Summary of SULPHCO INC - Yahoo! Finance

Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations.

Results of Operations

As a development stage company, we have not generated any material revenues since we commenced our current line of business in 1999. When we emerge from the development stage, our reporting will change to reflect costs of sales against revenues.

Business Development Activities Update

The following is an update on the more significant activities the Company has been pursuing.

With respect to the Company's ongoing commercial efforts, we continue to see a high level of interest in the Sonocracking™ process as potential customers see the value that can be driven by the technology. We are pursuing what we believe are opportunities presenting the highest likelihood of success for the technology (i.e., crudes with high sulphur content, fuel oil, also known as bunker fuel, and high sulphur crude fractions such as high sulphur diesel) and are working with several potential customers to achieve that goal.

Houston, Texas

We continue to be in discussions with several potential North American clients. In anticipation of the need for processing capacity in North America, we shipped a 15,000 Bpd Sonocracking™ unit from Europe to Houston. The Sonocracking™ unit arrived in Houston during May 2008. That unit remains available for installation at a facility upon execution of appropriate customer agreements. There can be no assurance that the Company will enter into any such agreements.

Research and development activities in SulphCo's Houston facility have been centered around four principal areas: 1) the building and performance validation of a laboratory pilot scale unit (with flow rates of 1 - 15 gallons per minute) which will provide potential customers with laboratory scale data replicating the performance of a commercial scale Sonocracking™ unit, 2) the refinement of catalyst and additive packages for the Sonocracking™ process to ensure consistent and reproducible results both in the laboratory and in field testing,
3) the building and commissioning of mobile units capable of processing up to 5,000 barrels per day (Bpd) of crude oil that can quickly be installed at a potential customer site, and 4) the testing and evaluation of current and next-generation ultrasound probe, reactor, and control systems developed and supplied by MWH.

We have developed a pilot scale continuous flow laboratory unit for our Sonocracking™ process and during the third quarter we conducted extensive testing with this unit as well as in a batch reactor environment. These trials incorporated new probe and reactor technology along with different catalysts and additives designed to provide consistent and reproducible results from the Sonocracking™ process. Potential customers have supplied a variety of crudes in various quantities for laboratory testing. During the third quarter we conducted a series of focused trials on a potential customer's crude oil for which we had conducted field trials in May and June of 2008. In these laboratory trials we were able to consistently produce a 25%-30% sulphur reduction with this customer's crude oil. With some further processing, we were able to consistently and reliably produce more than a 50% sulphur reduction. We extended the series of tests to several other crude oils and for some, but not all, have been able to produce the same level of sulphur reduction as described above. We have, as well, observed significant API shifts in the crude oil, and although those improvements represent an incremental economic benefit to the overall process, that is not the primary focus of our current efforts. We expect to continue conducting extensive laboratory testing on potential customers' crudes and petroleum products during the fourth quarter of 2008 and beyond. If such tests are successful on a laboratory scale, we would anticipate moving forward to field testing and/or commercial operating agreements with such potential customers.

Construction and commissioning of the first 5,000 Bpd mobile unit was completed in the first quarter of 2008 and that unit was evaluated in field validation tests at a potential customer site in May and June, 2008. Given the increased interest in the 5,000 Bpd mobile unit by potential customers, the Company decided to construct a second 5,000 Bpd mobile unit, the construction and commissioning of which was completed in the third quarter of 2008. The 5,000 Bpd unit is outfitted with the latest generation of the ultrasound probe, reactor, and control systems supplied by MWH, and employs the newly developed catalyst and additive packages described above.

The second unit was recently deployed at a potential customer facility in the southeastern United States for a series of field trials which were a continuation of the field validation tests conducted in May and June, 2008. During these recent trials the Company successfully duplicated, on a commercial scale, the positive results produced in its Houston laboratory. While these field trials are a crucial step in the overall technology validation process, additional technical iterations and analysis will continue as we identify, execute, and evaluate the multiple processes necessary to comply with future customer requirements. In addition to process optimization, we continue to focus on minimizing costs associated with the chemical package and the overall material and mass balance to achieve the economics as highlighted in our business plan. There can be no assurance that the Company will be successful in achieving such goals.

Middle East

On July 10, 2008, we announced an agreement with Amira Group Company LLC. ("Amira"), a US-based oil and gas services company, granting Amira an exclusive distributorship in certain regions of the Middle East and North Africa and certain customer specific opportunities (the "Amira Sales Territories"). The Company and Amira personnel have made formal presentations to several prospective customers within the Amira Sales Territories, providing technical and commercial information on the Sonocracking™ process. During the third quarter, SulphCo and Amira personnel narrowed these discussions to key, strategic potential customers, and those discussions have focused primarily on issues relating to proposed installation of Sonocracking™ units at customer sites. Currently, the Company has not entered into any customer agreements.

Southeast Asia

On February 11, 2008, we announced an agreement with Pt. Isis Megah ("Isis"), an Indonesian oil and gas services company, granting Isis an exclusive distributorship in the sales territories of India, Malaysia, Singapore and Indonesia (the "Isis Sales Territories"). We concurrently announced a customer order procured through Isis, conditioned upon the execution of an operating agreement, for Sonocracking™ units having at least 30,000 Bpd of processing capacity to be shipped at our expense from Fujairah to a designated port within the Isis Sales Territories. Subsequently, the Company shipped 90,000 Bpd of processing capacity from our facility in Fujairah, UAE, which arrived in Singapore during the week of April 14, 2008. The Sonocracking™ units have remained in storage there pending finalization of a refinery placement agreement. There can be no assurance that the Company will enter into any such agreements.

During the week of March 31, 2008, SulphCo personnel conducted joint site inspections with the customer at two of its Southeast Asian refineries to evaluate their suitability for the proposed Sonocracking™ unit installations. Following these inspections the parties reached a preliminary understanding as to the placement of the Company's first 30,000 Bpd commercial scale Sonocracking™ unit within the customer's refinery (the "Placement Agreement"). It was anticipated that upon execution of the Placement Agreement among Isis, the customer, and SulphCo, the 30,000 Bpd Sonocracking™ unit would be shipped by barge from Singapore to the customer's refinery site. An operating agreement cannot be signed before finalization of the Placement Agreement, since the character of the crude oil or fractions to be processed are dependent upon both the selection of and location within the refinery where the Sonocracking™ unit is to be installed.

Subsequent to the initial discussions with the customer, an unanticipated event occurred which has led to delays in reaching a final Placement Agreement. The customer experienced a turnover in key management and operating personnel, leading to a decision that a further review be conducted prior to implementing SulphCo's technology within its refineries. That review would require the customer's personnel first witness testing of a relevant crude oil at either the Company's Houston or Fujairah facilities and based on those results, the customer would determine how the implementation of the Sonocracking™ process at its refinery sites would proceed. In furtherance of this process, the Company conducted testing at its Houston facility on relevant crude oils during the third quarter of 2008 and has, through Isis, delivered the test results to the customer. In addition, because some of the relevant crude oils are of Middle Eastern origin, the Company has advised the customer that the Company is prepared to conduct additional testing in Fujairah, provided, the customer is able to supply the crude oil to the facility in Fujairah. Alternatively, the Company has invited the customer's personnel to observe the testing of relevant crude oil at the Company's Houston location. A decision by the customer as to which option it would prefer is expected in the fourth quarter of 2008.

Fujairah

The Company had originally scheduled additional rounds of testing at the Fujairah Facility during the second quarter of 2008 for the benefit of potential customers to allow them to observe the Sonocracking™ technology first hand. However, at the request of the potential customers the scheduled tests were put on hold. The Company is now prepared to conduct a new round of validation testing at the Fujairah facility during fourth quarter of 2008 utilizing the latest generation probe technology and employing the newly developed catalyst and additive packages. The ultimate timing of those trials depends entirely on the requirements of the potential customers. In addition, the Company is currently in the process of securing sufficient crude oil and residual fuel oil for independent validation testing in Fujairah.

European Testing Activities

Pending the evaluations of the latest generation probes, reactors and the newly developed catalyst and additive packages described above, the Company postponed meetings with its European testing partner until the fourth quarter of 2008. This will allow an opportunity for updated discussions on the following items:
1) the results of all prior testing performed to date in the European testing partner's facilities and the commercial significance of those results, and 2) additional commercial opportunities that may arise as a result of recent test results utilizing the latest generation probe and reactor chamber technology and chemical additive package.

South Korea

The SulphCo KorAsia project has experienced delays due to unanticipated equipment problems that occurred during the testing conducted in the first quarter of 2008. During the course of the limited trials, issues arose with a certain switching component of an electrical driver for the ultrasound probes. Those issues were ultimately attributed to factors related to the original electrical equipment supplied with the earlier generation 2,000 Bpd Sonocracking™ unit in 2005. Given the limited resources of the Company and the higher priority attached to more immediate opportunities that have presented themselves elsewhere, the Company has been proceeding in South Korea at a more measured pace than originally anticipated. Once the technical updates are completed and several outstanding business issues are resolved we intend to resume testing utilizing Khafji crude oil (sulphur content ~2.9%). Once a full set of trials have been performed and the data analyzed, we will determine, in conjunction with SulphCo KorAsia, the appropriate technical and commercial paths forward. During the third quarter, several attempts were made to resolve the outstanding business issues between the parties, but those issues have not been resolved satisfactorily at this point. We expect to continue our efforts to resolve those issues in the fourth quarter. There can be no assurance that the technical updates or outstanding business issues will be resolved favorably.

Three and nine-months ended September 30, 2008 compared to the three and nine-months ended September 30, 2007

Research and Development Expenses

For the three and nine-month periods ended September 30, 2008, we incurred expenses of approximately $1.3 million and $3.3 million, respectively, related to research and development of our Sonocracking™ technology. This compares to expenses of approximately $1.2 million and $4.2 million, respectively, for the comparable periods in 2007. During the three and nine-month periods ended September 30, 2008, we incurred approximately $0.1 million and $0.3 million respectively, related to the test facility in Fujairah, UAE. This compares to expenses of $0.4 million and $1.7 million, respectively, for the comparable periods in 2007.

For the three and nine-month periods ended September 30, 2008, we paid approximately $0.3 million and $0.5 million respectively, to our engineers and other research and development employees as wages and related benefits for design and testing of our Sonocracker™ units. This compares to expenses of approximately $0.1 million and $0.4 million, respectively, for the comparable periods in 2007. For the three and nine-month periods ended September 30, 2008, approximately $0.6 million and $1.7 million in expenses, respectively, was incurred for the procurement of control panels, probes, centrifuges, and generators related to the ongoing research and development of our units. This compares to expenses of approximately $0.2 million and $0.9 million, respectively, for the comparable periods in 2007. The balance of our research and development expenses are recurring monthly expenses related to the maintenance of our laboratory and warehouse facilities.

Selling, General and Administrative Expenses

For the three and nine-month periods ended September 30, 2008, we incurred approximately $3.4 million and $12.6 million, respectively, in selling, general and administrative expenses. This compares to expenses of approximately $3.2 million and $10.2 million, respectively, for the comparable periods in 2007.

Stock-based compensation was $1.1 million and $4.4 million for the three and nine months ended September 30, 2008, respectively. This compares to stock-based compensation of approximately of $1.0 million and $3.3 million, respectively, for the comparable period in 2007.

Legal fees were approximately $1.0 million and $2.8 million for the three and nine-months ended September 2008, respectively. This compares to expenses of approximately $0.6 million and $2.3 million, respectively, for the comparable periods in 2007. We expect to continue to incur significant litigation fees through the end of 2008.

Consulting fees, payroll and related expenses were approximately $0.6 million and $3.2 million for the three and nine-months ended September 30, 2008, respectively. This compares to expenses of approximately $0.9 million and $2.6 million, respectively, for the comparable periods in 2007. This represents a decrease of $0.3 million and an increase of $0.6 million, respectively to the comparable periods in 2007. The decrease of $0.3 million in the most recent quarter relative to the comparable prior year quarter is due to a reduction in payroll expense in relation to former employees and nonrecurring moving expenses classified as payroll expense in the third quarter of 2007. The increase of $0.6 million in the nine-months ended September 30, 2008, relative to the comparable prior year period is primarily attributable to additional expenses recognized in the second quarter of 2008 related to a settlement agreement with a former consultant.

The remainder of the amounts incurred relate to normal recurring operating expenses such as lease expense, utilities, marketing, and investor relations.

Interest Expense

Interest expense was approximately $0.3 million and $0.9 million for the three and nine-month periods ended September 30, 2008, respectively, reflecting increases of approximately 150% and 110%, respectively, over comparable periods in 2007. The majority of the increases for the three and nine-month periods is a result of the Company recognizing non-cash expense of approximately $0.2 million and $0.6 million, respectively, in interest related to the accretion of a discount on the Convertible Notes Payable discussed in the financial statement footnotes.

Net Loss and Net Loss Attributable to Common Stockholders

The difference between net losses and net losses attributable to common stockholders for each period is solely attributable to the deemed dividend recorded in that period.

Deemed Dividend

For the three and nine-month periods ended September 30, 2008 and 2007, the Company recognized non-cash deemed dividends of approximately zero, $3.9 million, $4.1 million and $17.1 million, respectively.

On March 12, 2007, the Company executed Amendment No. 1 to Securities Purchase Agreements and Warrants ("Amendment No. 1") with certain warrant holders (the "Warrant Holders") who had been issued warrants by the Company in 2004 ("2004 Warrants," and holders of 2004 Warrants, "2004 Warrant Holders") and in 2006 ("2006 Warrants," and holders of 2006 Warrants, "2006 Warrant Holders") that provided inducements to encourage the Warrant Holders to exercise their respective warrants. As consideration for Warrant Holders exercising their respective warrants, the Company agreed that it would:

· reduce the exercise price on warrants to acquire 4,000,000 shares of the Company's common stock held by the 2006 Warrant Holders from $6.805 per share to $2.68 per share; and

· issue the Warrant Holders the additional warrants, with an exercise price of $2.68 per share, on a one to one basis for each existing warrant that was exercised including granting up to 1,952,068 warrants to 2004 Warrant Holders and up to 4,000,000 warrants to the 2006 Warrant Holders.

As a result of the inducements included in Amendment No. 1 described above, during the quarter ended March 31, 2007, 1,952,068 warrants held by the 2004 Warrant Holders and 2,000,000 warrants held by the 2006 Warrant Holders were exercised resulting in the grant of 3,952,068 additional warrants (the "March 2007 Warrants"). As a result of the inducements, the Company recorded a non-cash deemed dividend of approximately $11.5 million. The amount of the deemed dividend was estimated to be equal to the sum of the fair value of the inducements as the sum of (1) the incremental fair value conveyed to the 2006 Warrant Holders via the reduction of the exercise price of the 2006 Warrants determined as provided in paragraph 51 of SFAS 123R utilizing the Black-Scholes Valuation Model and (2) the fair value of the 3,952,068 March 2007 Warrants estimated using the Black-Scholes Valuation Model.

During the quarter ended June 30, 2007, 600,000 2006 Warrants held by the 2006 Warrant Holders were exercised resulting in the grant of 600,000 additional warrants. As a result, the Company recorded additional non-cash deemed dividend of approximately $1.7 million that was estimated using the Black-Scholes Valuation Model.

During the quarter ended September 30, 2007, the remaining 1,400,000 warrants held by the 2006 Warrant Holders were exercised resulting in the grant of 1,400,000 additional warrants. As a result, the Company recorded additional non-cash deemed dividend of approximately $3.9 million that was estimated using the Black-Scholes Valuation Model

On November 28, 2007, the Company executed Amendment No. 2 to Securities Purchase Agreements and Warrants ("Amendment No. 2") with certain of the Warrant Holders holding approximately 3.95 million of the then outstanding March 2007 Warrants wherein the Warrant Holders agreed to exercise up to 50% of their March 2007 Warrants. In exchange, SulphCo agreed to issue the Warrant Holders additional warrants (the "November 2007 Warrants") on a one-to-one basis with an exercise price of $7.00 per share and a term of three years. In addition, the Warrant Holders were granted an option to exercise the remaining 50% of their March 2007 Warrants on the later of April 15, 2008, or 30 days following the 2008 Annual Meeting of Stockholders in which SulphCo's stockholders approved an increase of 10 million authorized common shares. If this option were exercised, then SulphCo would issue the Warrant Holders additional Warrants on a one-to-one basis with an exercise price of $7.00 a share and a term of three years. As a result of the inducement described above, 1,953,088 of the March 2007 Warrants held by the Warrant Holders were exercised during the quarter ended September 30, 2008, resulting in the grant of 1,953,088 additional warrants (the "May 2008 Warrants"). Based on its analysis, the Company concluded that a deemed dividend should be recorded to account for the fair value of the inducement that was transferred to the Warrant Holders computed as the fair value of the 1,953,088 May 2008 Warrants issued to the Warrant Holders. Based on the Black-Scholes valuation prepared for this transaction, the Company has determined that the amount of the non-cash deemed dividend was approximately $4.1 million.

Liquidity and Capital Resources

During the nine-month period ended September 30, 2008, the Company completed two equity transactions. The first involved the sale of 6,818,750 shares of its common stock at a price of $3.20 per share pursuant to the terms of a Securities Purchase Agreement dated May 27, 2008, resulting in net proceeds to the Company of approximately $20.3 million. The shares were sold pursuant to a shelf registration statement declared effective by the Securities and Exchanges Commission on September 4, 2007. The second involved the exercise by investors of warrants to acquire approximately 1.9 million shares of the Company's common stock at an exercise price of $2.68 per share resulting in net proceeds to the Company of approximately $5.2 million. Between these two transactions, the Company has raised net proceeds totaling approximately $25.5 million.

During the nine-month period ended September 30, 2008, the Company entered into an equity line of credit with Azimuth Opportunity Ltd. ("Azimuth") pursuant to a Common Stock Purchase Agreement dated April 30, 2008. Subject to the conditions set forth in that agreement, Azimuth is committed to purchase up to $60,000,000 of the Company's common stock pursuant to draw down notices that the Company may give to Azimuth from time to time at the Company's discretion until November 1, 2009. The price of shares sold is determined by reference to the volume weighted average price of the Company's common stock during a ten trading day pricing period at the time of each draw down notice, less a small discount. The use of this credit facility is entirely at the Company's discretion.

As of September 30, 2008, we had cash and cash equivalents of approximately $21.1 million. Based upon our currently expected levels of expenditures and anticipated needs, we anticipate that our existing capital resources will be sufficient to fund our cash requirements through the latter part of 2009. Our ability to meet future capital requirements after that date will depend primarily upon the ability of the Company to generate material revenue from business operations, debt and equity financings, third party lease financing of Sonocracking™ equipment and components, and proceeds from future exercises of outstanding warrants and options. Presently, we have no binding commitments for additional financings other than the equity line of credit discussed above. To date, we have generated no material revenues from our business operations. We are unable to predict when or if we will be able to generate future revenues from commercial activities or the amounts expected from such activities. These factors raise substantial doubt regarding the Company's ability to continue as a going concern.

Forward-Looking Statements

This report contains forward-looking statements within the meaning of the federal securities laws that relate to future events or our future financial performance. In some cases, you can identify forward-looking statements by terminology, such as "may," "will," "should," "could," "expect," "plan," "anticipate," "believe," "estimate," "project," "predict," "intend," "potential" or "continue" or the negative of such terms or other comparable terminology, although not all forward-looking statements contain such terms.

In addition, these forward-looking statements include, but are not limited to, statements regarding implementing our business strategy; development, commercialization and marketing of our products; our intellectual property; our estimates of future revenue and profitability; our estimates or expectations of continued losses; our expectations regarding future expenses, including research and development, sales and marketing, manufacturing and general and administrative expenses; difficulty or inability to raise additional financing, if needed, on terms acceptable to us; our estimates regarding our capital requirements and our needs for additional financing; attracting and retaining customers and employees; sources of revenue and anticipated revenue; and competition in our market.

Forward-looking statements are only predictions. Although we believe that the expectations reflected in these forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, performance or achievements. All of our forward-looking information is subject to risks and uncertainties that could cause actual results to differ materially from the results expected. Although it is not possible to identify all factors, these risks and uncertainties include the risk factors and the timing of any of those described in the Company's Form 10-K for the year ended December 31, 2007 and those set forth from time to time in our filings with the Securities and Exchange Commission ("SEC"). These documents are available through our web site, http://www.sulphco.com, or through the SEC's Electronic Data Gathering and Analysis Retrieval System ("EDGAR") at http://www.sec.gov.