Terra Systems Corp - Quarterly Report of Financial Condition (10QSB)

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United States
Securities and Exchange Commission
Washington, DC 20549

FORM 10-QSB

[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2007

[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934

Commission File Number: 0-31483

TERRA SYSTEMS, INC.
(Exact name of small business issuer as specified in its charter)

UTAH
(State or other jurisdiction of incorporation or organization)

87-0476073
(I.R.S. Employer Identification No.)

7001 South 900 East, Ste 260, Midvale, Utah 84047
(Address of principal executive offices)

[phone]
(Issuer's telephone number, including area code)

5912 West 11600 South, Payson, Utah 84651
(Former Address)

Check whether the registrant (1) has filed all reports required to be filed by section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. (1) Yes [X] No [ ] (2) Yes [X] No [ ]

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

The number of shares of the issuer's common stock, par value $0.001 per share outstanding as of November 5, 2007 was 49,143,056 shares.

Transitional Small Business Disclosure Format (Check one): Yes [ ] No [X]

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Terra Systems, Inc.

Form 10-QSB
For The Quarter Ending September 30, 2007

Part I. Financial Information Page

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Item 1. Financial Statements Condensed Consolidated Balance Sheets as of September 30, 2007, and December 31, 2006 (Unaudited) 2 Condensed Consolidated Statements of Operations for the Three and Nine Months ended September 30, 2007 and 2006, and for the Cumulative Period February 17, 1996 (Date of Inception) through September 30, 2007 (Unaudited) 3 Condensed Consolidated Statements of Cash Flows for the Nine Months ended September 30, 2007 and 2006 and for the Cumulative Period February 17, 1996 (Date of Inception) through September 30, 2007 (Unaudited) 4 Notes to Condensed Consolidated Financial Statements (Unaudited) 5 Item 2. Management's Discussion and Plan of Operation 8 Item 3. Controls and Procedures 11 Part II. Other Information Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 12 Item 6. Exhibits 12 Signatures 13

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PART I. FINANCIAL INFORMATION

Item I. Financial Statements

TERRA SYSTEMS, INC., AND SUBSIDIARY
(A Development Stage Company)

CONDENSED CONSOLIDATED BALANCE SHEETS
(UNAUDITED)

September 30, December 31, 2007 2006 ------------- -------------- Current Assets Cash $ 27,054 $ 52,091 Accounts receivable 6,836 - Other current assets 12,010 5,391 ------------- -------------- Total Current Assets 45,900 57,482 ------------- -------------- Property and Equipment Furniture and equipment 582,407 582,407 Software 10,380 10,380 Less: Accumulated depreciation (480,526) (474,128) ------------- -------------- Net Property and Equipment 112,261 118,659 ------------- -------------- Investment in joint venture 392,251 392,251 ------------- -------------- Total Assets $ 550,412 $ 568,392 ============= ==============

LIABILITIES AND STOCKHOLDERS' DEFICIT

Current Liabilities Accounts payable $ 470,229 $ 531,087 Accounts payable to related party 105,242 197,445 Accrued liabilities 244,956 331,935 Accrued interest payable 223,839 326,133 Notes payable to stockholders 854,680 970,554 ------------- -------------- Total Current Liabilities 1,898,946 2,357,154 ------------- -------------- Stockholders' Deficit Common stock - $0.001 par value; 100,000,000 shares authorized; 49,143,056 and 42,675,356 shares issued and outstanding, respectively 49,140 42,672 Additional paid-in capital 20,910,769 17,359,380 Accumulated deficit (22,308,443) (19,190,814) ------------- -------------- Total Stockholders' Deficit (1,348,534) (1,788,762) ------------- -------------- Total Liabilities and Stockholders' Deficit $ 550,412 $ 568,392 ============= ==============

See accompanying notes to condensed consolidated financial statements.

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TERRA SYSTEMS, INC., AND SUBSIDIARY (A Development Stage Company) CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED) From Inception of the Development Stage on For the Three Months For the Nine Months February 17, Ended September 30, Ended September 30, 1996 Through ---------- ---------- ------------ ------------ September 30, 2007 2006 2007 2006 2007 ---------- ---------- ------------ ------------ ------------- Revenues $ 21,223 $ - $ 159,286 $ - $ 777,428 Cost of Revenues 23,444 - 114,659 - 564,904 ---------- ---------- ------------ ------------ ------------- Gross Profit (Loss) (2,221) - 44,627 - 212,524 ---------- ---------- ------------ ------------ ------------- Expenses Research and development - - - - 2,063,996 General and administrative 575,355 314,127 3,082,426 1,035,820 18,098,268 Depreciation and amortization 2,132 2,133 6,398 6,399 801,499 ---------- ---------- ------------ ------------ ------------- Total Operating Expenses 577,487 316,260 3,088,824 1,042,219 20,963,763 Loss from Operations (579,708) (316,260) (3,044,197) (1,042,219) (20,751,239) ---------- ---------- ------------ ------------ ------------- Nonoperating Income/(Expenses) Other income 1,619 - 1,619 666 75,867 Interest expense (20,467) (28,014) (75,051) (101,441) (1,466,064) Interest income - - - - 1,709 Gain from relief of debt - - - - 64,284 Loss on sale of securities - - - - (99,000) Loss on sale of assets - - - - (134,000) ---------- ---------- ------------ ------------ ------------- Net Nonoperating Expenses (18,848) (28,014) (73,432) (100,775) (1,557,204) ---------- ---------- ------------ ------------ ------------- Net Loss $ (598,556) $ (344,274) $ (3,117,629) $ (1,142,994) $(22,308,443) ========== ========== ============ ============ ============= Basic and Diluted Loss Per Share $ (0.01) $ (0.01) $ (0.07) $ (0.03) ========== ========= ============ ============ Weighted Average Shares Outstanding 49,050,665 42,382,874 47,205,749 41,869,910 ========== ========== ============ ============ See accompanying notes to condensed consolidated financial statements.

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TERRA SYSTEMS, INC., AND SUBSIDIARY
(A Development Stage Company)

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)

From Inception of the Development Stage on For the Nine Months February 17, Ended September 30, 1996 Through ------------ ------------ September 30, 2007 2006 2007 ------------ ------------ ------------- Cash Flows from Operating Activities: Net loss $ (3,117,629) $ (1,142,994) $(22,308,443) Adjustments to reconcile net loss to net cash used in operating activities: Depreciation and amortization 6,398 6,399 801,499 Gain from debt relief - - (64,284) Loss on sale of investment securities - - 99,000 Loss on disposal of assets - - 139,000 Stock compensation 2,572,134 436,919 11,963,603 Write off of stock subscription - - 22,750 Common stock issued for financing fees 14,000 42,250 485,703 Changes in current assets and liabilities: Accounts receivable (6,836) - (6,836) Other current assets (6,619) - (12,010) Accounts payable (2,358) 85,965 966,986 Accounts payable - related party - 75,000 608,330 Accrued liabilities 168,021 (5,480) 1,609,113 Accrued legal settlement expense - - 44,967 Accrued interest payable 60,351 49,123 767,460 ------------ ------------ ------------- Net Cash Used in Operating Activities (312,538) (452,818) (4,883,162) ------------ ------------ ------------- Cash Flows from Investing Activities: Purchase of equipment and land - (62,367) (1,003,049) Advances to related party - - (290,328) Organization costs paid - - (4,755) Proceeds from sale of assets - - 367,715 ------------ ------------ ------------- Net Cash Used in Investing Activities - (62,367) (930,417) ------------ ------------ ------------- Cash Flows from Financing Activities: Proceeds from borrowings - stockholders - 50,000 1,690,111 Payments on borrowings - stockholders - (130,000) (385,730) Proceeds from stock issuance and subscriptions 287,501 425,220 4,721,892 Payments on capital leases - - (185,640) ------------ ------------ ------------- Net Cash Provided by Financing Activities 287,501 345,220 5,840,633 ------------ ------------ ------------- Net Increase (Decrease) in Cash (25,037) (169,965) 27,054 Cash at Beginning of Period 52,091 184,930 - ------------ ------------ ------------- Cash at End of Period $ 27,054 $ 14,965 $ 27,054 ============ ============ ============= Supplemental Cash Flow Information: Cash paid for interest $ - $ 10,000 Non Cash Investing and Financing Activities: Conversion of liabilities to equity $ 684,222 $ 45,000 Transfer of land to investment in joint venture $ - $ 392,251

See accompanying notes to condensed consolidated financial statements.

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TERRA SYSTEMS, INC. AND SUBSIDIARY
(A Development Stage Company)

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

NOTE 1 - INTERIM FINANCIAL STATEMENTS

The accompanying financial statements have been prepared by the Company, and are unaudited. In the opinion of management, the accompanying unaudited financial statements contain all necessary adjustments for fair presentation, consisting of normal recurring adjustments except as disclosed herein.

The accompanying unaudited interim financial statements have been condensed pursuant to the rules and regulations of the Securities and Exchange Commission; therefore, certain information and disclosures generally included in financial statements have been condensed or omitted. These financial statements should be read in connection with the Company's annual financial statements included in the Company's annual report on Form 10-KSB as of December 31, 2006. The financial position and results of operations of the interim periods presented are not necessarily indicative of the results to be expected for the year ended December 31, 2007.

NOTE 2 - BUSINESS CONDITION

The accompanying financial statements have been prepared on a going concern basis, which contemplates the realization of assets and the satisfaction of liabilities in the normal course of business. During the nine-month periods ended September 30, 2007 and 2006, the Company incurred net losses of $3,101,917 and $1,142,994, respectively. As of September 30, 2007, the Company's losses accumulated from inception totaled $22,292,731. These factors, among others, indicate that the Company may be unable to continue as a going concern for a reasonable period of time. The financial statements do not include any adjustments relating to the recoverability and classification of recorded asset amounts or the amount and classification of liabilities that might be necessary should the Company be unable to continue as a going concern. The Company's ability to continue as a going concern is dependent upon its ability to generate sufficient cash flow to meet its obligations on a timely basis, to obtain additional financing as may be required, and ultimately to attain successful operations.

The Company's management is in the process of negotiating various agreements to perform further research on and the development of three primary technologies. These include pneumatic conveyance systems to handle bulk materials in industrial research and processing applications, clean metallurgical coke technologies to produce high grade coke from an assortment of quality carbon fuels through a process expected to qualify for the Internal Revenue Code Section 45K tax credits, and carbon black agglomeration to facilitate bulk handling and processing. Management intends to use equity and debt financing as needed to supplement the cash flows that potentially could be generated through the successful negotiation of agreements. However, there can be no guarantee that these plans will be successful.

NOTE 3 - BASIC AND DILUTED PER SHARE

Basic loss per common share is computed by dividing net loss by the weighted-average number of common shares outstanding during the period. Diluted loss per share is calculated to give effect to potentially issuable common shares except during loss periods when those potentially issuable common shares would decrease the loss per share. For the three and nine months ended September 30, 2007, the Company had 12,500,000 stock options and 912,867 warrants, compared to 4,000,000 stock options and 812,867 warrants for the three and nine months ended September 30, 2006, that were not included in the computation of diluted net loss per common share as their effect would have been anti-dilutive, thereby decreasing the net loss per common share.

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TERRA SYSTEMS, INC. AND SUBSIDIARY
(A Development Stage Company)

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

NOTE 4 - STOCK BASED COMPENSATION

During the nine months ended September 30, 2007, the Company granted 10,000,000 options to purchase common stock. Terms for the options are as follows:

Number Exercise Vesting of Shares Price ---------------- ----------------- Immediately 3,333,334 $ 0.28 May 2008 3,333,333 0.31 May 2009 3,333,333 0.33

The weighted-average value for the options granted during the nine months ended September 30, 2007, was determined by the Black-Scholes option pricing model using the following assumptions:

Fair value of common stock $ 0.28 Risk free interest rate 4.57% Expected life 7 years Dividend yield - Volatility 157.13%

For the three and nine months ended September 30, 2007 and 2006, the Company calculated compensation expense of $1,670,634 and $388,005, respectively, related to stock options.

A summary of stock option activity for the nine months ended September 30, 2007, is presented below:

Weighted Weighted Average Shares Average Remaining Aggregate Under Exercise Contractual Intrinsic Option Price Life Value ----------- ------------ ------------ ------------- Outstanding at December 31, 2006 4,000,000 $ 0.21 Granted 10,000,000 0.31 Exercised (500,000) 0.10 Forfeited - - Expired (1,000,000) 0.10 ----------- Outstanding at September 30, 2007 12,500,000 $ 0.30 7.64 years $ 90,000 =========== Exercisable at September 30, 2007 4,690,478 $ 0.26 $ 90,000 =========== Weighted average fair value of options granted during the period $ 0.27

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TERRA SYSTEMS, INC. AND SUBSIDIARY
(A Development Stage Company)

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

As of September 30, 2007, there was approximately $1,706,441 of unrecognized compensation cost related to stock options that will be recognized over a weighted average period of 1.70 years.

NOTE 5 - RELATED PARTY TRANSACTIONS

Certain officers and shareholders of the Company have from time to time settled operating expenses on behalf of the Company. As of September 30, 2007, the Company owed these officers an aggregate of $105,242. All amounts are due on demand and bear no interest.

The Company has notes payable to shareholders and officers. These notes bear interest at 10% and are currently due. As of September 30, 2007, the aggregate amount due under these notes payable was $854,680. During the nine months ended September 30, 2007, the Company accrued interest on the notes of $60,351. As of September 30, 2007, the accrued interest due was $223,839.

NOTE 6 - STOCKHOLDERS' DEFICIT

Common Stock Issued for Cash - During the nine months ended September 30, 2007, the Company issued 375,000 shares of common stock and 100,000 warrants to purchase common stock, with an exercise price of $0.50 per share for proceeds of $75,000. The warrants vest immediately and expire in July 2008. The proceeds were allocated $67,935 to common stock and $7,065 to the warrants, based on their relative fair values on the date of issuance. The fair value of the warrants was determined by the Black-Scholes option pricing model using the following assumptions: estimated volatility of 112.47% estimated risk-free interest rate of 4.97% estimated yield of 0% and estimated term of one year.

The Company also issued 875,000 shares of common stock for proceeds of $162,501 or at prices ranging from $0.15 to $0.20 per share.

The Company issued 500,000 shares of common stock for proceeds of $50,000 to an individual who exercised his options to purchase common stock, at an exercise price of $0.10 per share.

Common Stock Issued for Services - During the nine months ended September 30, 2007, the Company issued 3,000,000 shares of common stock to employees for services rendered with a value of $901,500 at a price of $0.30 per share, which was the fair market value of the Company's common stock on the date of issuance.

Common Stock Issued for Financing Fees - During the nine months ended September 30, 2007, the Company issued 40,000 shares of common stock for financing fees of $14,000 at a price of $0.35 per share.

Common Stock Issued for Liabilities - During the nine months ended September 30, 2007, the Company issued 90,000 shares of common stock for satisfaction of accounts payable of $30,000 at a price of $0.33 per share; and 1,587,700 shares of common stock, at a price of $0.41 per share, for satisfaction of accounts payable of $28,500, related party payable of $92,203, accrued wages of $255,000, accrued interest of $162,645 and note payable to stockholders of $115,874.

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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.

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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

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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

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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.

Item 3. Controls and Procedures

Evaluation of Disclosure Controls and Procedures.

The Company maintains a set of disclosure controls and procedures (as defined in the Securities Exchange Act of 1934 (the "Exchange Act") Rules 13a-15(e) or 15d-15(e)) designed to ensure that information required to be disclosed by the Company in the reports filed under the Securities Exchange Act, is recorded, processed, summarized and reported within the time periods specified by the SEC's rules and forms. Disclosure controls are also designed with the objective of ensuring that this information is accumulated and communicated to the Company's management, including the Company's chief executive officer and a consultant performing services for the Company commonly performed by a chief financial officer, as appropriate, to allow timely decisions regarding required disclosure.

Based upon their evaluation as of the end of the period covered by this report, the Company's chief executive officer and a consultant performing services for the Company commonly performed by a chief financial officer concluded that the Company's disclosure controls and procedures were not effective to ensure that information required to be included in the Company's periodic SEC filings is recorded, processed, summarized, and reported within the time periods specified in the SEC rules and forms.

The Company was advised by Hansen, Barnett & Maxwell, P.C., the Company's independent registered public accounting firm, that during their performance of audit procedures for fiscal year 2006, Hansen, Barnett & Maxwell, P.C. identified a material weakness as defined by the Public Company Accounting Oversight Board.

This deficiency consisted primarily of inadequate staffing and supervision that led to the untimely identification and resolution of accounting and disclosure matters and failure to perform timely and effective reviews. However, the size of the Company prevents it from being able to employ sufficient resources to enable the Company to have adequate segregation of duties within its internal control system. Management is required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures.

Certifications of the Chief Executive Officer and the consultant performing services for the Company commonly performed by a chief financial officer regarding, among other items, disclosure controls and procedures are included immediately after the signature section of this Form 10-QSB.

Changes in Internal Controls.

In order to address the deficiency of inadequate staffing and supervision, management has implemented tighter cash flow controls and has set-up a centralized computer system to maintain the accounting records. Management will continue to monitor and review these remediation efforts.

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PART II - OTHER INFORMATION

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

During the three months ended September 30, 2007, the Company issued 500,000 shares of common stock for proceeds of $50,000 at a price of $0.10 per share.

The sales of shares to the buyers were made in reliance on Section 4(2) of the 1933 Act, and rules and regulations promulgated thereunder, as a transaction not involving any public offering. No advertising or general solicitation was employed in the issuance of the securities

Item 6. Exhibits

31.1 Section 302 Certification of Chief Executive Officer
31.2 Section 302 Certification of Consultant performing certain services for the Company commonly performed by a Chief Financial Officer
32.1 Section 1350 Certification
32.2 Section 1350 Certification

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SIGNATURES

In accordance with the requirements of the Exchange Act, the registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

Terra Systems, Inc.

By: /s/ Clayton Timothy ---------------------------------- Clayton Timothy CEO Date: November, 13, 2007 By: /s/ Mark Faerber ---------------------------------- Mark Faerber Consultant performing certain services for the Company commonly performed by a Chief Financial Officer Date: November, 13, 2007

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