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ESPH > SEC Filings for ESPH > Form 10-K on 17-Mar-2014All Recent SEC Filings

Show all filings for ECOSPHERE TECHNOLOGIES INC

Form 10-K for ECOSPHERE TECHNOLOGIES INC


17-Mar-2014

Annual Report


ITEM 7.

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

This discussion should be read in conjunction with the other sections contained herein, including the risk factors and the consolidated financial statements and the related exhibits contained herein. The various sections of this discussion contain a number of forward-looking statements, all of which are based on our current expectations and could be affected by the uncertainties and risk factors described throughout this this filing as well as other matters over which we have no control. 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 herein. See "Risk Factors" and "Cautionary Note Regarding Forward-Looking Statements."

Company Overview

Ecosphere is an innovative U.S. technology licensing and manufacturing company that develops environmental solutions for global markets. We help industry increase production, reduce costs, and protect the environment through a portfolio of more than 35 patented and patent-pending technologies: Technologies like Ozonix® and Ecos PowerCube®, which are licensable across a wide range of industries and applications throughout the world.

Business Model

Our management team executes on a business strategy that is driven by open innovation and innovative manufacturing. "Open Innovation" is a concept that was developed by Dr. Henry Chesbrough, the Executive Director of the Center for Open Innovation at the Haas School of Business at the University of California, Berkeley. The Open Innovation concept provides a formula whereby small companies can rapidly develop and deploy new technologies and then license those technologies to larger organizations for rapid market penetration. In response to this concept, we developed the "Open Innovation Network," our product development lifecycle that can be characterized by the following six stages:

1.

Identify a major environmental challenge,

2.

Invent new technologies and file patents,

3.

Partner with industry leaders,

4.

Commercialize and prove the technology with ongoing services paid for by customers and industry leaders,

5.

License the patented, commercialized technologies to well capitalized partners, and

6.

Create recurring revenues and increase shareholder value.

As a result, we have designed, developed, manufactured and commercialized technologies that are currently solving some of the world's most critical water and environmental challenges. Our patented Ozonix® technology is a revolutionary, high volume, Advanced Oxidation Process (AOP) designed to treat and recycle industrial wastewater without the use of toxic chemicals and our Ecos PowerCube® is the world's most powerful, mobile, solar-powered generator that can be used in the world's most remote, off-grid locations.

In addition to Ozonix® and Ecos PowerCube®, we have developed an extensive portfolio of intellectual property that includes approximately 35 patents have been filed and approved in various locations around the world. These patented technologies and corresponding trademarks can be purchased and licensed for use in large-scale and sustainable applications across industries, nations and ecosystems. Companies that license our patented technologies are able to improve their financial metrics while also reducing their ecological and environmental footprints. Our current focus is on licensing Ecosphere's patented Ozonix® and Ecos PowerCube® technologies, although our other technologies and patents remain a viable part of our long-term technology licensing strategy.

Ozonix® Intellectual Property Portfolio

Because of generally accepted accounting principles and SEC accounting rules, Ecosphere's patents and patents pending are reflected in its consolidated balance sheet based on the cost it pays its counsel to process and maintain those patents. This type of accounting method does not take in to account the actual fair value of the intellectual property created that can be licensed to customers and industry leaders for the 20 year life of the patents. Ecosphere's unique patents allow Ecosphere the sole right to exclude others from making, using or selling its proprietary solutions. Ecosphere's patents also allow Ecosphere to monetize its assets for shareholders by granting local, regional or global field-of-use licenses to industry-specific partners.


Accordingly, in 2013, Ecosphere retained a leading company in the field of intellectual property valuation, to perform an analysis of the value of our patented Ozonix® technology portfolio. The valuation company delivered the valuation in November 2013, which includes all of the potential industries and applications where Ozonix® can be used and licensed, including the global energy field-of-use, of which Ecosphere owns 30.6% interest in FNES. While this valuation is subject to a number of assumptions, Ecosphere believes it illustrates the hidden value that is not recognized on our Balance Sheet or by the investment community.

Since May 2013, Ecosphere has received $10 million from FNF for the sale of our 20% interest in FNES, which reduced our ownership interest in FNES to 30.6%. Ecosphere expects to monetize the remaining balance of its 30.6% ownership in FNES. In 2014 Ecosphere has formed six new subsidiaries which it expects will obtain exclusive sublicenses for global, industry-specific fields-of-use to its patented Ozonix® technology. See Note 1 to our consolidated financial statements contained herein. Ecosphere has hired investment banker Ladenburg Thalmann to assist it with obtaining equity financing for these subsidiaries, but initially will focus on Ecosphere Mining, LLC.

Recent Success

In 2009, Ecosphere formed Ecosphere Energy Services, LLC or EES, now Fidelity National Environmental Solutions, LLC or FNES, to deploy its patented Ozonix® water treatment technology across the global energy market. Ecosphere and FNES have received numerous awards and accolades for its patented and proven Ozonix® water treatment solutions for the energy sector, including:

·

2013 Oil and Gas Awards-Water Management Company of the Year Award, Midcontinent Region;

·

2013 Bloomberg New Energy Finance - New Energy Pioneer Award;

·

2013 IHS CERAWeek - Energy Innovation Pioneer Award;

·

2013 American Technology Awards "Clean Tech/Green Tech" Winner;

·

2013 World Technology Awards Corporate "Environment" Category Winner;

·

2012 Frost & Sullivan North American Product Leadership Award in Disinfection Equipment for Shale Oil and Gas Wastewater Treatment; and

·

2010, 2011, 2012 Artemis "Top 50 Water Technologies" Winner.

Since 2009, Ecosphere's patented Ozonix® technology has enabled oil and gas customers to treat, recycle and reuse over 4 billion gallons of water on more than 900 oil and natural gas wells around the United States.

Growth Strategy

Ecosphere's strategy is to further leverage the Ozonix® technology via widespread partnering and licensing to achieve substantial technology deployment and the corresponding revenue and profit growth. In addition to FNES, formerly EES, Ecosphere plans to replicate the success of its "subsidiary strategy" by granting global field-of-use licenses to numerous industry-specific Ecosphere subsidiaries. Newly formed subsidiaries include:

·

Ecosphere Agriculture, LLC;

·

Ecosphere Food & Beverage, LLC;

·

Ecosphere Industrial, LLC;

·

Ecosphere Marine, LLC;

·

Ecosphere Mining, LLC;

·

Ecosphere Municipal, LLC.

In late 2013, Ecosphere launched a private placement with our investment banker, Ladenburg Thalmann, seeking to sell a 20% minority position in Ecosphere Mining, LLC for $10 million. In furtherance of our strategy, we have opened an office in Park City, Utah, near much of the mining activity in the United States and have produced equipment to demonstrate how Ecosphere Mining can help mining companies deal with wastewater created by mining operations and enhance their recovery of valuable minerals.

From a technical standpoint, Ecosphere has proven the Ozonix® technology in the most challenging treatment market sector, the oil & gas segment of the energy industry; therefore, the technological risks faced when entering other target sectors and industries are significantly diminished.


From a business standpoint, Ecosphere has successfully created a subsidiary to target the Energy industry (one of numerous target market sectors for Ozonix®), and two recent equity sales to Fidelity National Financial, a Fortune 500 company, valued just this one subsidiary at $50 million. It is important for shareholders to note: that in 2009 when FNES, formerly EES, was initially established and the technology was not yet commercially or technologically proven FNF invested $7.5 million in FNES at a $37.5 million valuation to build the equipment that is in use today at Southwestern Energy.

Critical Accounting Estimates

Use of Estimates

The preparation of the consolidated financial statements in conformity with Generally Accepted Accounting Principles ("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, valuation of beneficial conversion features in convertible debt, valuation of equity-based instruments issued for other than cash, warranty reserve, valuation of remaining interest in unconsolidated investee, 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, Ecosphere 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, Ecosphere 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, Ecosphere 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.

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 Ecosphere 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 Ecosphere 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

Ecosphere 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.

Stock-Based Compensation

Ecosphere 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 16 to our consolidated financial statements contained herein. The BSM option pricing model requires the input of highly subjective assumptions including the expected stock price volatility.

Investment in Unconsolidated Investee

The Company accounts for investments in which the Company owns more than 20% of the investee, using the equity method in accordance with ASC Topic 323, Investments-Equity Method and Joint Ventures. Under the equity method, an investor initially records an investment in the stock of an investee at cost, and adjusts the carrying amount of the investment to recognize the investor's share of the earnings or losses of the investee after the date of acquisition. The amount of the adjustment is included in the determination of net income by the investor, and such amount reflects adjustments similar to those made in preparing consolidated statements including adjustments to eliminate intercompany gains and losses, and to amortize, if appropriate, any difference between investor cost and underlying equity in net assets of the investee at the date of investment. The investment of an investor is also adjusted to reflect the investor's share of changes in the investee's capital. Dividends received from an investee reduce the carrying amount of the investment. A series of operating losses of an investee or other factors may indicate that a decrease in value of the investment has occurred which is other than temporary and which should be recognized even though the decrease in value is in excess of what would otherwise be recognized by application of the equity method.


Results of Operations

Comparison of the Year ended December 31, 2013 with the Year ended December 31, 2012

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

RESULTS OF OPERATIONS


                                              For the Years Ended
                                                  December 31,
                                             2013              2012             Change
Revenues
Equipment sales and licensing            $           -     $ 22,602,408     $ (22,602,408)
Equipment sales and licensing, related
party                                        4,759,478                -          4,759,478
Field services                               1,547,786        7,405,266        (5,857,480)
Aftermarket part sales                         287,724        1,124,624          (836,900)
Aftermarket part sales, related party          124,827                -            124,827
Total revenues                               6,719,815       31,132,298       (24,412,483)
Costs and expenses
Equipment sales and licensing costs
(exclusive of depreciation shown
below)                                       4,059,136       16,430,617       (12,371,481)
Field services costs (exclusive of
depreciation shown below)                      721,214        2,492,397        (1,771,183)
Aftermarket part costs (exclusive of
depreciation shown below)                      304,758          773,929          (469,171)
Salaries and employee benefits               5,544,387        5,514,920             29,469
Administrative and selling                   1,342,463        1,619,351          (276,888)
Professional fees                            2,149,568          788,979          1,360,589
Depreciation and amortization                1,018,146        2,318,605        (1,300,459)
Research and development                       (3,403)           28,290           (31,693)
Total costs and expenses                    15,136,269       29,967,088       (14,830,817)
Income (loss) from operations              (8,416,454)        1,165,210        (9,581,666)
Loss on investment in unconsolidated
investee                                     (927,161)                -          (927,161)
Other income (expense)
Gain on deconsolidation                     29,474,609                -         29,474,609
Interest expense                             (455.237)         (360,031 )         (95,206)
Restructuring charge reversal                    3,170           62,000           (58,830)
Gain on sale/disposal of fixed assets,
net                                                  -          142,457          (142,457)
Other income (expense)                               -            3,057            (3,057)
Loss on sale of interest in
unconsolidated investee                      (600,000)                -          (600,000)
Change in fair value of derivative
instruments                                     90,531           41,374             49,157
Total other income (expense)                28,513,073         (111,143 )       28,624,216
Net income (loss)                           19,169,458        1,054,067         18,115,389
Preferred stock dividends                     (82,752)         (102,813 )           20,061
Net income (loss) applicable to common
stock                                       19,086,706          951,254         18,135,450
Net (income) loss applicable to
noncontrolling interest of
consolidated subsidiary                        187,806         (815,054 )        1,002,860
Net income (loss) applicable to
Ecosphere Technologies, Inc. common
stock                                    $  19,274,512     $    136,200     $   19,138,310

Comparison of the Year Ended December 31, 2013 to the Year Ended December 31, 2012

The Company reported net income applicable to Ecosphere common stock of $19.3 million during the year ended December 31, 2013 (the "2013 Period") as compared to net income applicable to Ecosphere common stock of $0.1 million for the year ended December 31, 2012 (the "2012 Period"). The driver of the variance of $19.1 million is discussed below.


Revenues

Revenues for the year ended December 31, 2013 decreased 24.4 million from the year ended December 31, 2012. The decrease in revenue was driven primarily by the absence from equipment sales due to Hydrozonix's failure to pay for Units 13-14 on April 15, 2013, causing Hydrozonix to lose its exclusivity to the U.S. onshore oil and gas industry. As a result, FNES regained the exclusive U.S. onshore oil and gas license for Ozonix®. After the deconsolidation of FNES in May 2013, the Company no longer reports field services revenue or expenses on its Statements of Operations since it no longer consolidates FNES operations. In July and November 2013, FNES purchased Ozonix® EF80 Units 13 and 14 for $2.4 million a unit with a down payment of $0.5 million (Unit 14) and $250,000 (Unit 13) with the remaining balances to be paid over a 36 month period. In October 2013, FNES purchased and took delivery of the first Ozonix® EF10M as well.

During the 2012 Period, the Company engaged in the sale of aftermarket parts, services, upgrades and enhancements related to the Ozonix® EF80 units in use by Hydrozonix. There was a decrease of $0.7 million in the sale of aftermarket parts for the 2013 Period due to the termination of the Hydrozonix agreement.

Costs and Expenses

Equipment Sales and Licensing Costs (exclusive of depreciation)

Equipment sales and licensing costs amounted to $4.1 million for the 2013 Period as compared to $16.4 million during the 2012 Period. The costs for the 2013 Period represent the cost to manufacture two Ozonix® EF80 water treatment units and one Ozonix® EF10M sold to FNES. The $12.4 million decrease in equipment sales and licensing costs over the 2012 Period is due to the decrease in manufacturing water treatment units.

Field Services Costs (exclusive of depreciation)

The cost of providing field services was $0.7 million in the 2013 Period compared to $2.5 million in the 2012 Period. 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. The $1.8 million decrease for the 2013 Period was primarily due to the deconsolidation of FNES as only approximately five months of operations are in the 2013 Period.

Aftermarket Part Costs (exclusive of depreciation)

The costs associated with the sale of aftermarket parts amount to $0.3 million for the 2013 Period as compared to $0.8 million for the 2012 Period. The Company began engaging in the sale of aftermarket parts, services, upgrades and enhancements related to the Ozonix® EF80 units in service by Hydrozonix during the 2012 Period of which limited amounts occurred in the 2013 Period.

Salaries and Employee Benefits

The increase for the 2013 Period in salaries and employee benefits was de minimis.

Professional Fees

The $1.4 million increase in professional fees during the 2013 Period was driven by the increase in consulting fees relating to two related party consulting agreements entered into in January 2013; one of these consulting agreements expired in December 2013 and was not renewed. During December 2013, Ecosphere launched a private placement with our investment banker, Ladenburg Thalmann, seeking to sell a 20% minority position in Ecosphere Mining, LLC for $10 million causing an increase in professional fees. In addition, legal fees increased due to the Halliburton arbitration.

Restructuring Charge Reversal

Revisions to previous estimates of restructuring costs associated with the June 2009 closing of the Company's New York office resulted in a reversal of $62,000 of expense in the 2012 Period.


Gain on Sale/Disposal of Fixed Assets, Net

The Company sold a water treatment unit that had been part of its historical fixed assets. The net book value of such unit was written off pursuant to a September 2010 impairment charge. The Company incurred costs of $33,933 to bring the unit to saleable condition. Such costs are included in capital expenditures. The Company received proceeds of $206,000 for the unit and, accordingly, recognized a gain of $172,067 on the transaction. Partially offsetting this gain was a loss on the disposal of certain demo equipment amounting to $29,610.

Income (Loss) From Operations

Loss from operations 2013 Period was $8.4 million compared to income of $1.2 million for the 2012 Period. See discussion above under "Revenues" and "Costs and Expenses" for further details.

Loss on Investment in Unconsolidated Investee

On May 24, 2013, the Company sold a 12% interest in FNES and transferred an additional 1.5% interest to a board member of FNES, reducing the Company's ownership in FNES from 52.6% to 39.1%. Since May 24, 2013, the Company accounts for its investment in FNES under the equity method of accounting. Furthermore, in July 2013, the Company sold an additional 8% interest in FNES and transferred an additional 0.5% interest in FNES reducing the Company's ownership in FNES from 39.1% to 30.6%. During the 2013 Period the Company sold two Ozonix®EF80 units and one Ozonix® EF10M unit to FNES. A portion of the profits from these sales reflecting the Company's ownership share are eliminated through an adjustment to "Loss on Investment in Unconsolidated Investee." Also, the Company records their 30.6% share of FNES's net loss and adjusts the loss on investment in unconsolidated investee accordingly.

Gain on Deconsolidation

The sale of the Company's controlling interest in FNES resulted in the recognition of a $29.5 million gain for the 2013 Period. Effective May 24, 2013, the Company began to account for its investment in FNES using the equity method of accounting. See "Loss on investment in unconsolidated investee" above for details.

Loss on Sale of Interest in Unconsolidated Investee

In July 2013, the Company sold 8% interest in FNES to Fidelity National Financial. In connection with the sale of the Company's interest in FNES, the Company transferred 0.5% interest and paid $250,000 in cash to an existing FNES board member. This further reduced the Company's investment in FNES and the 0.5% interest transfer and $250,000 cash payment was recorded on the statement of . . .

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