TSYI Terra Systems Inc (CE)

Item 2. Management's Discussion and Plan of Operation

Special Cautionary Statement Regarding Forward-Looking Statements

This Quarterly Report contains forward-looking statements about our business, financial condition, and prospects that reflect our assumptions and beliefs based on information currently available. We can give no assurance that the expectations indicated by these forward-looking statements will be realized. If any of our assumptions should prove incorrect, or if any of the risks and uncertainties underlying those expectations should materialize, our actual results may differ materially from those indicated by the forward-looking statements.

The key factors that are not within our control and that may have a direct bearing on operating results include, but are not limited to, acceptance of our services, our ability to expand our customer base, our ability to raise capital in the future, the retention of key employees, and changes in the regulation of our industry.

There may be other risks and circumstances that we are unable to predict. When used in this Quarterly Report, the words "believes," "expects," "intends," "plans," "anticipates," "estimates" and similar expressions are intended to identify forward-looking statements, although there may be some forward-looking statements not accompanied by these expressions. Additionally, statements concerning our projections, projected business strategies, projected revenues or performance, or future results may also constitute forward-looking statements. All forward-looking statements are intended to be covered by the safe harbor created by Section 21E of the Securities Exchange Act of 1934. We disclaim any obligation or intention to update any forward-looking statements.

General

Terra Systems was incorporated in Utah on February 17, 1996, and is a development-stage company. We are pursuing three primary businesses. The first of these is the development and commercialization of our patented pneumatic accelerator. This device is a gas linear particle accelerator that conveys and processes bulk materials at high velocity in a particle isolate state, using air as the medium of movement. The traditional and more costly medium for processing bulk materials is water. Our technology operates efficiently at ambient temperatures and at low pressures and does not use water. We believe that most if not all organic and inorganic bulk materials used in basic industries (such as coal, gypsum, black sands, corn, rice, and wheat) can be more economically separated and classified by our dry-process technology. This capability facilitates a number of associated procedures, including: drying, micropulverizing, mixing, forming, conveying, and loading. In addition, bulk materials can be beneficiated in important ways including moisture reduction, ash reduction, Btu enhancement, and electro-customization. Our system can perform multiple tasks, needs less maintenance, requires no chemical additives, and can improve the surrounding environmental quality.

The second business we are pursuing is clean coke technology. We have obtained the worldwide license to Combustion Resources LLC's ("Combustion Resources") clean coke technology. We believe that the carbon coke product produced by this process qualifies for tax credits under IRC Section 45K. The Energy Policy Act of 2005 (the "Energy Act") Section 1321 extended the date that facilities placed in service will qualify for this tax credit. We worked with the College of Eastern Utah to apply for and obtain an award of a Federal Center of Excellence grant under Section 404 of the Energy Act. This award will be used to further our development of this technology.

The third business we are pursuing is the agglomeration of carbon products. The material agglomerated may or may not be previously processed utilizing our patented pneumatic accelerator technology. Initially, we are agglomerating carbon black, a very fine-sized material that poses significant material handling issues in its unagglomerated state.

Our success and ability to compete will be dependent in part on the protection of our existing and potential patents, trademarks, trade names, service marks, trade secrets, and other proprietary rights. Thus, a majority of our research and development efforts have been focused on product development, testing, and patent application.

We seek to continue developing our products internally through research and development, or if appropriate, through strategic partnerships. We expect, however, that if we can purchase or license products, services, or technologies from third parties at a reasonable cost, we will do so in order to avoid the time and expense involved in developing these products, services, or technologies.

Results of Operations

Nine months ended September 30, 2007, compared to the nine months ended September 30, 2006:

From inception through September 30, 2007, we have incurred losses totaling $22,308,443 and generated revenues of $777,428 from operations. During the nine months ended September 30, 2007, we had sales revenues of $159,286. This factor, among others, raises substantial doubt concerning our ability to continue as a going concern. We intend to use capital and debt financing as needed to supplement the cash flows that we expect will be provided by licensing agreements. Our primary source of capital historically has been through the sale of our securities.

Realization of sales of our products and services is vital to operations. We may not be able to continue as a going concern without realizing additional sales or raising additional capital. We cannot guarantee that we will be able to compete successfully or that the competitive pressures we may face will not have a material adverse effect on our business, results of operations and financial condition. Additionally, a superior competitive product could force us out of business.

While we have been able to generate some testing and product development revenues since inception, we have been limited in the scope of potential clients that could be contacted until our patent application was approved. In January 2001, we received notification that we had been awarded a patent on our Pneumatic Accelerator. Since then we have been pursuing project development contracts and refining our design of the Pneumatic Accelerator.

In addition, during the first quarter, we were able to license the "Clean Coke Technology" of Combustion Resources LLC ("Combustion Resources"). The license agreement requires that the Company begin paying a $300,000 per year minimum royalty beginning in the year 2010. The royalty is set as a fixed percentage of the net operating profit realized from the licensed Clean Coke Technology, subject to a cap of $3 million in any one year. The Company believes that the Clean Coke Technology can be utilized to produce coke that qualifies under IRC Section 45K for the tax credit from alternative fuels provided a plant utilizing the Clean Coke Technology is built and placed in service by December 31, 2009. The Section 45K credit is subject to reduction as the Federal reference price of oil increases.

Combustion Resources, the College of Eastern Utah's Western Energy Training Center, and the Company were successful in obtaining a Federal Center of Excellence grant to develop the process controls for the system at its pilot plant (see below) in Price, Utah.

Also during the current year, we were contracted by Combustion Resources, and have worked with them to build and operate a pilot briquetting plant in Price, Utah. The pilot plant has a theoretical capacity of 1 ton per hour. The plant has been used to agglomerate carbon black. Carbon black is a very fine-sized material that is difficult to handle in its unagglomerated state. The plant has produced 162 tons of agglomerated carbon black to-date, all

of which has been shipped to a major industrial customer for testing at its production plant. The Company's revenue for the quarter and year has been generated from this activity. Until the results of the test are known, the pilot plant will be utilized to develop the Clean Coke Technology process controls mentioned above.

Our net loss for the nine months ended September 30, 2007, was $3,117,629, compared to a net loss for the nine months ended September 30, 2006, of $1,142,994. The net loss was attributable to lower than expected revenues from sales of our products and services. Our expenses for the nine months ended September 30, 2007, were approximately $3,163,875 of which approximately 97% were general and administrative expenses. Our expenses for the nine months ended September 30, 2006, were approximately $1,143,660, of which approximately 91% were general and administrative expenses. The increase in general and administrative expenses during the nine months ended September 30, 2007, was due to the issuance of 3,000,000 shares of common stock and 10,000,000 stock options valued at approximately $2,180,608 for services. For the nine months ended September 30, 2007, depreciation and amortization expense was $6,398, compared to depreciation and amortization expense of $6,399 for the nine months ended September 30, 2006.

Three months ended September 30, 2007, compared to the three months ended September 30, 2006:

Our net loss for the three months ended September 30, 2007, was $598,556, compared to a net loss for the three months ended September 30, 2006, of $344,274. The net loss was attributable to lower than expected revenues from sales of our products and services. Our expenses for the three months ended September 30, 2007, were approximately $597,954, of which approximately 96% were general and administrative. Our expenses for the three months ended September 30, 2006 were approximately $344,274, of which approximately 91% were general and administrative expenses. For the three months ended September 30, 2007, depreciation and amortization expense was $2,132, compared to depreciation and amortization expense of $2,133 for the three months ended September 30, 2006.

Since inception, we have realized minimal revenues while incurring normal fixed overhead and debt service costs. This operating trend is projected to continue for at least the remaining period of fiscal 2007.

Future Business

We see opportunities for our technology and business in an array of large industries, including power generation, agriculture, mining, environmental, construction, ceramics, and materials transportation. We anticipate that we will generate revenues through the sale of our proprietary equipment, fees, royalties, and profit sharing from licensing of our technology.

Besides the three primary businesses noted above, the Company is also pursuing potential energy projects through its subsidiary Mountain Island Energy, LLC, and its joint venture with United Fund Advisors, LLC, in Soda Springs, Idaho. Wind resource data is being collected at this site as part of the process of determining the feasibility of an approximate ten megawatt wind energy project.

Liquidity and Capital Resources

Given our current negative cash flows, it will be difficult for Terra Systems to continue as a going concern. It will be necessary to raise additional funds or reduce cash expenditures. Management anticipates generating cash by issuing more equity and incurring debt.

As mentioned in our audited financial statements included with our annual report on Form 10-KSB for the year ended December 31, 2006, our audited consolidated financial statements have been prepared on the assumption that we will continue as a going concern. Our product line is limited and it has been necessary to rely upon financing from the sale of our equity securities to

sustain operations. Additional financing will be required if we are to continue as a going concern. If additional financing cannot be obtained, we may be required to scale back or discontinue operations. Even if additional financing is available there can be no assurance that it will be on terms favorable to us. In any event, this additional financing will result in immediate and possible substantial dilution to existing shareholders.