The Growth of our Business.    Our selling, general and administrative expenses are expected to increase in line with the growth of our business.

Continued Development of our Solution.    In order to maintain our competitiveness, we will need to constantly refine our technology and processes, which will require significant ongoing research and development activity. The amount and nature of this activity will affect our research and development expenses from period to period.

Stock-based Compensation.    We include stock-based compensation as part of selling, general and administrative expenses and research and development expenses according to the role of the grantee. We incur these expenses in connection with the grant of stock options and other equity awards to our directors, employees and consultants, and any subsequent modification of those awards. We apply the fair value method in accordance with authoritative guidance for determining the cost of stock-based compensation at the time of the grant. We made stock-based compensation grants of $8.3 million, $1.2 million, $3.0 million and $19.0 million during the nine months ended September 30, 2011 and the years ended December 31, 2010, 2009 and 2008, respectively. For a detailed discussion of stock-based compensation and our accounting for such grants, including the timing of expense recognition, see “—Critical Accounting Policies and Management Estimates—Stock-based Compensation.”

Ability to Continue as a Going Concern

We are currently in the development stage and have not yet recognized any revenue. Our financial statements are presented on a going concern basis, which contemplates the realization of assets and satisfaction of liabilities in the normal course of business.

We have never been profitable and we have incurred significant losses and cash flow deficits. For the fiscal years ended December 31, 2010, 2009 and 2008, we reported net losses before non-controlling interest of $44.5 million, $36.8 million and $20.2 million, respectively, and negative cash flow from operating activities of $22.8 million, $27.6 million and $11.8 million, respectively. For the nine months ended September 30, 2011 and 2010, and the period from September 22, 2006 (inception) to September 30, 2011, we reported net losses before non-controlling interest of $21.9 million, $24.3 million, and $133.1 million, respectively, and negative cash flow from operating activities of $13.4 million, $17.1 million, and $80.7 million, respectively. As of September 30, 2011, the Company had an aggregate accumulated deficit of $117.1 million. We anticipate that we will continue to report losses and negative cash flow during the remainder of 2011. As a result of these net losses and cash flow deficits and other factors, there is substantial doubt about our ability to continue as a going

 

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concern. However, we expect this uncertainty to be resolved if this offering is successful and we enter into additional license agreements pursuant to which we generate revenue. See “—Liquidity and Capital Resources.”

Our financial statements do not include any adjustments that might result from the outcome of this uncertainty. As of September 30, 2011, these adjustments would likely include the substantial impairment of the carrying amount of our assets of $1.6 million, which excludes cash and restricted cash of $6.7 million, and potential contingent liabilities that may arise if we are unable to fulfill various operational commitments. In addition, the value of our securities, including common stock and warrants, would be greatly impaired. Our ability to continue as a going concern is dependent upon generating sufficient cash flow from operations and obtaining additional capital and financing.

Results of Operations

Comparison of the Nine Months Ended September 30, 2010 and 2011

 

     Nine Months Ended September 30,     Variance  
     2010     2011     Amount     Percentage  
     (Unaudited)              

Revenue

   $      $      $        N/M   
  

 

 

   

 

 

   

 

 

   

Costs and expenses:

        

Selling, general and administrative

     9,447,354        8,074,208        (1,373,146     (15)%   

Research and development

     11,184,021        8,462,806        (2,721,215     (24)%   

Interest expense—related party

     2,912,155        4,646,195        1,734,040        60%   

Depreciation

     772,732        669,124        (103,608     (13)%   
  

 

 

   

 

 

   

 

 

   

Total costs and expenses

     24,316,262        21,852,333        (2,463,929     (10)%   
  

 

 

   

 

 

   

 

 

   

Net loss before non-controlling interest

     (24,316,262     (21,852,333     2,463,929        10%   

Net loss attributable to non-controlling interest

     3,842,232        2,797,625        (1,044,607     (27)%   
  

 

 

   

 

 

   

 

 

   

Net loss attributable to PetroAlgae Inc.

   $ (20,474,030   $ (19,054,708     1,419,322        7%   
  

 

 

   

 

 

   

 

 

   

Basic and diluted common shares outstanding

     106,664,896        106,920,730        255,834        N/M   
  

 

 

   

 

 

   

 

 

   

Basic and diluted loss per share

   $ (0.19   $ (0.18   $ 0.01        5%   
  

 

 

   

 

 

   

 

 

   

Revenue.     No revenue has been recognized in the nine-month periods ended September 30, 2011 or 2010.

Total costs and expenses.     For the nine months ended September 30, 2011 as compared to the nine months ended September 30, 2010, total costs and expenses decreased by $2.5 million, or 10.1%, to $21.9 million. The decrease in the comparable nine-month periods was primarily due to decreases in selling, general and administrative expenses and research and development expenses, partially offset by an increase in interest expense.

Selling, general and administrative expenses.     Selling, general and administrative expenses include senior management and overhead costs, business development expenditures, system infrastructure support costs, finance and accounting costs, and intellectual property management costs. For the nine months ended September 30, 2011 as compared to the nine months ended September 30, 2010, selling, general and administrative expenses decreased by $1.4 million, or 14.5%, to $8.1 million. A selective headcount reduction resulted in $0.8 million savings during the nine months ended September 30, 2011 as compared to the same period in 2010. For the first nine months

 

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of 2011 as compared to 2010, equity compensation expense declined by $0.5 million as a result of termination-related forfeitures of employees whose roles were classified as selling, general and administrative.

Research and development expenses.     Research and development costs include the research and experimentation of the various system components and the design and construction of the commercial-scale pilot system for customer licensee demonstration. During the nine months ended September 30, 2011 as compared to the same period in 2010, research and development expenses declined by $2.7 million, or 24.3%, to $8.5 million. Savings in the areas of payroll, external consultants, temporary labor and materials and supplies ($3.3 million for the nine-month period) were partially offset by an increase in equity compensation expense of $0.5 million, which was primarily related to the accelerated vesting of restricted ownership units held by an employee terminated during the period as well as the stock options issued during the first nine months of 2011. The savings mentioned above were also partially offset by an impairment charge of $0.4 million recorded during the first nine months of 2011 to reduce certain assets to their estimated realizable values.

Interest expense—related party.     For the nine months ended September 30, 2011 as compared to the nine months ended September 30, 2010, interest expense—related party increased by $1.7 million, or 59.5%, to $4.6 million. These increases were due to additional funding of our operations through notes payable from related parties over the last year. The balance of these notes totaled $72.1 million at September 30, 2011 and $44.8 million at September 30, 2010.

Depreciation expense.     For the nine months ended September 30, 2011 as compared to the same period in 2010, depreciation expense decreased by $104,000, or 13.4%, to $669,000. The decrease during the nine months ended September 30, 2011 as compared to the same period in 2010 was due to assets which were fully depreciated or impaired over the last year, offset partially by the addition of new capital assets.

Non-controlling interest.     As of September 30, 2011 and 2010, non-controlling interests collectively owned approximately 12.7% and 13.2% of PA LLC, respectively, and have been attributed their respective portion of the loss of PA LLC. For the nine months ended September 30, 2011 and 2010, non-controlling interests were assigned $2.8 million and $3.8 million of the net loss, respectively.

Comparison of Years Ended December 31, 2009 and 2010

 

     December 31,
2009
    December 31,
2010
    Variance  
         Amount     Percentage  

Revenue

   $      $      $        N/M   
  

 

 

   

 

 

   

 

 

   

Costs and expenses:

        

Selling, general and administrative

     17,400,801        21,849,915        4,449,114        26%   

Research and development

     15,085,060        17,424,316        2,339,256        16%   

Interest expense—related party

     3,198,642        4,076,905        878,263        27%   

Depreciation

     1,137,733        1,128,249        (9,484     N/M   
  

 

 

   

 

 

   

 

 

   

Total costs and expenses

     36,822,236        44,479,385        7,657,149        21%   
  

 

 

   

 

 

   

 

 

   

Net loss before non-controlling interest

     (36,822,236     (44,479,385     (7,657,149     (21)%   

Non-controlling interest

     6,554,358        6,469,356        (85,002     N/M   
  

 

 

   

 

 

   

 

 

   

Net loss

   $ (30,267,878   $ (38,010,029   $ (7,742,151     (26)%   
  

 

 

   

 

 

   

 

 

   

Basic and diluted common shares outstanding

     104,866,065        106,731,469        (1,865,404     N/M   
  

 

 

   

 

 

   

 

 

   

Basic and diluted loss per share

   $ (0.29   $ (0.36   $ (0.07     (24)%   
  

 

 

   

 

 

   

 

 

   

 

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Revenue.    We did not record any revenues in 2010 or 2009.

Total costs and expenses.    Total costs and expenses increased by $7.7 million, or 20.8%, to $44.5 million in 2010 as compared to 2009, primarily due to an increase in selling, general and administrative expenses and research and development expenses for the reasons described below.

Selling, general and administrative expenses.    Selling, general and administrative expenses increased by $4.4 million, or 25.6%, to $21.8 million, in 2010 as compared to 2009. The increase in 2010, as compared to 2009, was due to a $9.1 million increase in equity compensation expense which was primarily related to a modification of terms to restricted ownership units previously issued to certain of our officers. This increase was partially offset by decreases in compensation expenses and consulting expenses of $4.2 million. Compensation expenses within selling, general and administrative functions decreased in 2010 as compared to 2009 due to certain employee salary reductions as well as a 21.1% decrease in employee headcount. Expenses related to external consultants decreased 41% for the same period in an effort to improve the efficiency of our operations.

Research and development expenses.    Research and development expenses increased by $2.3 million, or 15.5%, to $17.4 million, in 2010 as compared to 2009. Equity compensation expense increased by $2.5 million during 2010 as compared to 2009, primarily related to the modified terms of the restricted ownership units held by certain of our officers. Also, we recorded a $0.2 million impairment charge related to property and equipment. These increases were slightly offset by a $0.5 million decrease in spending as we needed less expensive materials and supplies for research and development efforts.

Interest expense—related party.    Interest expense—related party increased by $0.9 million, or 27.5%, to $4.1 million in 2010 as compared to 2009. The increase was due to additional funding of our operations during 2010 through notes payable from related parties. The balance of these notes totaled $51.7 million at December 31, 2010 as compared to $35.1 million at December 31, 2009.

Depreciation expense.    Depreciation expense remained relatively consistent in 2010 as compared to 2009, decreasing by $9,000, or 0.8%, to $1.1 million in 2010. We purchased fewer new assets in 2010 as compared to 2009, which was offset by a number of assets becoming fully depreciated during 2010.

Non-controlling interest.    As of December 31, 2010 and 2009, non-controlling interest parties collectively owned approximately 13% and 18%, respectively, of PA LLC and have been attributed their respective portion of the loss of PA LLC. The decrease in the non-controlling interest percentage during 2010 was due to the June 2, 2010 transaction with Arizona Sciences and Technology Enterprises, LLC, or AzTE, which provided for recovery of the 1,000,000 Class A voting units of PA LLC and the cancellation of all existing and future obligations and agreements between us and AzTE in exchange for the return of certain AzTE-licensed technology and a payment of $0.6 million. The amount of loss assigned to non-controlling interests was $6.5 million in 2010 as compared to $6.6 million in 2009.

 

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Comparison of Years Ended December 31, 2008 and 2009

 

     December 31,
2008
    December 31,
2009
    Variance  
         Amount     Percentage  

Revenue

   $      $      $        N/M   
  

 

 

   

 

 

   

 

 

   

Costs and expenses:

        

Selling, general and administrative

     8,251,676        17,400,801        9,149,125        111%   

Research and development

     9,865,844        15,085,060        5,219,216        53%   

Interest expense—related party

     1,764,039        3,198,642        1,434,603        81%   

Depreciation

     268,691        1,137,733        869,042        323%   
  

 

 

   

 

 

   

 

 

   

Total costs and expenses

     20,150,250        36,822,236        16,671,986        83%   
  

 

 

   

 

 

   

 

 

   

Net loss before non-controlling interest

     (20,150,250     (36,822,236     (16,671,986     (83)%   

Non-controlling interest

     162,400        6,554,358        6,391,958        3,936%   
  

 

 

   

 

 

   

 

 

   

Net loss

   $ (19,987,850   $ (30,267,878   $ (10,280,028     (51)%   
  

 

 

   

 

 

   

 

 

   

Basic and diluted common shares outstanding

     100,362,021        104,866,065        4,504,044        N/M   
  

 

 

   

 

 

   

 

 

   

Basic and diluted loss per share

   $ (0.20   $ (0.29   $ (0.09     (45)%   
  

 

 

   

 

 

   

 

 

   

Revenue.    We did not record any revenues in 2009 or 2008.

Total costs and expenses.    Total costs and expenses increased by $16.7 million, or 83%, to $36.8 million in 2009 as compared to 2008, primarily due to an increase in selling, general and administrative expenses and research and development expenses as we expanded our operations.

Selling, general and administrative expenses.    Selling, general and administrative expenses increased $9.1 million, or 111%, to $17.4 million in 2009 as compared to 2008. The increase in 2009, as compared to 2008, was due to a significant increase in the scope of our business development activities as well as increased compensation expense related to our enlarged management team. During the period from our inception to August 1, 2008, a portion of our selling, general and administrative functions, including the majority of business development activities, were provided by XL Tech and charged to us. The portion of selling, general and administrative expenses that arose from these related party charges was $2.2 million in 2008.

Research and development expenses.    Research and development expenses increased $5.2 million, or 53%, to $15.1 million in 2009 as compared to 2008. The increase in 2009, as compared to 2008, was driven by a higher number of both external consultants and employees involved in research and development relating to various components of our system, as well as higher materials and equipment costs related to the design and construction of our demonstration facility.

Interest expense—related party.    Interest expense on notes payable—related party increased by $1.4 million, or 81%, to $3.2 million in 2009 as compared to 2008. The increase in 2009, as compared to 2008, was due to additional funding of our operations through notes payable from related parties. The balance of these notes totaled $35.1 million at December 31, 2009 as compared to $23.6 million at December 31, 2008.

Depreciation expense.    Depreciation expense increased by $0.9 million, or 323%, to $1.1 million in 2009 as compared to 2008. The increase in 2009, as compared to 2008, was due to an increase in our capital asset base as a result of the purchase of more laboratory equipment, computer equipment, furniture, and leasehold improvements in 2009 as compared to 2008.

 

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Non-controlling interest.    As of December 31, 2009, non-controlling interest parties collectively owned approximately 18% of PA LLC and have been attributed their respective portion of the loss of PA LLC. The amount of loss assigned to non-controlling interests was $6.6 million in 2009 as compared to $0.2 million in 2008.

Critical Accounting Policies and Management Estimates

Our management’s discussion and analysis of our financial condition and results of operations is based on our consolidated financial statements, which have been prepared in accordance with generally accepted accounting principles, or GAAP. The preparation of these consolidated financial statements require us to make estimates and assumptions based on experience and on various assumptions that we believe are reasonable under the circumstances that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenue and expenses during the period. Actual results may differ from these estimates.

While our significant accounting policies are more fully described in Note 1 of our consolidated financial statements that are included elsewhere in the prospectus, we believe the following accounting policies are critical to the process of making significant judgments and estimates in the preparation of our consolidated financial statements.

Revenue Recognition

We will begin to record revenue when persuasive evidence of an arrangement exists, services have been rendered or product delivery has occurred, the sales price to the customer licensee is fixed or determinable, and collectability is reasonably assured. To the extent cash is received in advance of our performance or the availability of rights under a license agreement or such receipts are refundable at the customer licensee’s option, these amounts are reported as deferred revenue.

Cash and Cash Equivalents and Cash Concentrations

We consider all highly liquid investments with a remaining maturity of three months or less when purchased to be cash equivalents. At September 30, 2011, we had all of our cash on deposit at a single financial institution.

Fair Value of Financial Instruments

Fair value estimates discussed herein are based upon certain market assumptions and pertinent information available to management. The respective carrying values of certain on-balance-sheet financial instruments approximate their fair values. These financial instruments include cash and cash equivalents, accounts payable and accrued expenses. Fixed rate carrying values are assumed to approximate fair values for these financial instruments because they are short term in nature and their carrying amounts approximate the amounts expected to be received or paid.

The carrying value of our fixed-rate notes payable—related party approximate fair value based on the current market conditions for similar debt instruments.

Property and Equipment

Property and equipment is recorded at cost. Expenditures for major improvements and additions are added to property and equipment, while replacements, maintenance and repairs which do not extend the useful lives are expensed.

 

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Long-lived Assets

The carrying value of long-lived assets is reviewed on a regular basis for the existence of facts and circumstances that suggest permanent impairment. Specifically, our senior management considers in each reporting period the effectiveness of our significant assets to determine if impairment indicators such as physical deterioration, process change or technological change have resulted in underperformance, obsolescence or a need to replace such assets. We group our assets into three primary categories for this purpose. Due to the nature of our business, cash flows are not derived from specific asset groups, therefore this grouping is merely to aid our analysis.

 

  Ÿ  

Office equipment, including leasehold improvements

 

  Ÿ  

Demonstration system and engineering equipment

 

  Ÿ  

Computer software and hardware—applications and networking

We do not consider our net loss or cash outflow from operations to be an indicator of asset impairment as such financial results are typical for technology companies that are in the development stage. Rather, we evaluate the state of our technology, our process toward technical and business milestones, and relevant external market factors to ascertain whether a potential impairment has occurred. During 2010 and the nine months ended September 30, 2011, we identified certain changes in our process development plans that eliminated or changed the need or expected use of certain assets. As a result, impairment charges of $0.2 million and $0.4 million, respectively, were recorded as a reduction of property and equipment and an addition to research and development expense to reduce these assets to their estimated realizable value. No impairment indicators were noted in any of the years ended December 31, 2009, 2008 or 2007 or the nine-month period ended September 30, 2010 and our process of monitoring these assets was unchanged during these periods.

When we identify an impairment indicator, we measure the amount of the impairment based on the amount that the carrying value of the impaired asset exceeds our best internal estimate of the value of the asset while it remains in use, plus any proceeds expected from the eventual disposal of the impaired asset. Since we use most of our property and equipment to demonstrate our technology to prospective customer licensees and not to generate revenues or cash flows, a cash flow analysis of the categories above or the assets as a whole is not practicable. Instead, a depreciated replacement cost estimate is used for assets still in service and equipment secondary market quotes are obtained for assets planned for disposal. Depreciated replacement cost is determined by contacting vendors of the same or similar equipment or other assets to obtain an estimate of the market price of such assets, and then reducing this amount by a formula derived from the age of the equipment and the typical useful life of that equipment. For assets planned to be disposed, descriptions of the equipment are circulated to a number of purchasers of used machinery and equipment to solicit bids for such assets. Our best estimate of selling price based upon these purchasers’ responses is used to estimate the value of such assets, net of any costs to remove, recondition and/or ship the equipment to the buyer.

Income Taxes

We have not recorded any income tax expense or benefit for the four years ended December 31, 2010 and the nine months ended September 30, 2011 and 2010 primarily due to our history of operating losses. We follow Accounting Standards Codification, or ASC, 740, Income Taxes, for recording the provision for income taxes. Deferred tax assets and liabilities are computed based upon the difference between the financial statement and income tax basis of assets and liabilities using the enacted marginal tax rate applicable when the related asset or liability is expected to be realized or settled. Deferred income tax expenses or benefits are based on the changes in the asset or liability each period. If available evidence suggests that it is more likely than not that some portion or all of the deferred tax assets will not be realized, a valuation allowance is required to reduce the deferred tax

 

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assets to the amount that is more likely than not to be realized. Future changes in such valuation allowance are included in the provision for deferred income taxes in the period of change.

As required by ASC 740-10-05, Accounting for Uncertainty in Income Taxes, we recognize the financial statement effects of a tax position when it is more likely than not (defined as a likelihood of more than 50%), based on the technical merits, that the position will be sustained upon examination. The evaluation of whether a tax position meets the more-likely-than-not recognition threshold requires a substantial degree of judgment by management based on the individual facts and circumstances. Actual results could differ from these estimates.

PA LLC is organized as a limited liability company under the state law of Delaware. As a limited liability company that has elected to be taxed as a partnership, our earnings pass through to the members and are taxed at the member level. Accordingly, the income tax provision included in the accompanying consolidated financial statements represents the tax impact arising from our ownership interest in the operations related to PA LLC.

Because we have incurred an accumulated deficit during the development stage of $117.1 million as of September 30, 2011 and cannot predict with certainty our future profits, our deferred tax assets and the potential future benefit of our net operating losses, to the extent deductible for income tax purposes, are fully reserved.

Stock-based Compensation

We account for stock-based compensation in accordance with ASC 718, Stock Compensation. The Statement requires that the cost resulting from all stock-based transactions be recorded in the financial statements. The Statement establishes fair value as the measurement objective in accounting for stock-based payment arrangements with employees. The Statement also establishes fair value as the measurement objective for transactions in which an entity acquires goods or services from non-employees in stock-based payment transactions.

We have made the following equity-based compensation awards to our employees over the period from January 1, 2007 to September 30, 2011:

 

Grant Type and Dates

   Number
Granted
     Grant Date
Fair Value(1)
    Fair Value
Per Share
 

2007 PA LLC profits interests

     674,500       $ 2,786,199      $ 4.13   

2008 PA LLC profits interests

     2,816,471         19,046,340      $ 6.76   

2009 PetroAlgae Inc. stock options

     1,117,500         3,023,100      $ 2.71   

2010 PetroAlgae Inc. stock options

     322,000         1,223,600      $ 3.80   

2011 PetroAlgae Inc. stock options

     1,239,000         4,476,570      $ 3.61   

2011 PetroAlgae Inc. stock appreciation rights

     1,000,000         3,847,250      $ 3.85   
     

 

 

   

Total fair value at date of grant

      $ 34,403,059     

Aggregate impact of forfeitures

        (6,154,640  
     

 

 

   

Equals: net historical and future expense

      $ 28,249,019     
     

 

 

   

 

(1) Value reflects modifications made subsequent to original grant date, as discussed below.

PA LLC profits interests.    During 2007 and 2008, we granted the majority of our employees these interests as of the date that they began employment with PA LLC. These ownership interests give the recipient the right to participate in the income of PA LLC and any distribution that may arise from a liquidity event to the extent that such realized amounts exceed the ownership unit fair value at the date of grant. We determined the fair value of these grants using a probability-weighted present

 

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value calculation, as further described below. Upon the completion of this offering, these interests will become exchangeable into shares of our common stock. The total number of shares issuable upon such exchanges are included in the shares of our common stock reserved for issuance upon the exchange of units of PA LLC.

The fair value of the profit interests granted was calculated by modeling the cash impact of possible future liquidity event scenarios in relation to the economics of the agreements. The key steps in this process for each grant were as follows:

 

  Ÿ  

The likelihood and expected value of an initial public offering, a sale to a strategic buyer, and a financial sale or leveraged buyout were estimated based on information that was available to management at the date of the grants;

 

  Ÿ  

The probability of achieving each scenario was estimated based upon our outlook at grant date based upon milestones accomplished at that point and future hurdles;

 

  Ÿ  

The probability-weighted future values were converted to future liquidity per share by dividing projected proceeds by the units outstanding before each grant;

 

  Ÿ  

The estimated fair value per unit at grant date (determined by employing discounted cash flow analyses to the business’ projections) was deducted from the estimated future value per unit to derive the gross potential profits interest for each grant; and

 

  Ÿ  

The gross profits interest was then discounted to present value based upon the weighted average time required to accomplish estimated liquidity events using a 60% discount rate, which is consistent with discount rates applied in the valuation of development stage technology companies.

Upon issuance, the PA LLC profit interests grants contain restrictions that allow us to repurchase the shares for nominal consideration until a service period or other condition is met. This restriction is removed over a service period (generally four years) with regard to approximately 2.2 million of the interests with an initial grant date fair value of approximately $10.4 million. Consequently, the related compensation expense is recognized ratably over the remaining service period as a selling, general and administrative or research and development expense, depending upon the recipient’s role in us. Five senior officers received an aggregate 1.3 million profits interests that were subject to repurchase for nominal consideration until a significant liquidity event occurred. As of December 31, 2010, our principal stockholders authorized the modification of the terms of the grant to remove our right to repurchase the Interests held by all five officers, causing these grants to be immediately vested. This decision required a revaluation of the Interests held by the officers and immediate recognition of the calculated expense. Based upon current estimates and applying the same discounted cash flow methodology used as of the prior valuation dates, the compensation cost recognized during the fourth quarter of 2010 was $11.4 million, recorded as selling, general and administrative expense ($9.1 million) or research and development expense ($2.3 million) depending upon each officer’s role.

PetroAlgae Inc. stock options.    These options to purchase our stock generally become exercisable on a ratable basis over four years beginning at each recipient’s date of hire. We determined the fair value of these options using the Black-Scholes model using the assumptions listed below. Compensation cost is recognized as a selling, general and administrative or research and development expense, depending upon the recipient’s role with us, over the required service period of each grant.

On June 30, 2011, our board of directors authorized the re-pricing of all outstanding stock options, changing the exercise price from $8.00 or $8.50 to $5.50 per option. In accordance with ASC 718-20-35-3, we computed the additional compensation cost as the fair value of the new awards in

 

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excess of the fair value of the original awards immediately before their terms were modified, using the Black-Scholes pricing model. This calculation used the following assumptions determined as of June 30, 2011:

 

  Ÿ  

estimated fair value of the common stock of $5.10;

 

  Ÿ  

remaining terms ranging from 4.75 years to 5.89 years (depending on the date of the original grant);

 

  Ÿ  

risk free interest rate of 1.76%;

 

  Ÿ  

estimated volatility of 96.5%; and

 

  Ÿ  

dividend yield of 0.0%.

The modification affected 1,240,000 options and resulted in aggregate additional compensation cost of $0.4 million. Of the total additional compensation cost, $0.2 million was expensed immediately as it related to options which were vested as of June 30, 2011, and the remaining $0.2 million will be expensed through 2014.

Additionally, on June 30, 2011, our board of directors authorized the grant of 616,000 options to employees, in the aggregate, to purchase common shares at an exercise price of $5.50 per share. Of the 616,000 options authorized, 351,000 were granted on June 30, 2011 and the remaining 265,000 were granted on July 21, 2011. The fair value of the options was calculated using the Black-Scholes pricing model with assumptions identical the ones listed above.

Due to the significant number of equity transactions that occurred during June of 2011, including the stock option modification and stock option issuance discussed above and the stock appreciation rights, or SARs, issuance discussed below, we re-examined our volatility estimate and consequently increased it from 75.2% to 96.5% on a prospective basis. We estimate volatility in accordance with SEC Staff Accounting Bulletin, or SAB, No. 107, “Share-based Payment” based on an analysis of expected volatility of share trading prices for a peer group of companies. Over a period of time similar to that of the expected option life, the volatility in share price of these alternative energy and clean-tech companies averaged 70.4%. To account for the fact that we are in the development stage and can be expected to have a higher volatility at our present stage than the average of the comparable companies, we adjusted upward our volatility estimate. Specifically, we estimated our share volatility by calculating the average volatility of those members of our peer group that exhibited volatility measures in the top quartile of the group. Using this approach, we determined that a volatility estimate of 96.5% is appropriate in our fair value calculations.

The Black-Scholes calculations resulted in the determination of the following total compensation cost for each grant after the modification:

 

Grant Dates

   June 2009      July 2009      January 2010      January 2011      June and
July 2011
 

Fair value per option

   $ 2.70       $ 2.83       $ 3.80       $ 3.27       $ 3.96   

Number of options granted

     1,072,500         45,000         322,000         623,000         616,000   

Fair value

   $ 2,895,750       $ 127,350       $ 1,223,600       $ 2,037,210       $ 2,439,360   

Expected term(1)

     4.75 years         4.75 years         5.15 years         5.89 years         6.25 years    

 

(1) In all cases, with the exception of June and July 2011 issuances, the expected term shown here represents the remaining term used in the Black-Scholes calculation at the time the stock options were re-valued at June 30, 2011.

 

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PetroAlgae Inc. Stock Appreciation Rights.    In November 2010, we issued one million SARs to Mr. Harris, our former President and Chief Operating Officer, under the 2009 Plan. The vesting of these SARs was tied to continued employment with us and the accomplishment of certain milestones. Mr. Harris resigned during the first quarter of 2011, forfeiting all such SARs. The impact on all periods presented was not material.

In June 2011, our board of directors authorized the grant of one million SARs at a base grant price of $5.50 per share to our newly appointed Chief Executive Officer under the 2009 Plan. The SARs have a ten-year term and will vest in equal quarterly installments over a two-year period. In the event of a change of control (as defined in the 2009 Plan) or a qualified public offering (as defined in the executive’s employment agreement), the SARs will become 100% vested. The grant date fair value of the SARs aggregated to $3.8 million and was calculated using the Black-Scholes pricing model with the following assumptions determined as of the date of grant: estimated fair value of the common stock of $5.10, expected term of 5.75 years, risk free interest rate of 1.55%, an estimated volatility of 96.5%, and a dividend yield of 0%. The fair value will be charged to operations over the remaining vesting periods commencing on the grant date.

Issuance of Shares and Warrants in Financing Transactions

Estimation of Common Stock Fair Value. In each reporting period, we have determined our best estimate of the fair value of our common stock by considering the following indicators of value:

 

  Ÿ  

Level 3 valuations based upon a discounted cash flow analysis using inputs which were not externally observable, in this case our estimate of future cash flows from our business;

 

  Ÿ  

Prices paid in cash for shares of stock or securities units comprised of equity shares and five-year warrants to purchase equity shares; and

 

  Ÿ  

Over-The-Counter (“OTC”) quotation closing price and related statistics such as trading volume, volatility and recent price ranges.

Level 3 estimated cash flow valuations.    The Level 3 fair value estimate of our equity value was determined by applying discounted cash flow valuation techniques to expected future cash flows from our business as of each valuation date. Key assumptions utilized in this fair value estimate include the expected amount and timing of revenue from expected future sales of our technology licenses along with the associated cost of sales and other operating cash outflows. These cash flows are discounted to present value using a discount rate consistent with development stage technology companies and the resulting enterprise value was converted to an equity value per outstanding share.

The most significant uncertainty inherent in these calculations is the risk of obtaining and performing the contracts necessary to produce the estimated future revenues. In addition, the risk of collection of amounts that are expected to be due under projected contracts, the risk of unanticipated product development or delivery costs or timing delays and the risk of increased operating and overhead costs may each cause the estimates of future net cash flows from operations to vary from the assumptions that are made in these projections, and these variations may be material. Since we have not obtained or performed any commercial contracts to date, we do not have historical data on which to base our estimate of future revenues.

Because the Level 3 indications of value were able to take into account important information pertaining to the amount, timing and risk of our expected cash flows, they were given the most weight in our estimate of share value.

Third party transactions.    From January 2009 through August 2010, we completed several private sales of equity shares and securities units comprised of both shares and warrants to purchase

 

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shares. The transactions were completed with both related and unrelated parties in exchange for cash. Given the size of these transactions and the sophisticated nature of the parties involved in their negotiation, these indications of value were given significant weight in our estimate of share value. However, because most of these transactions were with affiliates, sole or primary reliance was not placed on these values.

OTC Values.    Our common stock is currently quoted on the OTCQB. A very small percentage of the issued and outstanding shares are available for active trading since approximately 94% of our outstanding shares are held by our principal stockholders. Due to the very limited size of our public float and the resulting low trading volume in our common stock, our public shares are susceptible to very large swings in price based on very few trades. As a result of these considerations, value indications provided by the OTC price quotation service were given the least weight of the three factors in our estimate of share value.

Estimation of Warrant Fair Value.    We estimated the fair value of warrants issued during 2010 using the Black-Scholes valuation model, based on the estimated fair value of our common stock on the valuation date, an expected dividend yield of 0%, a risk-free interest rate based on constant maturity rates published by the U.S. Federal Reserve applicable to the remaining term of the instruments, an expected life equal to the remaining term of the instruments and an estimated volatility of 75.2%. No warrants have been issued during 2011.

Liquidity and Capital Resources

Overview

To date, we have financed our operations primarily through loans from, and debt securities issued to, our principal stockholders. To a lesser extent, we have also raised funds by issuing equity securities to unrelated third parties. Since our inception through September 30, 2011, we have raised in the aggregate $102.0 million in debt and equity investments, with $92.1 million of this total raised from our principal stockholders and $9.9 million raised from unrelated third parties.

We are a holding company whose sole asset is our controlling equity interest in our operating subsidiary, PA LLC. We operate and control all of the business and affairs, and consolidate the financial results, of PA LLC. PA LLC was originally founded in September 2006 by XL Tech, as a private company focused on developing technologies for the renewable energy market. From its inception through August 2008, PA LLC was financed by XL Tech. XL Tech provided $16.6 million of debt financing through August 2008. In August 2008, XL Tech exchanged certain of its assets, including the equity it held in PA LLC, for the outstanding debt of XL Tech that was held by our principal stockholders. In December 2008, our principal stockholders acquired a shell company that was quoted on the OTCBB and assigned its interest in PA LLC to this shell company, which it then renamed PetroAlgae Inc. Since August 2008, our principal stockholders have been primarily funding our operations.

Issuances of debt instruments.     The majority of our capital has been debt financing provided by our principal stockholders, which is evidenced by promissory notes. Our fixed-rate notes, of which an aggregate principal amount of $52.5 million was outstanding at September 30, 2011, are secured by all of our assets, are each due on June 30, 2012 and each bear interest at an annual fixed rate of 12%. An earlier note with an outstanding balance of $19.6 million at September 30, 2011 bears interest at a floating rate of prime plus 2% and accrues interest on a payment-in-kind, or PIK, basis under which the accrued interest is added to the principal amount of the note. Subsequent to the end of the third quarter of 2011, our principal stockholders provided $4.4 million of additional debt financing to our operating subsidiary at an annual fixed rate of 12%.

 

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Issuance of common stock and warrants.     In December 2008, our principal stockholder paid $10.0 million for 3.2 million shares of our common stock (approximately $3.15 per share), which was estimated to be the fair value of the shares at that time. In the second half of 2009 through August of 2010, we issued units comprised of a share of our common stock and an option to purchase a second share of common stock at any time over a five-year period at a price of $15.00. In each case, these units were issued for a cash price of $8.00. Over this period, our principal stockholders paid $10.0 million in cash for 1,250,000 units and unaffiliated third parties paid $9.9 million in cash for 1,235,000 units.

Operating and Capital Expenditure Requirements

We intend to apply the net proceeds from this offering, any cash we generate from operations and our cash balances to meet our anticipated operating and capital expenditure requirements. In the future, we expect our operating and capital expenditures to increase as we increase our headcount, expand our business activities, grow our customer licensee base and implement and enhance our technology and processes.

If our available cash balances and net proceeds from this offering are insufficient to satisfy our liquidity requirements, we may seek to sell equity or debt securities or enter into a credit facility. The sale of equity may result in dilution to our stockholders and any deficit we issue may have rights senior to those of our common stock. If we raise additional funds through the issuance of debt securities, these securities could contain covenants that would restrict our operations. Any credit facility would be likely to contain very significant restrictions on our business activities and might not be available to us on economically viable terms. We may require additional capital beyond our currently anticipated amounts. Additional capital may not be available on reasonable terms, or at all.

Our estimates of the period of time through which our financial resources will be adequate to support our operations and the costs to support research and development and our sales and marketing activities are forward-looking statements and involve risks and uncertainties and actual results could vary materially and negatively as a result of a number of factors, including the factors discussed in the section “Risk Factors” of this prospectus. We have based our estimates on assumptions that may prove to be wrong and we could utilize our available capital resources sooner than we currently expect.

Our short- and long-term capital requirements will depend on many factors, including the following:

 

  Ÿ  

our ability to sign binding contracts and generate cash from operations;

 

  Ÿ  

our ability to control our costs;

 

  Ÿ  

the costs of competing with alternative technological developments;

 

  Ÿ  

the costs of filing, prosecuting, defending and enforcing any patent claims and other intellectual property rights or participating in litigation-related activities; and

 

  Ÿ  

our ability to consummate this offering.

 

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Sources and Uses of Cash

At September 30, 2011, we had unrestricted cash and cash equivalents of $6.7 million compared to $1.1 million at December 31, 2010 and $2.7 million at December 31, 2009. The changes in the level of cash balances principally relates to timing of debt and equity transactions. The following table presents a summary of our cash and cash equivalents, and cash flows, for the periods indicated.

 

    Summary of Net Cash Flows  
    For the year ended
December 31,
    For the nine months ended
September 30,
 
    2008     2009     2010     2010     2011  
                      (Unaudited)  

Net cash used in operations

  $ (11,849,362   $ (27,602,288   $ (22,783,504   $ (17,114,869   $ (13,423,545

Net cash used in investing activities

    (812,660     (2,435,233     (1,034,916     (785,010     (526,958

Net cash provided by financing activities

    22,894,700        22,300,000        22,280,000        15,580,000        19,525,000   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net (decrease) increase in cash

  $ 10,232,678      $ (7,737,521   $ (1,538,420   $ (2,319,879   $ 5,574,497   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Cash and cash equivalents-beginning of period

  $ 184,145      $ 10,416,823      $ 2,679,302      $ 2,679,302      $ 1,140,882   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Cash and cash equivalents-ending of period

  $ 10,416,823      $ 2,679,302      $ 1,140,882      $ 359,423      $ 6,715,379   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Cash Flows from Operating Activities

Cash flows used in operating activities totaled $13.4 million in the nine months ended September 30, 2011, compared to $17.1 million in the same period in 2010. The decrease in cash usage was primarily attributed to decreased payroll costs due to a lower headcount ($2.4 million) and cost savings resulting from less utilization of external consultants ($0.9 million) for the nine months ended September 30, 2011 as compared to the same period in 2010.

During 2010, cash flows used in operating activities totaled $22.8 million, compared to $27.6 million in 2009. This decrease was primarily attributed to cost savings of $3.8 million in the area of external consultants.

During 2009, cash flows used in operating activities totaled $27.6 million as compared to $11.8 million in 2008. The increase in cash usage from 2008 to 2009 was primarily attributed to increased compensation expenses and external consultant expenses of $12.1 million to fund our research and product development activities and to build our operational and business development efforts.

Cash Flows from Investing Activities

Cash flows used in investing activities totaled $0.5 million in the nine months ended September 30, 2011, compared to $0.8 million in the same period during the prior year. The decline in expenditures between the two periods reflects the purchase of less equipment during 2011 as compared to 2010 since our technology development and laboratory testing are approaching completion.

During 2010, cash flows used in investing activities totaled $1.0 million, compared to $2.4 million in 2009. This decrease was due to the purchase of less equipment during 2010 than in 2009 because our demonstration facility had been completed in 2009.

 

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During 2009, cash flows used in investing activities totaled $2.4 million, compared to $0.8 million in 2008. These amounts represented the continued growth and expansion of our technology development assets, primarily from the construction of our demonstration facility, which was completed in 2009.

Cash Flows from Financing Activities

Cash flows provided by financing activities totaled $19.5 million in the nine months ended September 30, 2011, compared to $15.6 million in the same period during the prior year. For the nine months ended September 30, 2011 and 2010, cash raised from the issuance of common stock and warrants decreased by $7.6 million while borrowings under notes payable-related party increased by $11.0 million.

During 2010, cash flows provided by financing activities totaled $22.3 million, including $20.2 million funded by affiliates and $2.1 million funded by third parties, compared to $22.3 million in 2009, $14.5 million of which was funded by affiliates and $7.8 million of which was funded by third parties.

During 2008, cash flows provided by financing activities totaled $22.9 million. This consisted of debt and equity funding, all from affiliates.

Capital Expenditures

During the nine months ended September 30, 2011, we made total capital expenditures of $0.5 million, primarily related to our demonstration facility, including purchasing the land and upgrading certain equipment used in our processing facility. For the nine months ended September 30, 2010, our total capital expenditures were $0.8 million, which consisted of equipment used in furthering our research and development related to our technology. Our total capital expenditures during 2010 were $1.0 million, compared to $2.5 million during 2009. This decrease in capital spending is attributable to the completion of construction on our demonstration facility in 2009.

Senior Secured Credit Financings

Our debt is comprised of the following senior secured notes (payable to our principal stockholders or their affiliates) at September 30, 2011:

 

Note Payable to Valens U.S. SPV I, LLC

  $ 417,512   

ŸInterest accrues monthly at an annual rate of 12%

 

ŸNote is due on June 30, 2012

 

Notes Payable to PetroTech

    42,047,089   

ŸInterest accrues monthly at an annual rate of 12%

 

ŸNotes are due on June 30, 2012

 

Convertible Note Payable to PetroTech

    10,000,000   

ŸInterest accrues monthly at an annual rate of 12%

Ÿ Note is due June 30, 2012 unless converted to common shares as described below

 

Up to $25,000,000 Note Payable to PetroTech

    19,588,014   

ŸInterest payable monthly, and is drawn into note on a monthly basis at Prime + 2% (5.25% at September 30, 2011 and December 31, 2010)

 

ŸNote is due on June 30, 2012

 

ŸPermits additional draws to fund interest. Maximum balance of this note is limited to $25,000,000.

 
 

 

 

 

Total Notes Payable—Related Party

  $ 72,052,615   
 

 

 

 

 

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As of September 30, 2011, the principal balance of notes payable—related party has been reclassified to current liabilities as the maturity date is within one year. The notes payable—related party are secured by all of our assets. The convertible note payable allows the holder (at the holder’s option) to convert all or any portion of the issued and outstanding principal amount and/or accrued interest and fees then due into shares of our common stock at a fixed conversion price of $5.43 per share.

Each note payable and the related master security agreement and equity pledge and corporate guaranty agreement contain provisions that specify events of default which could lead to acceleration of the maturity of the debt. These provisions prohibit the encumbrance or sale of our assets and require maintenance and insurance of our assets. The loan agreements do not contain any required financial ratios or similar debt covenants. Generally, an event of default would arise if we became insolvent, filed for bankruptcy, allowed a change in control or had unresolved judgments against its assets. Through the date of this prospectus, none of these events had occurred.

Interest charged to operations on these notes was $4.6 million and $2.9 million during the nine months ended September 30, 2011 and 2010, respectively. Interest expense-related party, including amortization of original issue discount, was $4.1 million, $3.2 million and $1.8 million during the years ended December 31, 2010, 2009 and 2008, respectively.

The principal amount of debt obligations as of September 30, 2011 was $72.1 million, of which $19.6 million was outstanding at a floating rate of 2% over the prime interest rate and $52.5 million was outstanding at a fixed rate of 12%. Floating rate borrowings will lead to additional interest expense if interest rates increase.

Contractual Obligations

The following table discloses aggregate information about our contractual obligations and period in which payments are due as of September 30, 2011:

 

    Payments Due by Period  
    Total     Less than
1 year
    1-3 years     3-5 years     More than
5 years
 

Debt: principal

  $ 72,052,615      $ 72,052,615      $      $         —      $         —   

Debt: accrued interest to date(1)

    8,682,148        8,682,148                        

Debt: estimated future interest(2)

    5,506,728        5,506,728                        

Operating lease commitments

    989,140        527,762        461,378                 
  

 

 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total contractual obligations

  $ 87,230,631      $ 86,769,253      $ 461,378      $      $   
  

 

 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

(1) Represents the amount of interest that has been accrued through the balance sheet date on $52.5 million of outstanding debt at a fixed annual rate of 12%. This amount is due at the June 30, 2012 maturity date of the related debt.
(2) Estimated future interest represents the amount of interest expected to accrue until the maturity date of the related debt, which in all cases is June 30, 2012. The estimated amount is calculated from the current balance sheet date through maturity based upon the principal balance of each note and the applicable interest rate, which is compounded monthly at prime + 2% (assumed to be 5.25%) on $19.6 million of debt and calculated on a non-compounded basis at 12% on the remaining principal amount.

Recent Transactions Affecting our Liquidity and Capital Resources

Equity issuances.     We have not sold any shares during 2011.

Debt issuances.     On each of October 5, 2011 and November 18, 2011, our principal stockholders funded $2.2 million to our operating subsidiary, PA LLC, pursuant to the terms of separate secured term notes. Each of these notes provides for interest at 12%, which is accrued as a PIK amount, and are due on June 30, 2012.

 

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Off-Balance Sheet Arrangements

As of September 30, 2011, we did not have any significant off-balance sheet arrangements, as defined in Item 303(a)(4)(ii) of SEC Regulation S-K.

Quantitative and Qualitative Disclosures about Market Risk

Interest Rate Risk

Our exposure to interest rate risk is related to our borrowings. The principal amount of our debt obligations as of September 30, 2011 was $72.1 million, of which $19.6 million was outstanding at a floating rate of 2% over the prime interest rate and $52.5 million was outstanding at a fixed rate of 12%. Floating rate borrowings will lead to additional interest expense if interest rates increase. We enter into loan arrangements when needed and borrowings are subject to interest rate risk because changes in the prime interest rate will have an effect on interest rate expense.

If interest rates would have increased by 1.0%, the additional interest expense for the nine months ended September 30, 2011 would have been $0.2 million. A similar increase in interest rates for the nine months ended September 30, 2010 would have resulted in approximately $0.1 million in additional interest expense.

Exchange Rate Risk

We are currently not subject to foreign exchange risk as a result of exposures to changes in currency exchange rates. Under the license agreements that we expect to enter into in the future with non-U.S. customer licensees, a portion of its license and royalty fee revenue may be denominated in currencies other than the U.S. dollar. Many of our costs, however, including most of the costs of our employees who we expect to support the operations of our customer licensees, and our research and development costs, will be denominated in U.S. dollars. We expect that fluctuations in the value of these revenues and expenses as measured in U.S. dollars will affect our results of operations, and adverse currency exchange rate fluctuations may have a material impact on our future financial results.

Commodity Price Risk

Our technology, once commercialized, will be used to produce protein for the agriculture market and biocrude for the energy market, each of which may directly or indirectly compete with existing commodities. In particular, we expect that the price our customer licensees will obtain from the sale of these products will most directly be impacted by market prices for protein, crude oil and petroleum-based fuels, respectively. These market prices, particularly for crude oil and petroleum-based fuels, can be volatile, and can be influenced by factors such as global demand, availability of supply, weather, political events and the market price of alternative forms of energy, all of which factors are beyond our control. Significant fluctuations in these commodity prices could impact the profitability of our technology to our customer licensees, and therefore the demand for our technology, and could also affect the amount of royalty revenues we receive from our customer licensees.

Recent Accounting Pronouncements

Adoption of New Accounting Standards

Revenue Recognition

In October 2009, the FASB issued Accounting Standards Update, or ASU, 2009-13, Multiple-Deliverable Revenue Arrangements, or ASU 2009-13. The new standard changes the requirements for establishing separate units of accounting in a multiple element arrangement and requires the allocation

 

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of arrangement consideration to each deliverable based on the relative selling price. The selling price for each deliverable is based on vendor-specific objective evidence, or VSOE, if available, third-party evidence if VSOE is not available, or estimated selling price if neither VSOE or third-party evidence is available. ASU 2009-13 is effective for revenue arrangements entered into in fiscal years beginning on or after June 15, 2010. The adoption of this new guidance did not have a material effect on our consolidated financial statements, nor does management expect it to have a material impact on our expected future revenues.

Fair Value

In January 2010, the FASB issued ASU 2010-6, Improving Disclosures About Fair Value Measurements, or ASU 2010-6, which requires reporting entities to make new disclosures about recurring or nonrecurring fair-value measurements, including significant transfers into and out of Level 1 and Level 2 fair-value measurements and information on purchases, sales, issuances, and settlements on a gross basis in the reconciliation of Level 3 fair-value measurements. ASU 2010-6 is effective for annual reporting periods beginning after December 15, 2009, except for Level 3 reconciliation disclosures which are effective for annual periods beginning after December 15, 2010. The adoption of ASU 2010-6 did not have a material impact on our consolidated financial statements.

Accounting Standards Not Yet Effective

In May 2011, the FASB issued ASU No. 2011-04, Fair Value Measurements and Disclosures (Topic 820): Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and International Financial Reporting Standards, or ASU 2011-04, to provide a consistent definition of fair value and ensure that the fair value measurement and disclosure requirements are similar between U.S. GAAP and International Financial Reporting Standards. ASU 2011-04 changes certain fair value measurement principles and enhances the disclosure requirements, mainly for level 3 fair value measurements. ASU 2011-04 is effective for our fiscal year beginning January 1, 2012. Early adoption is not permitted. We are currently evaluating the impact of this new guidance, but does not expect it to have a material impact on our consolidated financial statements.

In June 2011, FASB issued ASU 2011-05, Comprehensive Income (Topic 220): Presentation of Comprehensive Income, or ASU 2011-05. ASU 2011-05 will require companies to present the components of net income and other comprehensive income either as one continuous statement or as two consecutive statements. It eliminates the option to present components of other comprehensive income as part of the changes in stockholders’ equity. The standard does not change the items which must be reported in other comprehensive income, how such items are measured or when they must be reclassified to net income. ASU 2011-05 is effective for interim and annual periods beginning after December 15, 2011, with early adoption permitted. The adoption of ASU 2011-05 will only impact presentation and will not have any effect on our consolidated financial statements or on our financial condition.

 

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BUSINESS

Company Overview

Our Business

We provide renewable technology and solutions to address the global demand for new economical sources of feed, food and fuel.

Our objective is to be the leading global provider of technology and processes for the commercial production of micro-crop biomass for agriculture and energy markets. We seek to license renewable technology to meet the significant and growing demand for agricultural products and energy in both emerging and developed economies. We believe that our solution will deliver to our customer licensees strong and consistent economic returns as a consequence of continuous, predictable, year-round operations without the need for government subsidies. We also expect our solution to provide social benefits, through job creation and community investment, as well as significant environmental advantages, through sustainable production that absorbs atmospheric carbon dioxide and does not compete with the existing food supply, require arable land, or pollute soil or water.

We have developed proprietary technology, consisting of integrated environmental management systems, which we believe will allow our customer licensees to grow aquatic micro-crops at accelerated rates. This solution utilizes locally available micro-crops and commercially available processing equipment to produce biomass-based products that can be sold directly into agriculture and energy markets.

Our strategy is to license and provide management support for production facilities in equatorial regions around the world. Our solution is scalable and flexible, which we believe will allow our customer licensees to expand facility capacity and increase production to meet market demand. We intend to generate revenue from licensing fees and royalties primarily from customer licensees that are engaged in the global agriculture and energy markets, as well as from investment groups. Our licensing approach is designed to minimize our capital expenditures, because our customer licensees will be expected to invest in the development and construction of the production facilities.

Our proprietary technology uses indigenous micro-crops (from the Lemnaceae family) that are not genetically modified and demonstrate an optimal growth profile for a particular geography and environment. These micro-crops will then be grown, harvested and processed in a manner that we believe will optimize the production of our micro-crop biomass. To date, the operations at our demonstration facility have deepened our understanding of the variables relating to the micro-crop productivity of our technology. Based on this work, as well as additional modeling, we believe that these micro-crops can be grown and harvested on a commercial scale. Our processes use industry-standard agricultural and food processing equipment in specialized configurations to produce products with consistent quality. During our process, the micro-crops are pressed to separate the pulp from the liquid. The liquid is further processed to create our Lemna Protein Concentrate, or LPC, while the pulp is converted to create our Lemna Meal, or LM, and Biocrude product. Our Biocrude product requires further third-party conversion to facilitate the production of renewable fuels. These products can then be used locally or shipped to the end customer licensees and utilized in the markets depicted below.

 

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Our Products

The diagram below illustrates the products that we expect our technology to produce and their respective end markets.

LOGO

Our Markets

Our current product strategy is to enable customer licensees to sell our LPC product in the global animal feed market as a fish meal alternative and our LM product in the global animal feed market as an alternative to alfalfa meal. We believe that focusing in the near-term on the deployment of our technology for the production of animal feed helps to reduce the market risks associated with our solution, given the relatively high value, high demand, and low complexity of these products.

In addition, we believe that LPC is well-positioned as an alternative to kelp meal, commonly used in fertilizers for turf grasses, such as those on golf courses. In addition, we believe that LM could potentially be used as an ingredient in organic fertilizers and in animal bedding applications.

University studies and other third-party tests completed in 2011 indicate that LPC could potentially be used in human food applications. If the safety and viability of this use is confirmed, we believe that we will be successful in completing the process for regulatory approval required in various countries for the human use of our products, which would significantly increase the value of LPC. See “Business—Regulatory.”

We expect that the continued development of third-party fuel processes will facilitate the commercial production of renewable fuel from Biocrude. We expect these efforts to provide our customer licensees with the option to pursue multiple fuel options with our Biocrude product, including use as a renewable energy feedstock that can be converted into fuel products or burned directly as a

 

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combustion fuel. Biocrude has a high energy content as compared to other biomass feedstocks and does not contain fossil carbon. The process of developing our fuel technology is ongoing. We have completed a number of joint development and collaboration efforts with petrochemical companies that we believe will be of value in the progression of our fuel product platform commercialization.

Our Customer Licensees

We are currently negotiating agreements with prospective customer licensees, including, among others, state-owned enterprises and multinational food companies. We expect that the successful execution of early projects will help validate our technology and ultimately enhance our ability to enter into commercial-scale agreements with other customer licensees.

While we are a development stage company that has not generated any revenue and has experienced net losses since inception, we anticipate future revenues, profit and cash flows, given our recent achievement of important business and technological milestones that we believe will enable us to deliver to our current and future customer licensees solutions for the production of feed, food and fuel products at commercial scale, with attractive economic returns.

AIQ

On October 25, 2011, PA LLC entered into an amended and restated license agreement, or the AIQ Agreement, with AIQ. The AIQ Agreement provides for the construction of a pilot-scale bioreactor in the Republic of Chile and a framework for the subsequent build-out of a commercial-scale facility in South America, subject to the parties’ agreement that the pilot-scale bioreactor has been operated successfully.

The AIQ Agreement provides for three separate phases: the Preliminary Phase, Phase I and Phase II. In the Preliminary Phase, AIQ will construct and operate a pilot-scale bioreactor of 0.75 hectares to test and demonstrate the growth and harvesting aspects of our technology. We will grant AIQ a license to construct and operate the pilot-scale bioreactor in the Preliminary Phase in consideration for a limited license fee from AIQ.

If the parties agree that the Preliminary Phase has been operated successfully, we and AIQ will proceed to Phase I, during which the first commercial-scale unit increment of 150 hectares, including growth, harvesting and processing modules, will be constructed. We have agreed to construct the 150 hectare commercial growth unit on a turnkey basis, in return for payments from AIQ, billed on a progress basis, not to exceed a prescribed limit. After completion of Phase I, the parties will proceed to Phase II. In Phase II, AIQ will continue to expand the project in 150 hectare unit increments, including growth, harvesting and processing modules, until the facility forms a unit of up to 5,000 hectares. Under the AIQ Agreement, we will grant AIQ a license to use our technology to plan, construct and operate the Phase I and Phase II units and to sell the end products produced by these units in South America. We will receive a royalty on net sales of the products generated from every unit and unit increment during the 20-year term of the license.

Our Key Milestones

 

  Ÿ  

In 2006, we began the research and development of our growth and harvesting technologies. Our efforts focused on experimentation and testing, developing processes and equipment, and building the infrastructure and databases necessary to support our technology.

 

  Ÿ  

During 2007 and 2008, we developed our proprietary growth algorithms—the complex mathematical formulas we use to determine the correct harvesting density and sunlight exposure of the biomass.

 

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  Ÿ  

In 2009, we completed our fully operational demonstration facility and established our business development team. This facility consists of a large bioreactor (approximately one hectare) and three smaller bioreactors that display our technology and processes.

 

  Ÿ  

In November 2009, the Indonesian Ministry of Agriculture approved our LPC product as an approved raw material for use in animal feed.

 

  Ÿ  

In May 2011, we entered into an agreement for the construction of a pilot-scale bioreactor in the Republic of Suriname. The construction of this bioreactor was completed in October 2011 and testing is ongoing.

 

  Ÿ  

In October 2011, we entered into a license agreement with AIQ, a customer licensee in South America, with initial construction of a pilot-scale bioreactor having begun in September 2011.

 

  Ÿ  

In November 2011, CECEP, a prospective Chinese customer licensee with which we are currently negotiating a license agreement, began construction of a pilot-scale bioreactor.

Industry Overview

Our technology platform enables the production of LPC, LM and Biocrude. LPC and LM can currently be applied in the animal feed market, as well as fertilizer markets. We believe that, with further technology development, LPC could be applied in human food markets and Biocrude could be used as a feedstock for renewable fuels.

The feed, food and fuel markets are global and significant in size and the demand in these markets is expected to grow rapidly. We also believe our products will meet part of that growing demand.

According to data published by the World Health Organization in 2008, the current worldwide protein deficiency is at least 18 million metric tons per year, and is expected to grow. This shortage is particularly acute in developing countries. As population and per capita income grow in the developing world, the consumption of protein is expected to increase. As a consequence, the global feed and food industries require a new, economical source of adequate protein to eliminate this shortfall.

We believe that our technology will deliver high production yields, particularly in equatorial economies, in which we expect the demand for our feed and food substitutes will be strong, and will enable our customer licensees to address the needs of the following markets.

Animal Feed

Within the global animal feed market, we have developed our technology to address rising demand in the fish meal and alfalfa markets.

Fish Meal

Fish meal, most of which is produced by the commercial fishing of wild schools of small fish, is a critical ingredient in the diets of nursery animals and aquaculture stocks. The fish meal supply is currently limited due to the effects of overfishing, while the demand for fish meal as a source of protein in animal diets continues to rise sharply. Based on 2010 projections by Dr. Albert Tacon, global fish meal demand for aquafeed is expected to reach approximately 7 million metric tonnes in 2012 and to rise every year thereafter to approximately 16 million metric tonnes in 2020, a rate which will significantly outpace supply. As a consequence, there is a large and growing need for an alternative protein source to address this supply and demand imbalance.

Based on our internal assessment of its nutritive qualities, as well as the findings of a trial completed by the Aquaculture Research Institute at the University of Idaho in 2010, we believe that

 

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LPC is strongly positioned as a fish meal alternative. The study at the University of Idaho demonstrated that LPC can replace high-quality fish meal at levels up to 100% in feeds for tilapia. The study also found that LPC could be suitable as a fish meal replacement for other farmed fish species. In addition, LPC has been subject to third-party testing in poultry, nursery swine and salmon as an alternative to fish meal. Third-party trials are continuing in nursery swine, shrimp and other species. These trials form the basis of our belief that LPC is a viable fish meal alternative.

Furthermore, we believe that LPC would match the nutritive quality of fish meal while also providing our customer licensees with several commercial advantages. First, in addition to international sales opportunities, our solution would enable production in the end market, thereby avoiding the freight and import duty expenses that are typically associated with the cost of fish meal. Second, we expect the continuous production and just-in-time inventory management made possible by our year-round production and daily harvest to lead to significant savings by reducing storage costs and the need for forward purchasing. Third, as compared with fish meal, LPC would deliver a similar protein content and a more consistent quality, since the components of wild-caught fish exhibit significant variability. Our internal testing indicates that the amino acid profile of LPC is comparable to that of fish meal. Finally, based on LPC’s nutritional and growth similarity with fish meal, we expect that its market price will be comparable to fish meal.

Alfalfa Meal

Alfalfa meal is a premium forage ingredient, used to meet nutrition and growth requirements in numerous animal diets. The supply of alfalfa is limited due to the concentration of production in specific areas, such as the United States and Europe. According to a publication from the Food and Agriculture Organization, or the FAO, in December 2009, although these two regions represent 65 percent of global alfalfa production, production rates in both areas have dropped significantly in recent years. Meanwhile, demand is continuing to rise, particularly in Asia, which represents only 8 percent of global production but requires forage ingredients for its rapidly growing dairy and swine industries. For dairy and swine, our estimate—based on data we compiled by using the FAO’s Global Livestock Database and the United States Department of Agriculture’s Agriculture Marketing Service—is that the global demand for alfalfa meal will be approximately 254 million tones in 2012, rising every year thereafter to approximately 262 million metric tones in 2020.

Trials conducted by the University of Minnesota in 2011 demonstrated that LM is a high quality alternative for alfalfa meal in forage diets for dairy cattle. This testing demonstrated that LM performs as well as alfalfa meal in dairy cattle diets, with similar energy and dairy efficiency. Third-party testing is continuing with other animals that are customarily fed alfalfa, such as swine and horses. Based on LM’s nutritional similarity with alfalfa meal, we expect that its market price will be comparable.

Fertilizer

Kelp and other high nitrogen biomass can be used as organic fertilizers. However, the production of kelp is costly due to the limited areas in which it grows in the wild, as well as environmental regulations that limit the scale of its harvesting. We believe that LPC can be a lower-cost, potentially higher-value alternative to kelp. We also believe that LM could be used as a nitrogen source in organic fertilizers. We expect that LPC will be competitive in the specialty turf fertilizer market due to its high levels of nitrogen, phosphorus, and bio-stimulants, which promote strong growth. In addition, the chemical composition of the fertilizer containing the LPC will reduce run-off into nearby waterways—an environmentally damaging effect commonly associated with other fertilizer products. Due to LPC’s natural origin, any run-off would present a less harmful environmental impact than synthetic fertilizer run-off.

 

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Fortification of Basic Human Food Products

We are developing our technology to address the rising demand for human food, a market of particular relevance in the equatorial regions in which we believe our technology will be well-suited and in which we have focused our marketing strategy to a significant extent.

We believe that, pending further process enhancements and regulatory approvals, LPC can serve the global market for fortification of basic food ingredients for malnourished populations, particularly in developing and emerging countries. Given the rapidly growing populations in regions such as South Asia, Africa, and South America, we believe that there is a clear need for an alternative supply of high quality and economical protein to supplement and enhance basic foods, such as breads, tortillas, noodles and crackers.

Testing by Dr. Fadi Aramouni of the College of Animal Sciences and Industry at Kansas State University in 2011 indicated that, pending further process developments, there is potential for LPC to be used as an ingredient in common foods, such as tortillas, pasta, crackers and smoothies. We will continue to pursue internal and third-party research to explore the relationship between LPC’s nutritive properties and consumer acceptance in these basic human food applications.

Our planning indicates that this product application requires approximately one year of further technology development, to be followed by another year for regulatory approvals and product contract negotiations. By 2015, we anticipate that our technology will be licensed on a scale that would facilitate the production of LPC in quantities that would interest commercial buyers of protein for fortification of human food products.

Specialty Markets for Prepared Foods

In the long term, we believe we can develop a higher protein content product from lemna using alternative separation techniques. While this process change would increase the capital expenditure and operating costs associated with our technology, we anticipate that the increased value of the end product produced would in many cases justify the additional expenses. If we are able to achieve this objective, our customer licensees could access specialty markets for higher value prepared foods in which protein boosts nutritional or functional properties, such as baked goods, meats and frozen foods.

Furthermore, recent analyses completed by Purdue University and Craft Technologies (a leading testing laboratory that specializes in food and nutrient testing) in 2011, respectively, confirmed that LPC contains high levels of potentially valuable compounds and vitamins, which could provide significant human nutritional and health benefits. Third-party research is continuing to validate these results and enhance our understanding of these properties.

Renewable Fuels

We expect that third-party technology will lead to the conversion of Biocrude into drop-in fuels. If we are able to successfully develop our technology in this manner, we anticipate that our customer licensees will have the ability to create products that address the significant and continuing global demand for renewable fuel.

Our Solution and Customer Licensee Approach

We believe that our solution will result in the commercial scale production of renewable products specifically for the feed, food and fuel industries.

 

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To expand our initial base of prospective customer licensees and to enable our customer licensees to build-out more rapidly, we have developed a scalable and flexible model based on micro-crop growth units of 150 hectare increments. This model is designed to be attractive to a wide range of entities, including agricultural customer licensees with an interest in the sustainable production of feed products, larger operators of renewable fuel production facilities and financial investment groups.

The estimated capital expenditure for a 150 hectare facility as an entry point is $12 million (excluding the cost of land and improvements)—a model that we believe involves manageable costs, risks and build-out times, while also enabling our customer licensees to evaluate the commercial potential of the technology on a larger scale. Due to economies of scale, we believe that a 600 hectare unit, comprising four micro-crop growth units with a shared processing facility, would deliver an attractive internal rate of return on our customer licensees’ investment. Ultimately, we expect that our customer licensees will expand their facilities in 150 hectare increments at similar costs in order to complete facilities of up to 5,000 hectares. Depending on economies of scale, we expect that the capital expenditure for a 5,000 hectare facility will be approximately $375 million (excluding the cost of land and improvements). We believe that a license unit of this size will enable our customer licensees to deliver significant volumes of product to market, thereby maximizing the internal rates of return on their investments.

To facilitate the deployment of our solution, our sales and marketing strategy consists of targeting potential customer licensees that would be capable of deriving significant value from our technology and who may have also demonstrated interest in our technology. For the past three years, we have been communicating and building relationships with many of these potential customer licensees. We seek to ensure that potential customer licensees have access to suitable and economical sources of land, water, power and transportation for the efficient operation of our technology. We explain to our customer licensees that their productivity levels will vary based on their specific geographical location, climate and other factors. Please see “—Site Strategy.”

We expect that our early contracts will be conditional on pilot-scale projects meeting certain minimum performance levels on which we would base projections of commercial profitability. However, we would expect future customer licensees to proceed immediately to commercial-scale build-out.

Our Competitive Strengths

Our key competitive strengths are:

 

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Strong economic returns to our customer licensees without the need for government subsidies.

We believe that our solution will present our customer licensees with the opportunity to invest profitably in a renewable technology designed to meet the significant and growing demand for feed, food and fuel. The profitability of our technology and processes is not dependent on government subsidies; although any subsidies that we or our customer licensees receive will enhance the profitability of our technology and processes. Our product platform has been developed to serve growing demand in large global markets.

 

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Highly scalable and flexible technology, with initial license units providing the basis for larger-scale operations in the future.

To facilitate rapid deployment opportunities in the near future, we have developed a highly scalable and flexible model for potential customer licensees. Our solution involves the construction and operation of production facilities based on 150 hectare increments of micro-crop growth bioreactors. We expect each 150 hectare unit will be a profitable module that can be replicated as the components of a larger-scale project of up to 5,000 hectares. These units are expected to be immediately productive while the build-out of additional units proceeds. Initially, we believe that

 

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offering our customer licensees the opportunity to build-out in increments of 150 hectares will allow our customer licensees to quickly assess the technical and commercial viability of each unit.

 

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Fully integrated, comprehensive solution that transforms simple, naturally occurring inputs, such as sunlight, water and indigenous micro-crops, into valuable outputs.

We will provide our customer licensees with a comprehensive system that contains all components necessary for the creation of renewable products at commercial scale, from selection and testing of micro-crops to growth, harvesting and processing. In addition to a fully integrated technology platform, we expect to add value through our extensive facility planning, design and construction/operation management services, including a procurement and supply chain system that will enable our customer licensees to acquire equipment in a cost-effective manner to promote an efficient and profitable build-out of our technology.

 

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Product compatibility with the existing agriculture infrastructure.

Our processes for producing LPC and LM are designed to be compatible with standard processing techniques that can be implemented using existing agricultural equipment and infrastructure. Due to their nutritional characteristics, such as strong digestibility, palatability and amino acid profiles, we expect both products to become direct substitutes for existing protein supplies in animal feed applications. Our technology can potentially provide a new source of supply where existing demand or expected growth in demand cannot be met solely by existing sources due to environmental and other constraints.

 

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First mover advantage in providing renewable micro-crop technology to produce products that serve the global animal feed market.

We believe that the deployment of our solution will place our customer licensees in a position to enter the global animal feed market as a first-mover in producing animal feed from renewable micro-crops.

 

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Experienced management team with a track record of innovative growth, value creation and commercial scaling of businesses.

Our senior management team has broad expertise in guiding early-stage development companies to commercialization. Our management team has been involved in various technical and management roles within leading organizations across various industries.

Our Business Strategy

Building on our competitive strengths, our objective is to become the leading global provider of technology and processes for the commercial production of micro-crop biomass for the agriculture and energy markets. Key elements of our strategy include:

 

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Rapid deployment and support of modular and highly scalable license units.

Our customer licensees will be able to assemble our proprietary units from modular, cost-effective bioreactors and other ancillary equipment, which are currently operating at a smaller scale at our fully operational demonstration facility. These modular bioreactors are designed to enable rapid deployment at predictable cost and productivity levels. We offer our customer licensees extensive support services, including pre-planning, construction management and supervision, equipment procurement on-site support and assistance with development of off-take agreements.

 

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Leveraging our capital-light licensing model.

 

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Our customer licensees will be required to pay the upfront infrastructure costs as well as continued maintenance costs for their licensed facilities. This business model allows us to make minimal capital expenditures while generating fees and royalties over the term of the license.

 

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Expansion of our customer base on a global scale.

We are continuing to expand our marketing efforts internationally. In 2011, we expanded our operations in China to further our focus in the region, as well as to assist with equipment procurement efforts to reduce capital costs for our customer licensees. We also recently expanded our sales and marketing efforts in both Africa and South America, which represent key locations where we expect to license our technology. In 2011, we entered into a license agreement with a customer licensee in South America. In addition, we are establishing relationships and seeking opportunities with investment funds that would be interested in sole source or co-investment opportunities.

 

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Further development of our technology and pursuit of additional applications for our products.

We expect to further enhance our technology in order to provide our customer licensees with additional end market applications for our products along with the ability to capture higher economic returns. We expect these efforts to provide our customer licensees with access to markets for human food and renewable fuels. For example, in July 2011 we entered into an agreement with CRI Catalyst Company LP (CRI) to use Integrated Hydropyrolysis and Hydroconversion technology (IH²) for the conversion of our micro-crop residues into renewable fuels.

 

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Assisting our customer licensees in the identification of off-take partners.

We will continue academic and commercial testing of our products to confirm their market viability. This third-party validation will assist us and our customer licensees in establishing off-take arrangements in which companies will purchase products produced by our customer licensees.

 

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Creation of brand loyalty.

We intend to become recognized as the leading global provider of technology for the commercial production of micro-crop biomass for agriculture and energy markets. In the short term, we believe that our feed and fertilizer products will attract agricultural customer licensees and other investment partners. In the long term, we believe that we will have a substantial marketing opportunity with a variety of prospective customer licensees seeking sustainable, renewable fuel options, as well as customer licensees interested in creating and selling human food products. We intend to become a recognized provider of green technology solutions.

Product Development

We believe that our technology provides the basis for a broad product platform to bring to the agriculture and energy markets. Our current product development efforts are focused primarily on the production of animal feed and fertilizer, as well as protein for the fortification of basic food ingredients. We also plan to develop additional human food and renewable fuel products, and have already completed a number of tests with regard to these applications. However, these products will require enhancements to our technological process that are likely to increase the costs associated with our solution.

Our product strategy is based on the scalability and performance of our technology. With a licensing model based on highly scalable production facilities, we believe that our technology will facilitate the rapid and efficient production of end products in areas with large and growing demand.

The commercial viability of our technology largely depends on the ability of our customer licensees to sell into existing markets. Although we have achieved encouraging test results for several

 

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applications for our products, it has yet to be proven that there is a market for the specific end products produced by our technology. Please see “Risk Factors—The market may not accept the end-products produced by our technology.”

Lemna Protein Concentrate

LPC is a free-flowing powder containing a minimum 65% crude protein, which is extracted from non-genetically-modified plant species in the Lemnaceae family. Our customer licensees will manufacture LPC under internationally recognized process and quality control standards (including Association of American Feed Control Officials standards and the Codex Alimentarius) to enable approval for use in both animal and, potentially, human markets. Based on internal and third-party testing, we believe that LPC is similar in quality to fish meal and represents a potentially viable protein source for feed formulations in multiple industries, including aquaculture and swine.

Initially, LPC can be used as an alternative to fish meal. Fish meal is typically the most highly valued large source of protein for animal and aquaculture feeds. In addition, supplies have become restricted due to the effects of overfishing. We believe that LPC has multiple advantages over fish meal and is well-positioned to become a large scale alternative.

We believe that LPC could be well-suited to represent an alternative to kelp meal as a high-value fertilizer. Kelp is used in high-end fertilizers for applications such as golf course maintenance. LPC provides a natural source of nutrients as well as other bio-stimulants.

We also expect that LPC could serve as a nutritional enhancement to basic human food ingredients for breads, tortillas, noodles and crackers. The growing population in poorer parts of the world is often characterized by severe protein deficiencies. We believe that the addition of a relatively small proportion of LPC to basic foodstuffs could reduce or eliminate this protein deficiency in individuals without affecting the cooking and other properties of the food.

In the long term, we believe that significant potential exists for LPC in smaller, high-value niche markets, as a functional protein ingredient in packaged foods, and as a source of high-value nutritional additives.

Lemna Meal

LM is a free-flowing powder containing a minimum 15% crude protein, which is produced from the pulp of a non-genetically-modified plant species in the Lemnaceae family. The product contains an essential amino acid profile that is comparable to alfalfa—making it a competitive feed ingredient for a broad array of feed formulations in the dairy and swine industries.

Initially, our customer licensees will be able to use LM as an alternative to alfalfa meal. In addition, we believe that LM can be used as an ingredient in fertilizer or animal bedding.

Biocrude

With a small change in process conditions (but not equipment), our processing system can produce Biocrude rather than LM. Biocrude is a renewable energy feedstock that, through the use of a variety of third-party conversion systems currently under development, can be converted into renewable fuels or burned directly as a combustion fuel. Biocrude produces an energy content comparable to wood chips, and higher than most other agricultural biomass used as fuel, including palm waste, bagasse and corn stover. In addition, Biocrude does not contain fossil carbon and, as a cellulosic product, would qualify for cellulosic tax incentives, where available.

 

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Technology

Our technology consists of intellectual property that is a combination of multiple patent-pending systems, processes and configurations, trademarks, proprietary software and trade secrets. Based on the continued process refinements we make as a result of operations at our demonstration facility in Florida (see “—Scaling our Technology”), as well as our substantial overall investment in research and development, we continue to improve our technology and the ability of our customer licensees to bring valuable products to commercial markets.

Our technology platform primarily consists of four components: micro-crop selection and testing, growth and harvesting techniques, processing technology, and control systems. Our technology enables the selection of indigenous micro-crop species that demonstrate an optimal profile for a particular geography and environment, allowing our customer licensees to grow and harvest these micro-crops at economically attractive yields.

The diagram below illustrates the growth, harvesting and processing steps of our technological process.

LOGO

Selection and Testing

Our selection and testing approach is designed to identify naturally occurring micro-crops in regions of interest for our prospective customer licensees. We have substantial experience in this area. Over the past three years, through visits to regions of interest and analysis at our laboratories, our scientists have carefully analyzed a large number of possible micro-crop species suitable for the commercial-scale production of biomass in many regions throughout the world.

Our technology utilizes micro-crops that are indigenous to the region in which each customer licensee proposes to build facilities. We believe it is preferable to identify and choose dominant local species with a history of growth in the local environment. In our experience, dominant local species out-compete other organisms in open ponds.

We typically select several species from local areas to investigate. This process identifies potential micro-crops which can be grown in different seasons and climates. We then test the performance of the selected micro-crops and analyze the species composition.

Once a mix of viable species is chosen, we develop a site-specific plan to further qualify the desired location of the facility and subsequently grow and inoculate the mix at the site.

 

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Growth and Harvesting

Our micro-crops produce significantly more biomass per hectare than macro-crops, such as jatropha, palm, corn and soybeans. In addition, our micro-crops grow continuously and will be harvested throughout the year in equatorial climates, utilizing the available sunlight and consuming atmospheric carbon dioxide to create a predictable and consistent product yield.

The growth phase begins with open-air bioreactors, or production ponds, designed to provide controlled growing conditions. The bioreactors are specifically designed to be modular, which will enable our customer licensees to build-out in phases or to allow customization to various topologies. The bioreactor design will also provide our customer licensees with a reliable environment for large-scale production of biomass, including nutritional control, environmental control (such as water management) and monitoring control (for quality). The design of the bioreactors is intended to minimize capital and operational expenses, while maximizing the volume of material harvested for processing.

To help facilitate growth, we utilize a proprietary nutritional recipe that has been specifically tested and optimized for our micro-crops. The nutrients consist of commercially available fertilizers and minerals, although the composition and application remain proprietary to our system.

Our proprietary harvesting system helps to achieve optimal quality and yields for effective production. After harvesting, the biomass is typically transported to a nearby processing facility and approximately 98 percent of the water is recycled back into the ponds.

Production Process

Our process design is based on a configuration of equipment, infrastructure and knowledge that is specifically developed to optimize product yields and quality. The process consists of industry standard, commercially-available equipment that is commonly used in the agriculture and food processing industries in order to eliminate the risks and expense that would be associated with non-standard equipment. The essential processing steps remain similar across different projects, although the configuration of each facility varies depending on the local region of the customer licensee and the size of the facility.

After the biomass is transported from the bioreactors and dewatered, milling or grinding takes place. The milling operation essentially tears, grinds and shears the biomass into small particles. Next, the solids and the liquid of the lemna are separated. After the liquid is filtered and clarified, protein purification and concentration begins. Once extracted, the washed protein is dried to produce the final LPC, while the unused liquid is recycled to the bioreactors.

The second product produced by our process can be either LM or Biocrude. At the point of protein separation, the remaining solids are further processed into one of these two end products. This is accomplished through various pressing and drying techniques. A dryer is used to reduce the moisture content of the LM or the Biocrude to the desired application level, while not exceeding temperatures that may damage important characteristics of the final product.

These products can then be used locally or shipped to end users.

Control Systems

Our control systems comprise hardware and proprietary software throughout the production site. In the farming areas of the production site, the control system is designed to manage nutrient control and harvesting decisions. This will enable our customer licensees to focus on efficient management. In the processing facility of the production site, the control system is designed to optimize operations, ensure product quality and provide various safety measures.

 

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Data from each area of a customer licensee’s facility will be stored in a proprietary database for historical tracking of all key performance indicators. The report generation module will provide our customer licensees with the data and tracking needed to ensure efficiency, quality and output.

Each customer licensee’s software system will communicate key process data and productivity metrics to us to ensure ongoing efficient operations. Over time, we expect that this feature of the system will provide us with a significant competitive advantage, because we will be able to develop a clear understanding of operations around the world and use this information to enhance our processes and thereby offer increased efficiencies to future customer licensees.

In addition to daily operation and historical tracking, the system also features multiple mechanisms to safeguard all source code, object code and data. All information, including the encrypted source and object code, is remotely backed up on a regular basis.

Scaling our Technology

Since inception in 2006, we have focused on continuously developing our technology with the ultimate objective of enabling our customer licensees to produce renewable feed, food and fuel products at commercial scale. We believe research and development is an ongoing effort and we continue to look for ways to improve our technology and processes so that our customer licensees will be able to scale up our technology efficiently and profitably.

Although we have successfully built and operated a demonstration facility and have extracted small field-scale product quantities for technical validation, we have not demonstrated that our technology is viable on a commercial scale. While our bioreactors are modular in design, a single commercial-scale facility will be several orders of magnitude larger than our demonstration facility. Once a customer licensee begins to scale up and replicate such a system, unforeseen factors and issues may arise. Please see “Risk Factors—We have yet to construct our technology on a commercial scale, and may be unable to solve technical and engineering challenges that would prevent our technology from being economically attractive to prospective customer licensees.”

The process of scaling up our technology from the laboratory scale to demonstration scale to commercial scale has included the following key steps and milestones:

Laboratory-Scale

Beginning in 2007, we conducted initial important research and development at the NASA Kennedy Space Center (KSC) Space Life Sciences Laboratory. We leveraged the laboratory’s analysis capabilities for chemistry, molecular biology, microscopy and microbiology. The controlled environmental chambers allowed us to designate, control and manipulate environmental parameters, such as climate, temperature, day, night and seasonal cycles, to simulate growing conditions for research purposes as well as to understand climate conditions around the world. Our work at this facility increased our understanding of the likely performance of our technology in many parts of the world. Since mid-2011, we have continued our research efforts exclusively in our scientific laboratory in Fellsmere, Florida and at various customer sites around the world. Our Fellsmere laboratory has been developed for chemical analyses, culture storage, backup inoculum growth, bench top research experiments and fast turnaround analyses of field and product samples. Our work at this facility continues to further our technological understanding regarding product quality and environmental factors.

Demonstration-Scale

In June 2009, we completed our fully operational demonstration facility in Florida consisting of one large bioreactor (of approximately one hectare), three smaller bioreactors and an associated

 

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processing complex. This facility is not commercial scale and we cannot make any assurances that the results achieved at this facility can be replicated on a commercial scale. We use the facility to refine processing and growth reactor designs, generate test samples of our end products, and test solutions related to scalability.

In addition, through the use of our demonstration facility, we continue to evaluate new incremental technologies and processes to determine whether they would improve the economic proposition for our customer licensees. For example, in the past two years we have changed the configuration of our growth bioreactors from grid-based systems with static water to larger raceways with water movement systems that facilitate a consistent distribution of nutrition, as well as improved water quality, growth, harvesting and overall productivity.

Each customer licensee’s commercial-scale operations will include site and project-specific features, but the general conceptual and technical elements of the operations will be based on our demonstration facility. However, our technology has yet to be implemented beyond pilot scale and due to the inherent uncertainties in scaling up new technologies, including factors both within and beyond our control, we cannot guarantee the performance of our technology at commercial scale.

Pilot to Commercial Scale

In 2011, one customer licensee and two prospective customer licencees commenced construction of pilot-scale bioreactors in South America and Asia. If these pilot facilities are successful, these parties have expressed an intention to pursue commercial-scale projects, subject to further negotiation of license agreements.

In addition, the results of these projects will be important with respect to increasing our understanding of the performance of our technology in locations outside of the United States, including regions where we expect to achieve increased productivity and production yields.

If the pilot projects yield results that meet or exceed expectations, this would represent evidence of the viability of our technology and ultimately increase our ability to enter into agreements for commercial-scale projects.

Licensee Support Services

We believe that the provision of support services will be important to ensure the successful implementation of our technology system. As such, we offer project, construction management and operations support services to enable our customer licensees to scale up effectively. Examples of the licensee support services that we offer include:

 

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Pre-planning activities including site selection and qualification, preliminary project plan and cost analysis, contract development, equipment pricing and the finalization of the facility design.

 

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Construction management activities including advising and overseeing construction activities by the chosen contractor to ensure that the site is developed effectively and the facility is constructed safely and efficiently.

 

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Operations management activities including supplying a team of personnel to provide start-up operations and to train a customer licensee’s employees in the operation and maintenance of the facility. The principal goal of this team will be to optimize the facility output and efficiency.

 

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Equipment procurement and supply chain management that will allow our customer licensees to obtain cost-effective equipment that meets our technical specifications.

 

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In 2011, we supplemented our U.S.-based purchasing capabilities through the addition of a purchasing function focused on identification of sources of supply for the procurement of equipment and other materials in China and other Asian nations. Our expanded purchasing capabilities allow us to procure equipment and materials required by our customer licensees in a cost effective manner. We plan to continue to expand our staffing in our customer licensees’ regions to provide the support services listed above.

We expect to provide on-site customer support services to our customer licensees. We estimate the cost of these services will be approximately 20 to 25% of the ongoing fees we expect to receive in connection with the operation of a 5,000 hectare license unit.

In recent years, we have developed relationships that we believe will be valuable in terms of assisting our customer licensees to identify and enter into agreements with off-take partners. The characteristics of a suitable animal feed off-take partner include a strong understanding of the need for, and value of, alternative feed ingredients, and a strong understanding of the impact of diet on animal growth performance, as well as the knowledge, skills, and ability to properly assess and validate our products. Preferably, each off-take partner would have significant demand for our products.

Site Strategy

Our sales strategy targets customer licensees with the capacity to execute commercial-scale operations in regions on or close to the equator (generally within a range of 15 degrees North latitude to 15 degrees South latitude), due to the dependence of our technology on geographic proximity to the equator.

In determining appropriate sites, we also consider the following factors:

 

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the proximity of a potential licensee site to adequate infrastructure;

 

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the availability of labor to construct and operate the facilities;

 

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the availability of any state or local incentives;

 

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the availability and/or potential for the creation of local markets in which end products may be sold;

 

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the availability of economical and reliable sources of water and power; and

 

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the stability and support of the local and national political environment.

Competition

Our objective is to be the leading global provider of technology and processes for the commercial production of micro-crop biomass for agriculture and energy markets. In the near term, we expect the LPC and LM produced by our technology to compete primarily with fish meal and alfalfa, respectively. In these markets, our customer licensees will compete with the established providers of these products, including large international food and agriculture companies. In many cases these companies will have well-developed distribution systems and networks for their products, as well as sales and marketing programs in place to promote their products.

We believe that for LPC and LM to succeed in these markets, we must demonstrate to our customer licensees that they are comparable to both existing products and other alternative products that are being developed for the same markets based on some combination of cost, quality, availability of supply, compatibility with existing infrastructure, sustainability, and consumer preference characteristics. We believe LPC and LM will compete favorably with respect to all of these competitive factors.

 

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In the long term, we expect to develop human food applications for LPC, as well as applications of our Biocrude product for renewable fuel markets. Consequently, the products produced by our technology will compete in large, international agriculture and energy markets, including renewable fuels and transportation fuels markets. Many of our competitors in the fuels markets have resources and name recognition far in excess of ours. While we anticipate competition from these large, established companies, we may also seek to partner or collaborate with them.

For additional information, see “Risk Factors—If a competitor were to achieve a technological breakthrough, our operations and business could be negatively impacted.”

Intellectual Property

We have developed proprietary technology that we believe provides us with a competitive advantage. We seek to protect this technology through the use of a multilayered intellectual property protection strategy. Our intellectual property strategy is focused on a combination of patents, trade secrets and a proprietary control system.

As of December 2011, we have patent applications in the United States and foreign jurisdictions pending across the entire range of our technology and processes, including bioreactor construction, growth and harvesting, and processing of our micro-crops.

Our trade secrets complement and bolster the technology covered by patent applications and relate to each technological aspect of the system, such as growth and harvesting, nutrition, and processing.

Our proprietary control system and the accompanying algorithms manage the overall process to optimize yield. The control systems are protected through various multilayered security models that prevent unauthorized access to the software and source code. Under our licensing model, our customer licensees will not have access to our encrypted software, the underlying code or databases.

Raw Materials

Our processes primarily use four categories of raw materials: indigenous micro-crops (from the Lemnaceae family) that are not genetically modified and demonstrate an optimal growth profile for a particular geography and environment; fertilizer; water; and naturally-available elements, such as sunlight and carbon dioxide. The micro-crops our processes use will be indigenous to the regions in which our customer licensees operate and are available in the natural environment. The availability and quality of water in a specific location represents an important component of our site selection process. We intend to provide our customer licensees with our proprietary nutrient mix, which will consist of commercially-available ingredients.

Regulatory

To enable our customer licensees to sell the products produced by our technology in markets around the world, we will need to gain the necessary regulatory approvals. Our regulatory strategy consists of three main elements.

First, we organize and fund third-party trials at independent universities and other research institutions, with the objective of confirming or indicating the commercial viability and value of our products in various applications and markets. The results generated by these trials are critical in terms of informing our decisions to proceed with the relevant regulatory processes.

 

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Second, we conduct our own regulatory activities. For example, LPC and LM are subject to regulatory approvals required for animal feed. In November 2009, the Indonesian Ministry of Agriculture approved our LPC product as an approved raw material for use in animal feed. In 2012, we expect to receive similar regulatory approvals for other countries in which our customer licensees are most likely to be located, specifically Thailand, Chile, Philippines, China, Malaysia, and Vietnam. This will allow our customer licensees to sell our animal feed products at commercial scale in those jurisdictions.

We have also initiated the regulatory review process in the United States. We held an initial meeting with the FDA in April 2010. We presented an overview of our products and technology as well as the results of our research on lemna. As a result of this meeting, we agreed to prepare a white paper discussing the safety of lemna use in animal feed. We have also retained the services of a consultant to help expedite the regulatory process. We are currently pursuing the American Association of Feed Control Officials, or AAFCO, pathway for the use of LPC and LM as animal feed and have improved the design of our license units to be in compliance with AAFCO best management practices for animal feed production. We expect that the FDA will view our compliance with AAFCO best management practices in a favorable light and this will help the FDA to validate the products produced by our technology. We have not yet submitted a formal application for FDA approval.

Third, to help expedite the regulatory process, members of our product development and regulatory team will work directly with each customer licensee to understand the markets in which they intend to sell the products. Our team will assist each licensee in initiating and completing regulatory processes with the required regulatory bodies, as needed.

In relation to our products under development for human food markets, we intend to take advantage of widespread acceptance of the use of lemna in human nutrition to expedite regulatory approval for human consumption of LPC in India and China. Receiving regulatory approval for LPC in emerging markets, which represent the greatest potential source of demand, is an important priority, as we believe it would improve our economic proposition to customer licensees.

In addition, we believe that we will be able to obtain the required human approvals through the human GRAS (Generally Recognized as Safe by the AAFCO) pathway in the United States by leveraging the use of lemna in homeopathic medicine in other countries. We will also need to implement process improvements required to produce a product suitable for human consumption, including flavor enhancement, increase in purity, and a production line that meets food quality standards. We are in the initial stages of developing such enhancements.

Biocrude does not require any regulatory approvals for use as a fuel feedstock, but the products produced using Biocrude would require the same regulatory approvals as petroleum-based fuels, typically American Society for Testing and Materials standards in the United States.

Our products and the production facilities of our customer licensees will also be subject to inspection by federal, state, local and foreign environmental, health and safety authorities.

If we cannot meet the applicable requirements in countries in which we intend to use our technology to produce our products, then our business will be adversely affected . See “Risk Factors—Risks Related to Our Business—The end-products produced by our technology are subject to industry and regulatory testing.” We are unable to predict whether any governmental agency will adopt any laws or regulations that could have a material adverse effect on our operations. We will incur, capital and operating expenditures and other costs in the ordinary course of our business in complying with these laws and regulations.

 

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Environmental

Our licensed operations in the United States and abroad will be subject to a wide range of environmental laws and regulations at both the national and local levels. These laws and regulations govern, among other things, air emissions, wastewater discharges, solid and hazardous waste management, site remediation programs, and chemical use and management.

Pursuant to these laws and regulations, our customer licensees will be required to obtain and comply with a wide variety of environmental permits for different aspects of their operations. We are subject to similar laws with respect to the demonstration facility that we own. We believe that we are in material compliance with all current environmental laws and regulations to which we are subject. We currently estimate that any expenses incurred in maintaining compliance with these requirements will not materially affect our results of operations or cause us to exceed our level of anticipated capital expenditures. However, we cannot provide any assurance that regulatory requirements or permit conditions will not change, and we cannot predict the aggregate costs of additional measures that may be required to maintain compliance as a result of such changes or expenses.

We believe that the environmental risks we face are comparable to those faced by other companies in the agriculture or aquaculture markets.

Organization

Employees

We have a multidisciplinary team, including biologists, chemists, physicists, engineers and business executives. Currently, we have 69 direct, full-time, non-union employees, and we consider our employee relationships to be good.

We employ sales, marketing, and business development personnel, who have developed relationships throughout the agriculture and energy industries.

Research and Development

We believe research and development is an on-going effort and we continue to look for ways to improve our technology and processes. We have spent $9.9 million, $15.1 million, $17.4 million and $8.5 million during 2008, 2009, 2010 and the nine months ended September 30, 2011, respectively, on research and development activities. Through the use of our dedicated research and development bioreactors at our fully operational demonstration facility, we evaluate new incremental technologies and processes to determine if they improve our growth output. We believe that continued research and development efforts will allow us to further increase our micro-crop productivity, thereby increasing the economics for our customer licensees. We are continuing our research and development efforts to improve the value proposition of our technology and processes to our licensees and prospective customer licensees.

Facilities

Our corporate headquarters are located in Melbourne, Florida. This facility houses our executive and administrative offices, our finance, business development, operations and our information technology departments. It also includes meeting space and our computer network and communications infrastructure. We have leased 24,000 square feet at this facility through February 2014.

Our fully operational demonstration facility is located in Fellsmere, Florida. The facility provides demonstration-scale live operation of all aspects of our technological processes.

 

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We believe that our current facilities are suitable and adequate to meet our needs and that suitable space will be available to accommodate the foreseeable expansion if our operations.

Sales and Marketing

Our sales and marketing strategy consists of targeting customer licensees that are capable of deriving significant value from our technology. We employ sales and marketing personnel who have developed relationships throughout the agriculture and energy industries.

Legal Proceedings

We are not a party to any material litigation or proceeding and are not aware of any material litigation or proceeding, pending or threatened against us.

 

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MANAGEMENT

Executive Officers and Directors

Our executive officers and directors, and their ages as of December 1, 2011, are set forth below:

 

Name

   Age     

Position(s)

Anthony John Phipps Tiarks

     56       Chief Executive Officer

James P. Dietz

     47       Chief Financial Officer

Peter Sherlock

     55       Chief Operating Officer

John S. Scott

     60       Non-Executive Chairman

Sayan Navaratnam

     37       Director

Isaac D. Szpilzinger

     63       Director

Anthony John Phipps Tiarks has been our Chief Executive Officer since June 2011. Prior to joining the Company, Mr. Tiarks was President and Chief Executive Officer of Liberty Aerospace, Inc., which he established in the United States in 2000 with the purpose of developing, certifying and delivering an entry level aircraft. Prior to starting Liberty Aerospace, Mr. Tiarks was a Managing Director in London of Donaldson, Lufkin & Jenrette, a U.S. investment bank, Chairman of Tide Brokers Limited, a wholesale money broker, and Managing Director of Tide (U.K.) Limited, an international foreign exchange fund management group. Mr. Tiarks has a B.S. in Systems and Management from City University, London, United Kingdom.

James P. Dietz has been our Chief Financial Officer since July 2011, and served as our Vice President of Finance and Accounting from May 2010 to July 2011. From May 2009 through April 2010, Mr. Dietz served as chief financial officer of U.S. Capital Holdings, LLC, an international private equity investor and developer, whose parent company is Tangshan Ganglu Iron & Steel Co., Ltd., a Chinese industrial company. Mr. Dietz also serves on the board of Global Income Trust (formerly known as MacQuarie CNL Global Income Trust, Inc.) a non-traded public real estate investment company, since his appointment as an independent director in November 2009. From May 2008 until May 2009, Mr. Dietz served as Vice President – Finance and Business Development for PACT, LLC, a real estate development company. From 1995 until December 2007, Mr. Dietz was with residential community developer WCI Communities, Inc., or WCI, and various predecessor firms, as its Chief Financial Officer. In August 2007, shareholders at WCI approved a new composition for WCI’s board of directors which had been submitted to them for vote at their annual meeting pursuant to an agreement between WCI and affiliates of Carl Icahn that resulted from a proxy contest. Mr. Dietz resigned as WCI’s Chief Financial Officer in December 2007. WCI filed a voluntary petition under Chapter 11 of the federal bankruptcy laws on August 4, 2008, from which it emerged on August 31, 2009. From 1993 to 1995, Mr Dietz managed asset-backed financing originations for GTE Leasing Corporation (a subsidiary of GTE, a predecessor to Verizon Communications). He began his professional career in December 1986 joining Arthur Andersen & Co where he advanced to manager, providing audit and financial consulting services to clients in the construction, real estate, healthcare and legal industries. Mr. Dietz earned a BA in accounting and economics from the University of South Florida in 1986. Mr. Dietz is a certified public accountant.

Peter Sherlock has been our Chief Operating Officer since July 2011. Between 1999 and 2011, Mr. Sherlock held the positions of Vice President, Product Development and Vice President/Chief Technology Officer at AuthenTec, Inc., a semiconductor, biometrics and security company. From 1996 until 1999, Mr. Sherlock established and directed the Raleigh (NC) Design Center for Integrated Device Technologies (IDT, California), a semiconductor electronics company. From 1990 until 1996, Mr. Sherlock held the positions of Vice President, Operations and Senior Vice President Business

 

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Development at IVEX Corporation, a real time visual simulation systems company, where he was recruited from the United Kingdom to work in the Atlanta, USA based operation. From 1977 until 1990, Mr. Sherlock spent his early career with Ferranti Computer Systems in the United Kingdom. Mr. Sherlock holds a First Class BSc in Electrical Engineering from the University of Salford, United Kingdom.

John S. Scott, Ph.D. was our Chief Executive Officer from August 2009 until June 16, 2011 and has been the Chairman of our board of directors since December 2008. In 2002, Dr. Scott founded XL Tech and has been its Chief Executive Officer since 2002 and a director since 2004. Since 2008, XL Tech has been an inactive holding company controlled in part by Dr. Scott. He has also been a director of XLTG LLC since 2010. He was a professor at the Universities of Maryland and Arizona, and a visiting professor at the University of North Carolina. Dr. Scott has published extensively on the development of successful technology enterprises and also lectures at business schools throughout the United States. Dr. Scott has served as a consultant to the United States and various European governments, and was a national research council fellow at NASA. He holds a B.Sc. in physics and astrophysics from Michigan State University and a Ph.D. in the astrophysics/physics dual program from the University of Arizona’s Steward Observatory. Dr. Scott’s experience with founding and developing technology companies, along with his academic credentials, enables him to provide important insight and guidance to our management team and board of directors.

Sayan Navaratnam has been a member of our board of directors and served on the board of PA LLC since December 2008. Since March 2009, Mr. Navaratnam has been a Senior Managing Director of Laurus Capital Management, LLC and a Senior Managing Director of Valens Capital Management, LLC, entities affiliated with our principal stockholders. Since 2004, he has been the Chairman of Creative Vistas, Inc., which installed and serviced broadband services to consumers and currently integrates security systems for commercial customers in Canada. From 2000 to 2003, Mr. Navaratnam was the Chief Operating Officer of ASPRO Technologies Ltd. ASPRO Technologies Ltd., which provided printer circuit boards to manufacturers of digital video recorders in the security industry and was sold in 2002 to private investors. He currently serves on the board of a number of other privately-held companies. Mr. Navaratnam holds an Honors Double Specialist degree in economics and political science from the University of Toronto. Mr. Navaratnam’s extensive background in technology, finance, operations, expertise in workout situations and experience as the chairman of a public company enables him to make a valuable contribution to our board of directors.

Isaac D. Szpilzinger has been a member of our board of directors since December 2008. He is an attorney in solo private practice licensed in the state of New York. From 1987 to 2006, Mr. Szpilzinger practiced with the law firm of Herzfeld & Rubin, P.C., where he was named a partner in 1994. He began his legal career in 1985 with a clerkship in the New York State Supreme Court, Appellate Division, Second Judicial Department. Mr. Szpilzinger holds a B.S. in Chemistry, cum laude, from Brooklyn College, and an M.A. in Chemistry and an Advanced Certificate in Educational Administration and Supervision from Brooklyn College. He also holds a J.D., cum laude, from New York Law School. Mr. Szpilzinger’s legal expertise and his academic background in the sciences enables him to provide valuable insight and guidance to our board of directors.

Structure of the Board of Directors

Our board of directors currently consists of three members: Dr. Scott, Mr. Navaratnam and Mr. Szpilzinger.

Upon the completion of this offering, our board of directors will consist of five directors: Mr. Tiarks, our current Chief Executive Officer, and four directors who will qualify as independent within the meaning of the applicable                      listing standards and Rule 10A-3 of the Exchange Act.

 

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Within six months of the completion of this offering, our board of directors will appoint two additional members to our board, each of whom will qualify as independent within the meaning of the applicable                      listing standards and Rule 10A-3 of the Exchange Act. Pursuant to the stockholders agreement, our principal stockholders will agree to maintain on our board of directors at least a majority of directors who are independent within the meaning of the applicable                      listing standards and Rule 10A-3 of the Exchange Act.

Upon completion of this offering, our bylaws will be amended and restated to provide that the authorized number of directors may be changed only by resolution of the board of directors, and our amended and restated certificate of incorporation will divide our board of directors into three classes of directors of the same or nearly the same number of directors (designated Class I, Class II and Class III) each with a staggered three-year term. At each annual meeting of stockholders, the directors whose terms then expire or their successors will be elected to serve from his or her time of election and qualification until the third annual meeting of stockholders following election or until their earlier death, resignation or removal.

Our amended and restated certificate of incorporation will provide that our directors may only be removed for cause. To remove a director for cause, 66 2/3% of the voting power of our outstanding voting stock must vote as a single class to remove the director at an annual or special meeting. Our amended and restated certificate of incorporation will also provide that, if a director is removed or if a vacancy occurs due to either an increase in the size of our board of directors or the death, resignation, removal or other cause, the vacancy will be filled solely by the affirmative vote of a majority of the remaining directors then in office, even if fewer than a quorum remain.

This classification of our board of directors, together with the ability of our stockholders to remove our directors only for cause, may have the effect of delaying or preventing a change in control or a change in management. See “Description of Capital Stock—Certain Provisions of our Amended and Restated Certificate of Incorporation and Amended and Restated Bylaws” for a discussion of anti-takeover provisions found in our amended and restated certificate of incorporation.

Our amended and restated certificate of incorporation will provide that, as soon as our principal stockholders and its affiliates beneficially own less than 25% of our outstanding common stock (as set forth on the cover of our then most recently filed annual report on Form 10-K or quarterly report on Form 10-Q), each of our directors’ terms will expire at the next annual meeting of stockholders and thereafter each director will be elected to serve from his or her time of election and qualification until our next annual meeting of stockholders or until his or her earlier death, resignation or removal.

In addition, prior to the completion of this offering, we will enter into the stockholders agreement. The stockholders agreement will become effective upon the completion of this offering. The stockholders agreement will contain a voting agreement that provides, among other things, that:

 

  Ÿ  

our principal stockholders will agree to vote any shares of our common stock they and their affiliates own pro rata with our unaffiliated stockholders (other than in connection with any vote relating to (i) a consolidation or merger of the company or any of its affiliates into or with any other person (other than affiliates of our principal stockholders); or (ii) a sale, lease or transfer of all or substantially all of our assets or capital stock to another person (other than affiliates of our principal stockholders)); and

 

  Ÿ  

our principal stockholders will not vote in favor of the removal of any of our independent directors unless our unaffiliated stockholders approve such removal.

For more information regarding our governance, see “Relationships and Related Party Transactions—Stockholders Agreement.”

Upon the completion of this offering, our common stock will be listed on                     . The rules of require that a majority of the members of our board of directors be independent within specified periods following the closing of this offering. We will not avail ourselves of the “controlled company” exemption

 

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provided for by the                  listing standards and therefore expect to fully comply with such requirements, including the maintenance of a majority independent board of directors and fully independent audit, compensation, and nominating and governance committees. Pursuant to the terms of the stockholders agreement, our principal stockholders will have the right to appoint one observer, or the observer, to our board of directors. The observer will be entitled to receive notice of all meetings of our board of directors and all information distributed in connection with such meetings and to attend such meetings. The observer will not have any voting rights. See “Relationships and Related Party Transactions—Stockholders Agreement.”

There will be no limit on the number of terms a director may serve on our board of directors. Our board of directors may consist of not less than one and not more than          directors. The authorized number of directors may be changed only by vote of our stockholders. Our board of directors will have the ability to fill vacancies on our board of directors.

Our board of directors intends to be committed to strong corporate governance practices and to value independent board oversight as an essential component of managing corporate performance.

Board Committees

Our board of directors does not currently have an audit committee, compensation committee, or nominating and corporate governance committee. Prior to the completion of this offering, our board of directors will establish an audit committee, a compensation committee, and a nominating and corporate governance committee. Each of the members of these committees will meet the criteria for independence, and the functioning of these committees will comply with the requirements of, the Sarbanes-Oxley Act, the listing requirements of                      and SEC rules and regulations that will become applicable to us upon the consummation of this offering. Upon the completion of this offering, each of these committees will have adopted a written charter that will be available on our corporate website and will have the composition and responsibilities described below.

Audit Committee.    Our audit committee will provide assistance to our board of directors in fulfilling its oversight responsibilities regarding:

 

  Ÿ  

the integrity of financial statements;

 

  Ÿ  

our compliance with applicable legal and regulatory requirements;

 

  Ÿ  

the integrity of our financial reporting processes, including our systems of internal accounting and financial controls;

 

  Ÿ  

the performance of our internal audit function and independent registered public accounting firm; and

 

  Ÿ  

our financial policy matters.

Our audit committee will determine and pre-approve the engagement of our independent registered public accounting firm to perform audit services and any permissible non-audit services. Our audit committee will also review and discuss with management and our registered independent public accounting firm the results of the annual audit and their reports regarding our accounting practices and systems of internal accounting controls, including significant issues that arise regarding accounting principles and financial statement presentation. Our audit committee will also evaluate the performance of our independent registered public accounting firm, determine whether to retain or terminate their services and take those actions as it deems necessary to satisfy itself that such accountants are independent of management. Our audit committee will also be responsible for establishing procedures for the receipt, retention and treatment of any complaints we receive regarding accounting, internal control or auditing matters.

 

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Upon the consummation of this offering, the members of our audit committee will be             ,              and             , with              serving as the chairperson of our audit committee. Each member of our audit committee will be an independent director, as defined under the listing standards of             and Rule 10A-3 of the Exchange Act. Each member of our audit committee will meet the applicable requirements for financial literacy. Our board of directors intends to appoint at least one director to our audit committee who will qualify as an “audit committee financial expert,” as defined under applicable SEC rules. Effective upon consummation of this offering, our audit committee will operate under a written charter that satisfies the applicable standards of the SEC and the             .

Compensation Committee.    Our compensation committee will:

 

  Ÿ  

oversee our overall compensation structure, policies and programs; and

 

  Ÿ  

assess whether our compensation structure establishes appropriate incentives for officers and employees.

Our compensation committee will review and approve corporate goals and objectives relevant to the compensation of our Chief Executive Officer and other executive officers, evaluate the performance of these officers in light of those goals and objectives and set the compensation of these officers based on such evaluations. In addition, our compensation committee will review and recommend to our board of directors any employment-related agreements, any proposed severance arrangements or change of control or similar agreements with these officers. Our compensation committee will also administer the issuance of stock options and other awards under any stock plans we may have. Our compensation committee will review and evaluate, at least annually, the performance of the compensation committee and its members and the adequacy of the charter of our compensation committee. Our compensation committee will also prepare a report on executive compensation, as required by SEC rules, to be included in our annual report and annual proxy statement.

The members of our compensation committee will be             ,              and             , with              serving as the chairperson of the committee. Each member of our compensation committee will be an independent director under applicable              listing              standards, will be a non-employee director as defined in Rule 16b-3 under the Exchange Act and will be an outside director as that term is defined in Section 102(m) of the Code. Effective upon the consummation of this offering, our compensation committee will operate under a written charter that satisfies applicable              listing standards.

Nominating and Corporate Governance Committee.    Our nominating and corporate governance committee will be responsible for:

 

  Ÿ  

developing and recommending to our board of directors criteria for identifying and evaluating candidates for directorships; and

 

  Ÿ  

making recommendations to our board of directors regarding candidates for election or reelection to our board of directors at each annual stockholders’ meeting.

Our nominating and corporate governance committee, in recommending candidates for election to our board of directors, and our board of directors, in approving (and, in the case of vacancies, appointing) such candidates, will take into account many factors, including:

 

  Ÿ  

diversity of personal background, perspective and experience;

 

  Ÿ  

personal and professional integrity;

 

  Ÿ  

experience in corporate management, operations or finance;

 

  Ÿ  

experience in our industry; and

 

  Ÿ  

experience as a board member of another publicly-held company.

 

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Our board of directors will evaluate each individual in the context of our board of directors as a whole, with the objective of assembling a group that can best perpetuate the success of the business and represent stockholder interests through the exercise of sound judgment using its diversity of experience in these various areas. In addition, our nominating and corporate governance committee will be responsible for overseeing our corporate governance guidelines and reporting and making recommendations to our board of directors concerning corporate governance matters. Our nominating and corporate governance committee will be also responsible for making recommendations to our board of directors concerning the structure, composition and function of our board of directors and its committees.

The members of our nominating and corporate governance committee will be             ,              and             , with             serving as chairperson of the compensation committee. Each member of the nominating and corporate governance committee will be independent under applicable              listing standards. Effective upon the consummation of this offering, our nominating and corporate governance committee will operate under a written charter that satisfies the applicable standards of             .

Overview of Risk Management

Our management is responsible for the day-to-day management of the risks we face, while our board of directors, as a whole and through its committees, has responsibility for the oversight of risk management. This oversight will be conducted primarily through committees of our board of directors, as disclosed in the descriptions of each of the committees below and in the charters of each of the committees. Our audit committee will be responsible for overseeing the management of our risks relating to accounting matters, financial reporting and legal and regulatory compliance. Our compensation committee will be responsible for overseeing the management of risks relating to our executive compensation programs and arrangements. Our nominating and corporate governance committee will be responsible for overseeing the management of our risks associated with the independence of our board of directors and potential conflicts of interest. While each committee will be responsible for evaluating certain risks and overseeing the management of such risks, our entire board of directors will be regularly informed through committee reports about such risks.

Executive Officers

Our executive officers are elected by, and serve at the discretion of, our board of directors.

Code of Business Conduct and Ethics

We have adopted a Code of Business Conduct and Ethics for all directors, officers and employees. The Code of Business Conduct and Ethics is available under the investor section of our website at www.petroalgae.com. A copy of the Code of Business Conduct and Ethics may also be obtained at no charge by written request to the attention of the Investor Relations Department at PetroAlgae Inc., 1901 S. Harbor City Blvd., Suite 600, Melbourne, FL 32901, telephone: (321) 409-7272, email: investorrelations@petroalgae.com.

Compensation Committee Interlocks and Insider Participation

David P. Szostak, our former Chief Financial Officer, is a director of XL Tech. John S. Scott, the Chairman of our board of directors, which has heretofore administered our executive compensation programs and initiatives, is the Chief Executive Officer of XL Tech.

 

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EXECUTIVE COMPENSATION

Summary Compensation Table

The following table provides information concerning compensation paid or accrued during the fiscal years ended December 31, 2008, 2009 and 2010 to our principal executive officers, our principal financial officers and our other most highly paid executive officers, collectively referred to as the named executive officers, determined during and at the end of the last fiscal year:

 

Name and
Principal Position

   Fiscal
year
     Salary     Bonus      Stock
Awards(2)
     Option
Awards
     Total
Compensation
 

John S. Scott(6).

     2008       $ 451,923      $ 99,375       $ 3,576,000       $      —            $ 4,127,298   

Chairman of the Board

and Chief Executive Officer

     2009         477,404 (1)      —             —               —              477,404   
     2010         485,592 (1)      —             3,252,920         —              3,738,512   

David P. Szostak(5)

     2008       $ 271,114      $ 59,625       $ 1,206,900       $ —            $ 1,537,679   

Chief Financial Officer

     2009         225,000 (1)      —             —               —              225,000   
     2010         225,298 (1)      —             1,097,861         —              1,323,159   

Gregory W. Haskell(5)

     2008       $ 115,385      $ 35,329       $ —             $ —            $ 150,714   

Executive Vice President – Strategy

     2009         270,058 (1)      —             —               472,000         742,058   
     2010         273,070 (1)      20,000         —               —              293,070   

Heinrich Gugger(5)

     2008       $ 230,000      $ —           $ —             $ —            $ 230,000   

Executive Vice President – Technology

     2009         88,684        —             —               —              88,684   
     2010         181,372        —             —               529,500         710,872   

Fred G. Tennant(5)

     2008       $ 150,385      $ 27,030       $ 276,500       $ —            $ 453,915   

Executive Vice President – Business Development

     2009         206,154        —             —               —              206,154   
     2010         212,076        —             —               —              212,076   

John Kinney

     2008       $ —           $ —           $ —             $ —            $ —         

Vice President – Corporate Development

     2009         46,731 (3)      —             —               —              46,731   
     2010         135,000        5,600         —               176,500         317,100   

Ted Hollon(5)

     2008       $ —           $ —           $ —             $ —            $ —         

Deployment Program Manager

     2009         —             —             —               —              —         
     2010         220,673 (4)      —             —               88,250         308,923   

 

(1) Includes certain amounts that, upon mutual agreement between PA LLC and the executive officers, have been withheld. The aggregate amount is approximately $80,000 and $310,000 for 2009 and 2010, respectively, for the officers referenced above.
(2) Incentive equity awards in PA LLC are in the form of restricted units. When granted, the units are subject to repurchase by PA LLC. Based upon either a service period or the accomplishment of a liquidity event, the right of PA LLC to repurchase these units is removed.
(3) Mr. Kinney joined the Company on August 24, 2009.
(4) Mr. Hollon joined the Company on January 4, 2010.
(5) During 2011, these individuals separated from the Company.
(6) Dr. Scott resigned as Chief Executive Officer on June 16, 2011, but he remains non-executive Chairman of the Board.

The following table summarizes the stock options granted to our named executive officers as of the end of the last fiscal year:

 

    Outstanding Equity Awards at Fiscal Year-End  
     Option Awards     Stock Awards  

Name

  Number of
Securities
Underlying
Unexercised
Options
Exercisable
    Number of
Securities
Underlying
Unexercised
Options
Unexercisable
    Equity
Incentive Plan
Awards:
Number of
Securities
Underlying
Unexercised
Unearned
Options
    Option
Exercise
Price
    Option
Expiration
Date
    Number
of Shares or
Units of Stock
That Have
Not Vested
    Market Value 
of Shares or
Stock That
Have Not
Vested
    Equity
Incentive Plan
Awards:
Number of
Unearned
Shares, Units
or Other
Rights That
Have Not
Vested
    Equity
Incentive
Plan Awards:
Market or
Payout Value
of Unearned
Shares, Units
or Other
Rights That
Have Not Vested
 

John S. Scott

                                                              

David P. Szostak

                                                              

Gregory W. Haskell

    100,000        100,000             $ 8.50        6/16/19                               

Heinrich Gugger

    37,500        112,500             $ 8.00        1/26/20                               

Fred G. Tennant

                                                              

John Kinney

    20,833        29,167             $ 8.00        1/26/20                               

Ted Hollon

           25,000             $ 8.00        1/26/20                               

 

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The following table summarizes the PA LLC equity incentives granted to our named executive officers as of the end of the last fiscal year:

 

      Grants of Plan Based Awards  

Name

   Grant
Date
     Number of
Restricted Units
Underlying
Grant (1)
     Number of
Units Unrestricted as
of  12/31/10(2)
     Fair
Value per
Unit
     Total Fair 
Value
 

John S. Scott

     8/1/08         800,000         800,000       $ 8.54         6,828,920   

David P. Szostak

     8/1/08         270,000         270,000       $ 8.54         2,304,761   

Gregory W. Haskell

                                       

Heinrich Gugger

                                       

Fred G. Tennant

     1/15/07         50,000         37,500       $ 4.51         169,125   
     8/1/08         50,000         25,000       $ 5.53         138,250   

John Kinney

                                  

Ted Hollon

                                  

 

(1) Incentive equity awards in PA LLC are in the form of restricted units. When granted, the units are subject to repurchase by PA LLC. Based upon either a service period or the accomplishment of a liquidity event, the right of PA LLC to repurchase these units is removed.
(2) Employees holding Class B Membership Units that are not subject to repurchase by PA LLC will be able to exchange their equity interests for PetroAlgae Inc. common stock.

Compensation Discussion and Analysis

Compensation philosophy and objectives.     Our success depends, among other things, on attracting and retaining executive officers with the experience and skills in a number of different areas as we continue to further develop our business and technology. Historically, our principal stockholders played a significant role in establishing our executive compensation philosophy. In addition, those executive officers who were employees of XL Tech before the formation of PetroAlgae Inc. in December 2008 retained their base salaries when they became our employees.

We intend to establish a philosophy with respect to executive compensation policies and practices based on the alignment of each element of compensation with our short-term and long-term strategic objectives, while providing competitive compensation that enables us to attract and retain top-quality executive talent. We anticipate that the primary objectives of our compensation policies and practices for the named executive officers will be to:

 

  Ÿ  

attract, retain, motivate and reward highly qualified and competent executives who have extensive industry experience through a mix of base salary, annual cash incentives and long-term equity incentives that encourage and recognize individual and company performance; and

 

  Ÿ  

provide incentives to increase and maximize stockholder value by:

 

  ¡   

emphasizing equity-based compensation to more closely align the interests of executives with those of our stockholders; and

 

  ¡   

structuring short-term compensation contingent upon the achievement of performance measures intended to reward performance year-over-year that we believe creates stockholder value in the short-term and over the long-term.

We intend to adopt this philosophy because we believe that it will be critical to our continued success and the achievement of our short-term and long-term goals and objectives as a company for our stockholders.

 

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Administration.    Since our inception, our board of directors has administered our executive compensation programs and initiatives. Our board of directors has also sought, and received, significant input from our principal stockholders with respect to the performance and compensation of our executive officers.

Prior to the completion of this offering, our board of directors will establish a compensation committee. We anticipate that our compensation committee will recommend, and our board of directors will adopt, a charter for our compensation committee which will delegate the responsibility for determining executive compensation and initiatives to our compensation committee. In accordance with our compensation committee’s charter, we anticipate that our compensation committee will have the authority to determine the annual compensation of our chief executive officer and other executive officers, and will regularly report its compensation decisions to the full board of directors. We also anticipate that our compensation committee will administer any equity compensation plans we may have, including our 2009 Equity Compensation Plan, or the 2009 Plan. See “—2009 Equity Compensation Plan.”

Our compensation committee may in the future engage compensation consultants familiar with our industry to advise the committee regarding certain compensation issues.

Compensation program.    Based on and consistent with the philosophy and objectives stated above, our executive compensation program and practices will consist of the following elements:

 

  Ÿ  

base salary;

 

  Ÿ  

annual cash incentive awards;

 

  Ÿ  

long-term equity incentive awards; and

 

  Ÿ  

benefits and perquisites.

We have chosen these elements to remain competitive in attracting and retaining executive talent and to provide strong incentives for consistent high performance with current and potential financial rewards. We also plan to continue to provide employee benefits, such as health, dental and life insurance, to the named executive officers pursuant to plans that are generally available to our employees. We believe that our mix of compensation will instill in our executive officers the importance of achieving our short-term and long-term business goals and objectives and thereby increase stockholder value.

Additional details regarding elements of our executive compensation program are as follows:

Base salaries    Our board of directors established the base salary range for the named executive officers with significant input from our principal stockholders. In relation to long-term and short-term incentives, we view base salary as a less significant element of compensation than long-term equity, so the levels are less than those of peer companies. Our board of directors approves all increases in base salary for the named executive officers in advance and reviews salaries of executive officers at periodic intervals and awards increases, if appropriate. In assessing the amount and timing of salary adjustments, if any, our board of directors considers, and we anticipate that our compensation committee will consider, individual performance, changes in functions and responsibilities, if any, competitive salaries and peer comparisons, and relative positions within the company. At the end of 2008 and during 2009, certain former members of our management elected to defer a portion of their salary in order to assist us in preserving our financial position. Base salaries for all named executive officers for the fiscal years ended December 31, 2008, 2009 and 2010 are shown in the “Salary” column of the Summary Compensation Table above.

 

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Bonuses.    Our executive officers participate in our annual cash bonus plan in which all of our full-time employees are eligible to participate. Our board of directors administers this bonus plan. Under this plan, each executive officer is eligible to receive a cash bonus amount based on a certain percentage of their salary. Our board of directors decides the amount of any bonus, as a percentage of such executive officer’s salary, for any given year. Our board of directors makes this determination based on the achievement by us of certain goals and objectives during the calendar year. Such goals and objectives are set forth in advance by the board of directors. To date, due to the development stage of our operations and specifically that we have not begun to generate net cash flows from operations, very little bonus compensation has been paid.

Long-term equity incentive compensation.    We provide equity incentives pursuant to the 2009 Plan, which we adopted on June 17, 2009 and which seeks to give (i) our employees and the employees of PA LLC, (ii) certain consultants and advisors who perform services for us and our subsidiaries, and (iii) non-employee members of our board of directors and our parent and subsidiaries the opportunity to receive grants of incentive stock options, nonqualified stock options, stock awards and other stock-based awards. We believe that the 2009 Plan will encourage the participants to contribute materially to our growth, thereby benefiting our stockholders, and will align the economic interests of the participants with those of our stockholders.

Our board of directors currently administers the 2009 Plan.    Our board of directors determines the individuals to whom awards shall be made under the 2009 Plan, as well as the type, size and terms of the awards, the time when the awards will be made and the duration of any applicable exercise or restriction period, including the criteria for exercisability and the acceleration of exercisability. Our board of directors may establish all other terms, conditions, and limitations applicable to awards, award programs and the shares of our common stock issued pursuant to such award programs, amend the terms of any previously issued award, and address any other matters arising under the 2009 Plan. Upon the consummation of this offering, our board of directors is expected to delegate each of the aforementioned responsibilities to our compensation committee.

Awards under the 2009 Plan may consist of grants of options, stock awards and other stock-based awards. Subject to certain adjustments, the aggregate number of shares of our common stock that may be issued pursuant to awards granted under the 2009 Plan may not exceed 4,000,000 shares of our common stock.

Employment Agreements

We do not have formal employment agreements with any of the named executive officers. See “Relationships and Related Party Transactions—Employment Agreements with Officers” for a description of our employment agreements with several of our current executive officers.

Other Executive Officer Perquisites

We generally do not provide any additional perquisites to the named executive officers except in certain limited circumstances to be approved by our board of directors or, after its establishment, our compensation committee.

Other Executive Officer Benefits

We provide the following benefits to our executive officers on the same basis as other eligible employees:

 

  Ÿ  

health insurance;

 

  Ÿ  

vacation, personal holidays and sick days;

 

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  Ÿ  

life insurance;

 

  Ÿ  

short-term and long-term disability; and

 

  Ÿ  

a 401(k) plan.

Impact of accounting and tax treatments.    Section 162(m) of the Internal Revenue Code disallows a tax deduction for any publicly-held corporation for individual compensation exceeding $1.0 million in any taxable year for our chief executive officer and each of the other named executive officers (other than our chief financial officer), unless compensation is performance based. Our board of directors has not previously taken the deductibility limit imposed by Section 162(m) into consideration in setting compensation. We expect that our compensation committee will adopt a policy at some point in the future that, where reasonably practicable, will seek to qualify the variable compensation paid to our executive officers for an exemption from the deductibility limitations of Section 162(m). Until such policy is implemented, our board of directors and, after its establishment, our compensation committee may, in its judgment, authorize compensation payments that do not consider the deductibility limit imposed by Section 162(m) when it believes that such payments are appropriate to attract and retain executive talent.

Policy regarding the timing of equity awards.    We have no program, plan or practice pertaining to the timing of stock option grants to executive officers coinciding with the release of material non-public information. We do not, as of yet, have any plans to implement such a program, plan or practice after the consummation of this offering. However, we intend to implement policies to ensure that equity awards are granted at fair market value on the date that the grant action occurs.

Policy regarding restatements.    We do not have a formal policy regarding adjustment or recovery of awards or payments if the relevant performance measures upon which they are based are restated or otherwise adjusted in a manner that would reduce the size of the award or payment. Under those circumstances, we anticipate that our board of directors or, after its establishment, our compensation committee would evaluate whether adjustments or recoveries of awards were appropriate based upon the facts and circumstances surrounding the restatement.

Stock ownership policies.    We have not established stock ownership or similar guidelines with respect to our executive officers. All of our executive officers currently have a direct or indirect, through their stock option holdings or otherwise, equity interest in us, and we believe that they regard the potential returns from these interests as a significant element of their potential compensation for services to us.

Pension benefits.    None of the named executive officers participates in, or has an account balance in, a qualified or non-qualified defined benefit plan sponsored by us.

Non-qualified deferred compensation.    None of the named executive officers participates in, or has an account balance in, a traditional non-qualified deferred compensation plan or other deferred compensation plans maintained by us.

2009 Equity Compensation Plan

Stock Options.    We adopted the 2009 Plan on June 17, 2009. The 2009 Plan is intended to provide employees, consultants and others the opportunity to receive employee stock options and is limited to 4,000,000 shares of our common stock. The exercise price is equal to or greater than the fair value of the underlying common stock on the date the option is granted and its term does not exceed 10 years. Awards will not vest in full prior to the third anniversary of the award date. We reserved a pool of shares of our common stock for issuance to (i) our employees and the employees of PA LLC,

 

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(ii) certain consultants and advisors who perform services for us and our parent and subsidiaries, and (iii) non-employee members of our board of directors and our parent and subsidiaries pursuant to awards granted under the 2009 Plan. It provides for awards under three separate categories: (i) the option program pursuant to which eligible persons may be granted options, (ii) the stock award program pursuant to which eligible persons may be granted awards of our common stock, restricted stock, deferred stock and stock units, and (iii) the other stock-based awards program pursuant to which eligible persons may be granted awards that are based on our common stock as a bonus for achievement of performance goals or other conditions. The 2009 Plan is administered by our board of directors, which may delegate administrative responsibilities to a committee thereof. We expect that after the completion of this offering our board of directors will delegate the administration of the 2009 Plan to our compensation committee. Our board of directors has, and after its establishment our compensation committee will have, the authority to grant additional acceleration rights or waive any conditions relating to vesting, exercise, payment or distribution of any award upon a change of control to holders of options issued pursuant to the 2009 Plan.

We entered into stock option agreements, or SOAs, with 89 individuals, including 3 executive officers, to provide them with the option to purchase our common stock pursuant to the 2009 Plan. For the majority of the 86 individuals who were employees of PA LLC at the time we granted the option, the options vest ratably each year following each employee’s date of hire or the date of the grant so that the options are fully vested after four years. The three remaining SOAs provide for full vesting of the options over a four-year period, though not by equal numbers of shares each year. See “—2009 Equity Compensation Plan” for a more detailed analysis of the 2009 Plan.

A summary of stock option activity is as follows:

 

     Number of
Shares
    Weighted
Average
Exercise
Price
    Weighted
Average
Fair
Value
 

Balance at December 31, 2008

          $      $   

Granted June 2009

     1,072,500      $ 5.50      $ 2.70   

Granted July 2009

     45,000      $ 5.50      $ 2.83   

Forfeited

     (200,000   $ (5.50   $ (2.70
  

 

 

     

Balance at December 31, 2009

     917,500      $ 5.50      $ 2.37   

Granted January 2010

     322,000      $ 5.50      $ 3.80   

Forfeited

     (247,750   $ (5.50   $ (2.95
  

 

 

     

Balance at December 31, 2010

     991,750      $ 5.50      $ 2.68   

Granted January 2011

     623,000      $ 5.50      $ 3.27   

Granted June 2011

     351,000      $ 5.50      $ 3.96   

Granted July 2011

     265,000      $ 5.50      $ 3.96   

Forfeited

     (530,000   $ (5.50   $ (2.92
  

 

 

     

Balance at September 30, 2011

     1,700,750      $ 5.50      $ 3.47   

On June 30, 2011, our board of directors authorized the re-pricing of all outstanding stock options, changing the exercise price from $8.00 or $8.50 to $5.50 per option. We computed the additional compensation cost as the fair value of the new awards in excess of the fair value of the original awards immediately before their terms were modified, using the Black-Scholes pricing model. This calculation used the following assumptions determined as of June 30, 2011: estimated fair value of the common stock of $5.10, remaining terms ranging from 4.75 years to 5.89 years (depending on the date of the original grant), risk free interest rate of 1.76%, an estimated volatility of 96.5%, and a dividend yield of 0%. The modification affected 1,240,000 options and resulted in aggregate additional compensation cost of $0.4 million. In the table above, the values shown for each grant prior to June 30, 2011 have been revised to reflect the new exercise price and recalculated fair.

 

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The weighted average grant date fair value for vested options as of September 30, 2011 was $3.11. The weighted average grant date fair value for unvested options as of September 30, 2011 was $3.66.

The weighted average contractual life of outstanding stock options at September 30, 2011 was 8.7 years. The weighted average contractual life of vested and unvested stock options at September 30, 2011 was 7.2 years and 9.4 years, respectively. As of September 30, 2011, a total of 574,917 of the options granted were exercisable and the fair value of such options was $1.8 million.

Stock awards program.    The 2009 Plan provides for the grant of awards that are payable in shares of our common stock or denominated in units equivalent in value to shares of our common stock or are otherwise based on or related to shares of our common stock, restricted stock, deferred stock and stock units. These awards may not vest in full prior to the third anniversary of the award date; provided, however that our board of directors or a committee thereof may, in its sole discretion, grant awards that provide for accelerated vesting. At the discretion of our board of directors or the committee, these awards may be made subject to or may vest on an accelerated basis, upon the achievement of performance criteria related to a period of performance of not less than one year, which may be established on a companywide-basis or with respect to one more business units or divisions.

Other stock-based awards program.    Our board of directors or a committee thereof may grant other stock-based awards, which are awards (other than those described above) that are based on or measured by our common stock, on such terms and conditions as our board of directors or a committee thereof determines. Other stock-based awards may be awarded subject to the achievement of performance goals or other conditions and may be payable in cash, common stock or any combination of the foregoing, as our board of directors or a committee thereof shall determine.

PA LLC Equity Incentive Plan

PA LLC has an equity compensation plan which allows it to grant employees and consultants awards of profits interests in restricted Class B ownership units, or the Interests, and is limited to 14% of the total outstanding units. PA LLC has granted 3,490,971 of its units to various employees through unit grant agreements. The unit grants generally vest over four years of continual service.

PA LLC granted 2,816,471 and 674,500 Interests during 2008 and 2007, respectively, to the majority of its employees as of the date that they began employment with PA LLC. As of September 30, 2011 and December 31, 2010, the granted Interests, net of Interests forfeited and repurchased by PA LLC, totaled 2,754,571 and 2,837,691, respectively, or 12.7% and 13.0%, respectively, of total outstanding units. The Interests give the recipient the right to participate in the income of PA LLC and any distribution that may arise from a liquidity event to the extent that such realized amounts exceed the ownership unit fair value at the date of grant.

The grants of Interests contain restrictions that allow PA LLC to repurchase the units for $0.01 per unit until a service period or other condition is met. This restriction is removed over a service period (generally four years) with regard to approximately 2.15 million Interests. On March 4, 2011, we modified the terms of the Interests granted to a former employee, causing the Interests to be immediately vested.

Five senior officers, including two executive officers, were granted an aggregate 1.34 million Interests that were subject to repurchase for $0.01 per unit until a significant liquidity event occurred. As of December 31, 2010, our principal stockholders authorized the modification of the terms of the grant to remove the right of PA LLC to repurchase the Interests held by all five officers, causing these

 

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grants to be immediately vested. This decision required a revaluation of the Interests held by the officers and immediate recognition of the calculated expense.

Stock Appreciation Rights

In November 2010, we issued one million Stock Appreciation Rights, or SARs to Mr. Harris, our president and chief operating officer, under the 2009 Plan. The vesting of these SARs was tied to continued employment with us and the accomplishment of certain milestones. Mr. Harris resigned during the first quarter of 2011, forfeiting all such SARs.

In June 2011, our board of directors authorized the grant of one million SARs at a base grant price of $5.50 per share to our newly-appointed chief executive officer under the 2009 Plan. The SARs have a ten-year term and will vest in equal quarterly installments over a two-year period. In the event of a change of control (as defined in the 2009 Plan) or a qualified public offering (as defined in the executive’s employment agreement), the SARs will become 100% vested.

401(k) Plan

We maintain a deferred savings retirement plan for our U.S. employees. The deferred savings retirement plan is intended to qualify as a tax-qualified plan under Section 401 of the Internal Revenue Code. Contributions to the deferred savings retirement plan are not taxable to employees until withdrawn from the plan. The deferred savings retirement plan provides that each participant may contribute his or her pre-tax compensation (up to a statutory limit, which is $16,500 in 2011). For employees 50 years of age or older, an additional catch-up contribution of $5,500 is allowable. Under the plan, each employee is fully vested in his or her deferred salary contributions. The deferred savings retirement plan also permits us to make additional discretionary contributions, subject to established limits and a vesting schedule.

Compensation of Directors

Our employee directors and any director appointed by our principal stockholders will not receive any additional compensation in connection with their service as directors. The compensation we pay our employee directors is discussed in “—Summary Compensation Table.” Currently, we pay our non-employee directors who are not affiliated with us a fee of $2,007 a month. Following this offering, we intend to pay our non-employee directors who are not affiliated with us a fee that commensurates with fees paid by peer companies for each meeting attended by them. Each non-employee director may also be entitled to participate in the 2009 Plan.

The following table summarizes the compensation we paid to our non-employee directors in 2010:

 

Name

   Fees Earned
or Paid in
Cash

($)
     Stock
Awards
($)
     Option
Awards
($)
     All Other
Compensation
($)
     Total
($)
 

Isaac Szpilzinger

   $ 26,091         —           —           —         $ 26,091   

Sayan Navaratnam

     —           —           —           —           —     

 

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RELATIONSHIPS AND RELATED PARTY TRANSACTIONS

Stockholders Agreement

Prior to the completion of this offering, we will enter into the stockholders agreement. The stockholders agreement will become effective upon the completion of this offering. The stockholders agreement will contain a voting agreement that provides, among other things, that:

 

  Ÿ  

our principal stockholders will agree to vote any shares of our common stock they and their affiliates own pro rata with our unaffiliated stockholders (other than in connection with any vote relating to (i) a consolidation or merger of the company or any of its affiliates into or with any other person (other than affiliates of our principal stockholders); or (ii) a sale, lease or transfer of all or substantially all of our assets or capital stock to another person (other than affiliates of our principal stockholders)); and

 

  Ÿ  

our principal stockholders will not vote in favor of the removal of any of our independent directors unless our unaffiliated stockholders approve such removal.

At each stockholders’ meeting, our principal stockholders will be required to take all necessary or desirable actions within its control to effect the terms of the stockholders agreement, including with respect to the election of directors.

Pursuant to the terms of the stockholders agreement, our principal stockholders will have the right to appoint the observer to our board of directors. The observer will be entitled to receive notice of all meetings of our board of directors and all information distributed in connection with such meetings and to attend such meetings. The observer will not have any voting rights.

The stockholders agreement will also provide that we will not enter into any transaction with our principal stockholders or any of its affiliates without the prior written approval of a majority of the disinterested members of our board of directors.

The stockholders agreement will remain in effect so long as our principal stockholders and their affiliates beneficially own more than 25% of our outstanding common stock (as set forth on the cover of our then most recently filed annual report on Form 10-K or quarterly report on Form 10-Q).

Sublease from XL TechGroup, Inc.

As of December 31, 2010, we subleased space from XL Tech, on a month-to-month basis, at a current rate of $45,461 per month. The sublease was terminated in February 2011. Mr. Scott serves as a director and executive officer and is a principal shareholder of XL Tech. XL Tech founded and developed PA LLC from its inception.

Issuance of Shares to a Director

On December 19, 2008, in a private placement, we issued 1,000,000 shares of our common stock for a value of $3,150,000 to Nationwide Solutions Inc., or Nationwide Solutions, that is performing consulting services for us. Sayan Navaratnam, a director and an employee of our principal stockholders, had an interest in the transaction as the sole owner of Nationwide Solutions.

Issuance of Shares to Entities Affiliated with our Principal Stockholders

On May 5, 2010, April 7, 2010, March 1, 2010, October 9, 2009, September 29, 2009, September 14, 2009, September 4, 2009, and August 28, 2009, we issued and sold in the aggregate (i) 686,625 shares of our common stock to Valens U.S. SPV I, LLC for a purchase price of

 

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$8.00 per share and warrants to purchase 686,625 shares of our common stock at an exercise price of $15.00 per share, and (ii) 563,375 shares of our common stock to Valens Offshore SPV I, Ltd. for a purchase price of $8.00 per share and warrants to purchase 563,375 shares of our common stock at an exercise price of $15.00 per share. The aggregate proceeds from these private placements was $10,000,000.

On December 22, 2008, we issued and sold 666,667 shares of our common stock to Valens U.S. SPV I, LLC for a purchase price of $3.15 per share and 2,507,936 shares of our common stock to Valens Offshore SPV I, Ltd. for a purchase price of $3.15 for consideration of $2,100,000 and $7,900,000, respectively.

These were private placement transactions exempt from the registration requirements of the Securities Act pursuant to the exemption afforded by Section 4(2) thereof and/or Regulation D promulgated thereunder. We used the proceeds of these private placements to fund the working capital needs of PA LLC.

Employment Agreements with Officers

We entered into the following employment agreement with the following executives: (i) Anthony John Phipps Tiarks as our Chief Executive Officer, effective as of June 15, 2011 and (ii) Peter Sherlock as our Chief Operating Officer, effective as of July 21, 2011.

Each employment agreement has an initial term of one year and will continue on a year-to-year basis thereafter until the executive’s employment is not renewed or otherwise terminated as set forth therein.

Mr. Tiarks will receive the following compensation and benefits: (i) an annual base salary of $300,000 (subject to increase, but not decrease, in the sole discretion of our board of directors); (ii) a one-time signing bonus (before taxes) of $30,000; (iii) eligibility to receive an annual performance bonus based upon the achievement of targets established in our sole discretion; (iv) a grant of SARs on a base number of 1,000,000 of our shares at a base grant price of $5.50 per share; (v) eligibility to receive a special cash bonus upon the achievement of certain milestones; (vi) participation in a commission plan and (vii) a one-time bonus of $100,000 if we complete a total capital raise of at least $25,000,000. Mr. Sherlock will receive the following compensation and benefits: (i) an annual base salary of $220,000 (subject to increase, but not decrease, in the sole discretion of our board of directors); (ii) eligibility to receive an annual performance bonus based upon the achievement of targets established in our sole discretion; (iii) a grant of stock options on a base number of 200,000 of our shares at a base grant price of $5.50 per share; (iv) eligibility to receive a special cash bonus four times per year, each in the amount of $5,000, upon the achievement of certain milestones and (v) a one-time bonus of $100,000 if we complete a total capital raise of at least $25,000,000.

Each of the executives will also receive (i) eligibility to participate in all employee benefit plans and programs maintained from time to time for our employees and (ii) four weeks of annual paid vacation.

In the event the executive’s employment is terminated for any reason (including by expiration of the term of his employment agreement), the executive will be paid the following through the date of termination: (i) any accrued but unpaid base salary; (ii) reimbursement for any business expenses properly incurred; and (iii) vested benefits, if any, to which he may be entitled under our employee benefit plans or stock option plans, or, collectively, the Accrued Benefits. If the executive’s employment is terminated by us for “cause”, then he shall not be entitled to any further compensation or benefits other than the Accrued Benefits. If the executive’s employment is terminated by us “other than for

 

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cause”, then the executive shall be entitled to the Accrued Benefits and (subject to signing a mutual release) a lump sum amount equal to the number of days (at the base salary date) between the date of termination and the next anniversary of the execution of the his employment agreement. If the executive’s employment is terminated by him for “good reason”, then he shall be entitled to the Accrued Benefits and (subject to signing a mutual release) a lump sum amount equal to the number of days (at the base salary rate) between the date of termination and the next anniversary of the execution of his employment agreement. The executive can voluntarily resign his employment at any time, effective 31 days following the date on which a written notice to such effect is delivered to us. If the executive’s employment is terminated through a voluntary resignation and for no other reason, he shall be entitled to payment of the Accrued Benefits. In the event of termination of employment by reason of the executive’s death, his beneficiary or estate, as applicable, shall be entitled to the payment of the Accrued Benefits. Following a termination by the us for cause or voluntary resignation by the executive, each executive will be subject to a two-year non-competition and non-solicitation agreement. In addition, following termination of employment, each executive will be subject to a covenant not to disparage us.

In addition, in the event Mr. Tiarks’ employment is terminated by us through non-renewal of the term of his employment agreement, then Mr. Tiarks shall be entitled to the Accrued Benefits and (subject to signing a mutual release) a lump sum amount equal to the number of days (at the base salary rate) between the date of termination and the next anniversary of the execution of his employment agreement.

We also entered into an employment agreement with James P. Dietz as our Vice President of Accounting and Finance, effective as of May 10, 2010 and as amended on November 11, 2010. As of the date of this prospectus, Mr. Dietz serves as our Chief Financial Officer and his employment agreement remains in effect. Mr. Dietz will receive the following compensation and benefits: (i) an annual base salary of $200,000 (subject to adjustment, in the sole discretion of our board of directors), (ii) eligibility to receive a grant of stock options, (iii) 15 days of annual paid vacation, (iv) a one-time bonus of $100,000 if we compete a total capital raise of at least $25,000,000, (v) eligibility to receive an annual bonus of up to half his salary, (vi) eligibility to participate in all employee benefit plans and programs maintained from time to time for our employees, and (vii) reimbursement for relocation expenses not to exceed $5,000.

In the event Mr. Dietz’s employment is terminated (except by us for “cause”, by reason of his death or by reason of his disability), he will be eligible to receive an amount equal to two weeks of his then current-salary. If his employment is terminated by us for “cause”, then we will pay all compensation to which he is entitled to through the date of termination. In the event of termination of employment by reason of his death, his beneficiary or estate, as applicable, shall be entitled to the payment of any compensation then due and owing. In the event of termination of employment due to his disability, he shall be entitled to the payment of any compensation then due and owing. During Mr. Dietz’s term of employment and for two years after termination of his employment, Mr. Dietz will be subject to a non-disclosure covenant. If Mr. Dietz terminates his employment at any time for any reason or no reason at all, our obligations under his employment agreement cease.

Related Party Expenses

In 2008, we paid XL Tech $2.2 million as reimbursement for administrative, executive management, business development and other services. Since 2008, we have not made any additional payments to XL Tech, and we do not expect to make any additional payments to XL Tech with respect to these services.

 

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Assignment by our Principal Stockholders

On December 16, 2008, PetroTech acquired a shell company for $350,000 and, on December 19, 2008, assigned its entire interest in PA LLC to this shell company, which it then renamed PetroAlgae Inc.

Indemnification Agreements

Our amended and restated certificate of incorporation will contain provisions limiting the liability of directors, and our bylaws will provide that we will indemnify each of our directors to the fullest extent permitted under Delaware law. Our amended and restated certificate of incorporation and amended and restated bylaws will also provide our board of directors with the discretion to indemnify our officers and employees when determined appropriate by the board.

Policy on Future Related Party Transactions

Prior to the closing of this offering, our board of directors will adopt a written related party transaction policy setting forth the policies and procedures for the review and approval or ratification of related party transactions. This policy, which will become effective upon the closing of this offering, covers any transaction, arrangement or relationship, or any series of similar transactions, arrangements or relationships, in which we were or are to be a participant and a related person had or will have a direct or indirect material interest, as determined by the audit committee of our board of directors, including, without limitation, purchases of goods or services by or from the related person or entities in which the related person has a material interest, and indebtedness, guarantees of indebtedness or employment by us of a related person. In reviewing any such proposal, our audit committee will be tasked with considering all relevant facts and circumstances, including, but not limited to, the commercial reasonableness of the terms, the benefit or perceived benefit, or lack thereof, to us, opportunity costs of alternate transactions, the materiality and character of the related person’s direct or indirect interest and the actual or apparent conflict of interest of the related person.

All related party transactions described in this section occurred prior to adoption of this policy and therefore were not subject to the approval and review procedures set forth in the policy. However, these transactions were reviewed and approved by our board of directors prior to the completion of the offering.

 

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PRINCIPAL AND SELLING STOCKHOLDERS

As of December 1, 2011, PetroTech held 2,417,215 shares of the common stock of PetroAlgae, representing 2.2% of the issued and outstanding common stock, and a $13.1 million promissory note convertible into a further 3,125,475 shares of common stock.

PetroTech is owned by the following private investment entities:

 

  Ÿ  

Valens U.S.;

 

  Ÿ  

Valens Offshore SPV I, Ltd., or Valens SPV I;

 

  Ÿ  

Valens Offshore SPV II, Corp., or Valens SPV II;

 

  Ÿ  

Laurus Master Fund, Ltd. (In Liquidation), or the Fund, and its wholly-owned subsidiary, CCC; and

 

  Ÿ  

PSource Structured Debt Limited, or PSource.

Valens U.S., Valens SPV I and Valens SPV II are each managed by VCM.

The Fund is in liquidation under the supervision of the Grand Court of the Cayman Islands. The joint official liquidators, or JOLs, have discretion over the management of the Fund and the disposition of its assets. LCM provides day-to-day investment management services to the Fund.

PSource is managed by LCM, subject to certain preapproval rights of the board of directors of PSource.

Eugene Grin and David Grin are the controlling principals of LCM and VCM.

We refer to the private investment entities described above, and that are managed by VCM and LCM, as our principal stockholders and also as the Laurus-Valens Funds. The Laurus-Valens Funds have invested in micro-cap and small private and publicly-traded companies since 2001.

The following table sets forth certain information with respect to the beneficial ownership of our common stock at December 1, 2011, as adjusted to reflect the sale of shares of our common stock offered by us in this offering, for:

 

  Ÿ  

each person, or group of affiliated persons, who we know beneficially owns more than 5% of our outstanding shares of our common stock;

 

  Ÿ  

each of our directors;

 

  Ÿ  

each of our named executive officers; and

 

  Ÿ  

all of our current directors and executive officers as a group; and

 

  Ÿ  

the selling stockholders.

We have determined beneficial ownership in accordance with the rules of the SEC. Except as indicated by the footnotes below, we believe, based on the information furnished to us, that the persons and entities named in the table below have sole voting and investment power with respect to all shares of our common stock that they beneficially own, subject to applicable community property laws.

 

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For purposes of the table below, we have assumed that             shares of our common stock will be outstanding upon completion of this offering. In computing the number of shares of our common stock beneficially owned by a person and the percentage ownership of that person, we deemed to be outstanding all shares of our common stock subject to options, warrants or other convertible securities held by that person or entity that are currently exercisable or exercisable within 60 days of September 30, 2011. We did not deem these shares outstanding, however, for the purpose of computing the percentage ownership of any other person.

Unless otherwise indicated, the address of each beneficial owner listed in the table below is c/o PetroAlgae Inc., 1901 S. Harbor City Blvd., Suite 600, Melbourne, FL 32901. Beneficial ownership representing less than 1% is denoted below with an asterisk (*).

 

    Shares of Our Common
Stock Beneficially Owned
Before This Offering
    Number of
Shares
Being
Offered by
Stockholder
  Shares of Our Common
Stock Beneficially Owned
After This Offering

Name and Address of Beneficial Owners and
the Selling Stockholders

  Number
of Shares
    Percentage
of
Class
      Number
of
Shares
  Percentage
of Class

5% Stockholders

         

PetroTech Holdings Corp.(1)

    104,424,603        97.7      

Directors and Executive Officers

         

Sayan Navaratnam

    1,000,000        *         

John S. Scott

           *         

Isaac D. Szpilzinger

           *         

Anthony John Phipps Tiarks

           *         

James P. Dietz

    50,000        *         

Peter Sherlock

           *         

All directors and officers as a group (six persons)

    1,050,000        *         

Selling Stockholders

         

                                                         (2)

      *         

 

(1) PetroTech Holdings Corp., or PetroTech, is owned by Valens U.S. SPV I, LLC, a Delaware limited liability company, or Valens U.S., Valens Offshore SPV I, Ltd., a Cayman Islands limited company, or Valens SPV I, Valens Offshore SPV II, Corp., a Delaware corporation, or Valens SPV II, Laurus Master Fund, Ltd. (In Liquidation), a Cayman Islands limited company, or the Fund, Calliope Capital Corporation, a Delaware corporation, or CCC and PSource Structured Debt Limited, a Guernsey company, or PSource. The Fund, CCC and PSource are each managed by Laurus Capital Management, LLC, a Delaware limited liability company, or LCM. Valens U.S., Valens SPV I and Valens SPV II are each managed by Valens Capital Management, LLC, or VCM. Eugene Grin and David Grin, through other entities, are the controlling principals of LCM and VCM and share sole voting and investment power over all securities of the Company held by PetroTech. Eugene Grin and David Grin disclaim beneficial ownership of the securities of the Company held by PetroTech, except to the extent of such person’s pecuniary interest in PetroTech, if any. PetroTech pledged all of the common shares it holds to L.V. Administrative Services, an affiliate of the Laurus-Valens Funds, as administrator and collateral agent for Valens U.S., as security for a $417,511.92 promissory note made by PA LLC in favor of Valens U.S.
(2)                                              .

 

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DESCRIPTION OF CAPITAL STOCK

Prior to the completion of this offering, we will amend our restated certificate of incorporation and restated bylaws. We will file copies of the forms of our amended and restated certificate of incorporation and amended and restated bylaws as exhibits to the registration statement of which this prospectus is a part. The provisions of our amended and restated certificate of incorporation and amended and restated bylaws that will be in effect upon consummation of this offering and relevant sections of the DGCL are summarized below. The following description of our capital stock and provisions of our amended and restated certificate of incorporation and our amended and restated bylaws are summaries and are qualified by reference to our amended and restated certificate of incorporation and our amended and restated bylaws that will be in effect upon the closing of this offering.

Authorized Capital Stock

Our authorized capital stock will consist of             shares, including: (i)              shares of our common stock, par value $0.001 per share, and (ii)              shares of preferred stock, $0.001 par value per share. As of September 30, 2011, we had outstanding 106,920,730 shares of our common stock, held of record by 393 stockholders, and no shares of preferred stock outstanding.

Common Stock

Holders of our common stock will be entitled to one vote per share on all matters submitted to a vote of stockholders, including the election of directors. Our common stockholders will not be entitled to cumulative voting in the election of directors. Subject to preferences that may be applicable to any outstanding shares of preferred stock, holders of our common stock will be entitled to receive ratably such dividends as