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ESPH > SEC Filings for ESPH > Form 10-Q on 21-May-2013All Recent SEC Filings

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Form 10-Q for ECOSPHERE TECHNOLOGIES INC


21-May-2013

Quarterly Report


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

The following discussion and analysis should be read in conjunction with our unaudited consolidated financial statements and related notes appearing elsewhere in this report. In addition to historical information, this discussion and analysis contains forward-looking statements that involve risks, uncertainties, and assumptions. Our actual results may differ materially from those anticipated in these forward-looking statements as a result of certain factors, including but not limited to those set forth under "Risk Factors" in our Form 10-K for the year ended December 31, 2012.

Company Overview

Ecosphere is a water engineering, technology licensing and innovative U.S manufacturing company that develops environmental water treatment solutions for industrial markets throughout the world. The Company is a leader in emerging advanced oxidation processes and has an extensive portfolio of intellectual property that includes five U.S. patents for the Ecosphere Ozonix® process. The patented Ecosphere Ozonix® process is a revolutionary advanced oxidation process that is currently being used by global energy exploration companies to reduce costs, increase treatment efficiencies and eliminate liquid chemicals from wastewater treatment operations around the United States.

The Company's Open Innovation Network is a business model that was created to invent, develop, commercialize and license and/or sell green technologies using water treatment as a key component. Ecosphere designs, develops and manufactures all of its Ozonix® units at its Stuart, Florida facility; all material components are also made in the United States. The business model is used to:

1. Identify a major environmental water challenge

2. Invent technologies and file new patents

3. Partner with industry leaders

4. Commercialize and prove technologies with ongoing services paid for by customers and industry leaders

5. License and/or sell the patented, commercialized technologies to well capitalized partners

6. Create shareholder value

Ecosphere focused its early efforts to successfully develop and commercialize the Ozonix® technology for its majority-owned subsidiary, Ecosphere Energy Services, LLC, ("EES"), and will now be able to broaden the Company's ability to introduce and duplicate its efforts in the many other water intensive industries and applications that can benefit from this technology including but not limited to agriculture, environmental, industrial, marine, mining, and municipal wastewater treatment applications.

2013 Highlights

·

In January 2013, Ecosphere announced that the Company appointed Dean Becker to its Board of Directors. Mr. Becker is currently the Chief Executive Officer of ICAP Patent Brokerage and ICAP Ocean Tomo Auctions. As a creator and leader of patent auctions since 2006, he has distinguished himself as one of the world's leading entrepreneurs in the development of next generation technology markets. Mr. Becker is also serving as an intellectual property consultant to Ecosphere and is working with Founder and Chief Executive Officer, Dennis McGuire, to monetize the Company's intellectual property and accelerate the deployment of its patented Ozonix® technology in fields beyond U.S. onshore energy production.

·

In February 2013, Ecosphere launched a new corporate website, www.ecospheretech.com, which reflects the Company's focus on expanding the use of its revolutionary Ozonix® technology into new industrial markets in which wastewater treatment is of critical importance. The content contained on our website is not incorporated into this report.

·

In February 2013, Ecosphere announced that it had been selected to IHS CERAWeek's 2013 class of Energy Innovation Pioneers. The Energy Innovation Pioneers program, held annually in conjunction with IHS CERAWeek, aims to identify the most innovative and distinctive new technologies in the energy spectrum. Criteria include creativity, feasibility of plan, scalability of technology and leadership team.

·

In February 2013, Ecosphere entered into a definitive securities purchase agreement with CIM Investment Management Ltd., a London-based institutional investment firm, to issue $3.4 million of convertible notes and warrants. Ecosphere received the initial tranche of $750,000. Assuming Ecosphere completes a financing it has been negotiating, it expects that the lenders will advance the remaining balance.

·

In March 2013, Ecosphere announced that its subsidiary, Ecosphere Exploration and Mining Services LLC (EEMS) signed a Letter of Intent with Dominion Water LLC of Sedalia, Colorado. In connection with the Letter of Intent, Ecosphere will deploy its patented Ozonix® technology to mine sites in Colorado for both companies to explore mining applications of the Ozonix® technology.


ECOSPHERE TECHNOLOGIES, INC. AND SUBSIDIARIES

·

In March 2013, Ecosphere investor Drew Bledsoe, former NFL quarterback and principal of Bledsoe Capital Group, appeared on CNBC's Closing Bell to discuss how Ecosphere's patented Ozonix® technology is allowing oil and gas exploration companies to recycle wastewater and eliminate chemicals traditionally used in the hydraulic fracturing process.

·

In April 2013, Ecosphere announced that its majority-owned subsidiary, Ecosphere Energy Services, LLC, has regained the exclusive U.S. license to Ecosphere's patented Ozonix® technology for the treatment and recycling of water used during oil and gas exploration and production.

·

In April 2013, Ecosphere announced that Bloomberg New Energy Finance, the definitive source of insight, data and news on the transformation of the energy sector, selected Ecosphere Technologies, Inc., as a 2013 New Energy Pioneer. The winners were recognized on stage at the sixth annual Bloomberg New Energy Finance Summit in New York City.

·

In May 2013, Ecosphere was named a finalist in Clean Tech/Green Tech category for the 2013 TechAmerica Foundation American Technology Awards (ATAs). The ATAs cross the technology industry recognizing products and services like Ecosphere's patented Ozonix® technology for the treatment and recycling of water used during oil and gas exploration and production.

CRITICAL ACCOUNTING ESTIMATES

Use of Estimates

The preparation of the consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect reported amounts of assets and liabilities and disclosures of contingent liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Significant estimates in the accompanying consolidated financial statements include the allowance for doubtful accounts receivable, valuation of inventory, estimates of depreciable lives and valuation of property and equipment, estimates of amortization periods for intangible assets, restructuring charges, valuation of equity-based instruments issued for other than cash, warranty reserve, valuation of derivatives and the valuation allowance on deferred tax assets.

Revenue Recognition

For each of our revenue sources we have the following policies:

Equipment and Component Sales

Revenues and related costs on production type contracts are recognized using the "percentage of completion method" of accounting in accordance with ASC 605-35, Accounting for Performance of Construction-Type and Certain Production Type Contracts ("ASC 605-35"). Under this method, contract revenues and related expenses are recognized over the performance period of the contract in direct proportion to the costs incurred as a percentage of total estimated costs for the entirety of the contract. Costs include direct material, direct labor, subcontract labor and any allocable indirect costs. All unallocable indirect costs and corporate general and administrative costs are charged to the periods as incurred. However, in the event a loss on a contract is foreseen, the Company will recognize the loss as it is determined. Contract costs plus recognized profits are accumulated as deferred assets, and billings and/or cash received are recorded to a deferred revenue liability account. The net of these two accounts for any individual project is presented as "Costs and estimated earnings in excess of billings on uncompleted contracts," an asset account, or "Billings in excess of costs and estimated earnings on uncompleted contracts," a liability account.

Production type contracts that do not qualify for use of the percentage of completion method, the Company accounts for these contracts using the "completed contract method" of accounting in accordance with ASC 605-35-25-57. Under this method, contract costs are accumulated as deferred assets, and billings and/or cash received is recorded to a deferred revenue liability account, during the periods of construction, but no revenues, costs, or profits are recognized in operations until the period within which completion of the contract occurs. Costs include direct material, direct labor, subcontract labor and any allocable indirect costs. All unallocable indirect costs and corporate general and administrative costs are charged to the periods as incurred. However, in the event a loss on a contract is foreseen, the Company will recognize the loss as it is determined. The deferred asset (accumulated contract costs) in excess of the deferred liability (billings and/or cash received) is classified as a current asset under "Costs in excess of billings on uncompleted contracts". The deferred liability (billings and/or cash received) in excess of the deferred asset (accumulated contract costs) is classified under current liabilities as "Billings in excess of costs on uncompleted contracts".

A contract is considered complete when all costs except insignificant items have been incurred; the equipment is operating according to specifications and has been accepted by the customer.


ECOSPHERE TECHNOLOGIES, INC. AND SUBSIDIARIES

The Company may manufacture products in anticipation of a future contract. Since there are no binding contracts relating to the purchase of these products, ASC 605-35 is not applicable. Accordingly, revenue is recognized when persuasive evidence of an arrangement exists, products are delivered to and accepted by the customer, economic risk of loss has passed to the customer, the price is fixed or determinable, collection is reasonably assured, and any future obligations of the Company are insignificant.

Field Services

Revenue from water treatment contracts is earned based upon the volume of water processed plus additional period based contractual charges and is recognized in the period the service is provided. Payments received in advance of the performance of services or of the delivery of goods are deferred as liabilities until the services are performed or the goods are delivered.

Some projects the Company undertakes are based upon our providing water processing services for fixed periods of time. Revenue from these projects is recognized based upon the number of days the service has been provided during the reporting period.

Aftermarket Part Sales

The Company recognizes revenue from the sale of aftermarket parts during the period in which the parts are delivered to the buyer.

Royalties

Revenue from technology license royalties will be recorded as the royalties are earned.

The Company includes shipping and handling fees billed to customers in revenues and handling costs in cost of revenues.

Stock-Based Compensation

The Company follows the provisions of ASC Topic 718-20-10, Compensation - Stock Compensation that establishes standards surrounding the accounting for transactions with employees in which an entity exchanges its equity instruments for services. Under ASC 718-20-10, we recognize an expense for the fair value of our outstanding stock options generally over the requisite service period of the employee service. We follow the measurement and recognition provisions of ASC 505-50 Equity Based Payments to Non-Employees for non-employee stock-based transactions.

We estimate the fair value of each stock option at the grant date by using the Black-Scholes-Merton ("BSM") option pricing model based upon certain assumptions, which are contained in Note 11 to our unaudited condensed consolidated financial statements contained in this report. The BSM option pricing model requires the input of highly subjective assumptions including the expected stock price volatility.

Fair Value of Liabilities for Warrant Derivative Instruments

We estimate the fair value of each warrant liability with a repricing feature at the issuance date and at each subsequent reporting date by using the BSM option pricing model based upon certain assumptions which are contained in Note 6 to our unaudited condensed consolidated financial statements contained in this report. The BSM model requires the input of highly subjective assumptions including the expected stock price volatility.


                 ECOSPHERE TECHNOLOGIES, INC. AND SUBSIDIARIES



Results of Operations


Comparison of the Three Months ended March 31, 2013 with the Three Months Ended
March 31, 2012


The following table sets forth a modified version of our unaudited Condensed
Consolidated Statements of Operations that is used in the following discussions
of our results of operations:



                                            For the Three Months Ended
                                                     March 31,
                                               2013              2012            Change
                                                    (Unaudited)
Revenues
Equipment sales and licensing             $             -     $ 5,648,093     $ (5,648,093 )
Field services                                    751,684       2,712,702       (1,961,018 )
Aftermarket part sales                            109,935               -          109,935
Total revenues                                    861,619       8,360,795       (7,499,176 )
Costs and expenses
Equipment sales and licensing
(exclusive of depreciation show below)                  -       4,107,662       (4,107,662 )
Field services (exclusive of
depreciation show below)                          446,596         801,717         (355,121 )
Aftermarket part costs (exclusive of
depreciation show below)                          109,543               -          109,543
Salaries and employee benefits                  1,132,818       1,255,146         (122,328 )
Administrative and selling                        370,636         357,218           13,418
Professional fees                                 566,515         248,792          317,723
Depreciation and amortization                     545,011         551,600           (6,589 )
Research and development                            8,484               -            8,484
Restructuring charge                                6,491               -            6,491
Total costs and expenses                        3,186,094       7,322,135       (4,136,041 )
Income (loss) from operations                  (2,324,475 )     1,038,660       (3,363,135 )
Other income (expense)
Interest expense                                  (92,505 )       (97,481 )          4,976
Other income (expense)                                  -           3,764           (3,764 )
Change in fair value of derivative
instruments                                       (85,968 )      (198,162 )        112,194
Total other income (expense)                     (178,473 )      (291,879 )        113,406
Net (loss) income                              (2,502,948 )       746,781       (3,249,729 )
Preferred stock dividends                         (20,688 )       (25,750 )          5,062
Net (loss) income applicable to common
stock                                          (2,523,636 )       721,031       (3,244,667 )
Net loss (income) applicable to
noncontrolling interest of consolidated
subsidiary                                        170,496        (356,245 )        526,741
Net (loss) income applicable to
Ecosphere Technologies, Inc. common
stock                                     $    (2,353,140 )   $   364,786     $ (2,717,926 )

The Company reported net loss applicable to Ecosphere Technologies, Inc. common stock of $2.4 million during the three months ended March 31, 2013 (the "2013 Quarter") as compared to a net income applicable to Ecosphere Technologies, Inc. common stock of $0.4 million for the three months ended March 31, 2012 (the "2012 Quarter"). The drivers of the $2.7 million quarter-over-quarter change are discussed below.

Revenues

Revenues for the 2013 Quarter decreased $7.5 million from the 2012 Quarter. The decrease in revenue was driven primarily by the absence of revenues from equipment sales due to Hydrozonix's failure to pay for Units 13-14 on April 15, 2013, causing Hyrdozonix to lose its exclusivity to the U.S. onshore oil and gas industry. As a result, EES regained the exclusive U.S. onshore oil and gas license for Ozonix®. Additionally, EES treated lower volumes of water used to hydraulically fracture natural gas wells and the processing of raw, flowback and produced waters in the Company's services business. We were not permitted to market finished goods inventory, costing approximately $3.5 million to manufacture, until April 15, 2013. Management expects that the sale of this equipment will occur during the second quarter of 2013.

In addition, in the 2013 Quarter, the Company engaged in the sale of aftermarket parts, services, upgrades and enhancements related to the Ozonix® EF80 units in use by Hydrozonix. Such activities resulted in $0.1 million in revenues in the 2013 Quarter. There were no aftermarket part sales in the 2012 Quarter.


ECOSPHERE TECHNOLOGIES, INC. AND SUBSIDIARIES

Cost and Expenses

Equipment Sales and Licensing Costs (exclusive of depreciation)

There were no equipment sales and licensing costs for the 2013 Quarter as compared to $4.1 million for the 2012 Quarter. The lack of equipment sales and licensing costs for the 2013 Quarter were due to Hydrozonix failure to pay for Units 13-14.

Field Services Costs (exclusive of depreciation)

The cost of providing field services for the 2013 Quarter was $0.4 million compared to $0.8 million in the 2012 Quarter. Included in these costs for both periods are payroll related expenses for field personnel and parts and supplies used in support of the operation of Ozonix® water treatment systems and Ecos-Frac® products, which were lower due to (i) lower sales volume in the 2013 Period, (ii) efficiencies in our processes resulting in part from additional multiple well pad processing sites, and (iii) lower gas costs in the 2013 Period.

Aftermarket Part Costs (exclusive of depreciation)

The costs associated with the sale of aftermarket parts amount to $0.1 million for the 2013 Period. After the 2012 Quarter, the Company began engaging in the sale of aftermarket parts, services, upgrades and enhancements related to the Ozonix® EF80 units in service by Hydrozonix.

Salaries and Employee Benefits

The decrease in salaries and employee benefits of $0.1 million was primarily the result of a decrease in non-cash stock-based compensation expense in the 2013 Quarter compared to the 2012 Quarter.

Professional Fees

The $0.3 million increase in professional fees for the 2013 Quarter was driven by the increase in consulting fees relating to two consulting agreements entered into during the 2013 Quarter. In addition, legal fees increased due to corporate legal matters including ongoing financial efforts.

(Loss) Income from Operations

Loss from operations for the 2013 Quarter was $2.3 million compared to income of $1.0 million for the 2012 Quarter. See discussion above under "Revenues," "Cost and Expenses" for details.

Net loss (Income) Applicable to Noncontrolling Interest in Consolidated Subsidiary

Net loss (income) applicable to the noncontrolling interest in our EES consolidated majority-owned subsidiary decreased by $0.5 million due to the decreased performance in the services business, and the lack of equipment sales and licensing revenue.

LIQUIDITY AND CAPITAL RESOURCES


A summary of our cash flows is as follows:


                                                           Three Months Ended
                                                               March 31,
                                                          2013             2012
                                                              (Unaudited)
Net cash (used in) provided by operating activities   $ (2,196,536 )   $ 1,105,583
Net cash (used in) investing activities               $   (506,571 )   $   (14,115 )
Net cash provided by (used in) financing activities   $    671,890     $  (618,734 )


ECOSPHERE TECHNOLOGIES, INC. AND SUBSIDIARIES

2013 Period

Operating Activities

Net cash used in operating activities was $2.2 million for the 2013 Quarter, compared to net cash provided by operating activities of $1.1 million for the 2012 Quarter. For the 2013 Quarter, cash used in operating activities of $2.2 million resulted from the net loss applicable to Ecosphere common stock of $2.3 million, a significant increase in inventory of $3.3 million, non-cash charges of $0.9 million, partially offset by $0.7 million decrease in accounts receivables and $0.5 million of depreciation and amortization.

Investing Activities

The Company's net cash used in investing activities consisted primarily of $0.5 million of construction in process purchases.

Financing Activities

The Company's net cash provided by financing activities consisted primarily of $0.7 million of proceeds from the sale of convertible notes and warrants.

2012 Period

Operating Activities

Cash provided by operating activities in the 2012 period of $1.1 million resulted from net income applicable to Ecosphere Technologies, Inc. common stock of $0.7 million, non-cash charges of $1.3 million, partially offset by a $0.9 million use of cash resulting from working capital changes.

Non-cash charges included (i) depreciation and amortization of $0.6 million,
(ii) vesting of options and restricted stock of $0.4 million, (iii) $0.2 million in losses pursuant to the change in fair value of derivative instruments, and
(iv) $0.1 million in debt accretion.

Changes in working capital amounted to a use of $0.9 million in cash and were largely due to increases in accounts receivable which are driven by increased business activity. See the unaudited condensed consolidated statements of cash flows for additional details.

Investing Activities

During the 2012 Quarter, the net cash used in investing activities was de minimis.

Financing Activities

The Company's net cash used in financing activities consisted of a $0.9 million cash distribution to the noncontrolling partners of the Company's majority-owned EES subsidiary. Partially offsetting the cash distribution was $0.3 million in cash proceeds from option and warrant exercises and warrant modifications.

Liquidity

Through the end of 2012, the Company had sufficient liquidity and revenue to support its growing operations as evidenced by the record 2012 revenue and the net income. As the result of the unexpected failure of Hydrozonix to pay for Units 13-14, the Company has been focusing its efforts on providing liquidity while it implements its business model of developing, commercializing and selling innovative environmentally friendly technologies and maintaining the manufacturing rights for the products which use the technologies.

Our management has been actively engaged in seeking to sell a portion of its 52.6% interest in EES. The Company expected it would have closed that sale last week or the transaction would have terminated. However, the Company finds itself in a situation where definitive and complex agreements have essentially been agreed upon by the parties, but there has been no communications apparently due to another transaction involving the buyer.

Regardless of whether this transaction closes, the Company has retained a nationally known investment banking firm and charged it with monetizing its EES investment. During 2012, EES paid its members approximately $6.7 million in dividends. The Company's goal is to monetize all or part of EES while maintaining the right to manufacture all equipment using Ozonix® technology. At the


ECOSPHERE TECHNOLOGIES, INC. AND SUBSIDIARIES

same time, the Company has requested the investment banker to solicit an interim bridge loan to provide working capital. We cannot assure you that the pending sale of a part of the Company's interest in EES or those transactions through the investment banker will close.

When Hydrozonix failed to pay for Units 13-14, the Company and its majority-owned subsidiary, EES, had to take back the exclusivity it had granted Hydrozonix for the U.S. onshore oil and gas exploration market. The U.S. exclusivity for the patented Ozonix® technology for onshore oil and gas exploration was based on Hydrozonix receiving an approximate 25% discount off of the retail price of an Ozonix® EF80 system for agreeing to pay for two EF80 Units every quarter to maintain their exclusivity. The retail price for an EF80 was originally set at $4.5 million and Hydrozonix was allowed to purchase them for approximately $3 million plus paying a 20% EBIT royalty fee during their exclusivity period and a 15% royalty fee if they were to lose their exclusivity. At this time EES will now receive a 15% royalty of the EBIT of Hydrozonix for the life of the Ozonix® patents. If Hydrozonix was to sell their business to a larger service company we would still receive that royalty for the life of the Ozonix® patents. During the period from January 1, 2013-April 13, 2013, Hydrozonix principals assured Company executives repeatedly that they would be purchasing Units 13-14, as well as placing deposits on Units 15-16. Because of these promises from a customer that had been keeping up their end of the exclusive agreement, the Company, as the majority managing partner of EES, continued building Units 13-14 to be able to deliver these Units on time and on schedule. Units 13-14 were built on time and even tested and signed off for meeting its technical acceptance program by Hydrozonix at the Company's Stuart, Florida facility by March 31, 2013. During the first quarter of 2013, Ecosphere was also completing its newest mobile Ozonix® demonstration Unit to be able to showcase its Ozonix® technology for mining, municipal, and agriculture applications. The Company and its subsidiary used a significant amount of its available cash resources on hand to manufacture these Units in order to be able to tender delivery to Hydrozonix as well as have equipment to build out its other vertical markets. As of the date of this filing, the Company does not have sufficient working capital on hand to sustain operations for the next 12 months. As of the date of this filing, our cash balance is approximately $255,000 and we . . .

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