UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

———————

Amendment No. 1

To

FORM 10-K

———————

 

þ	ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the fiscal year ended: December 31, 2013

OR

 

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

 

For the transition period from: _____________ to _____________

 

Commission file number: 000-25663

 

Ecosphere Technologies, Inc.

(Exact name of registrant as specified in its charter)

 

Delaware	20-3502861
(State or Other Jurisdiction	(I.R.S. Employer
of Incorporation or Organization)	Identification No.)

3515 S.E. Lionel Terrace, Stuart, Florida	34997
(Address of Principal Executive Office)	(Zip Code)

Registrant’s telephone number, including area code: (772) 287-4846

 

Securities registered pursuant to Section 12(b) of the Act: None

 

Securities registered pursuant to Section 12(g) of the Act: Common Stock, $0.01 par value

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes o   No þ

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Exchange Act. Yes o   No þ

Indicate by check mark 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. Yes þ   No o

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes þ   No o

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  þ

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company.  See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer	o	Accelerated filer	þ
Non-accelerated filer	o	Smaller reporting company	o

 

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

The aggregate market value of the voting and non-voting common equity held by non-affiliates computed by reference to the closing price as of the last business day of the registrant’s most recently completed second fiscal quarter, June 30, 2013, was approximately $51,000,000.

The number of shares outstanding of the registrant’s common stock, as of March 12, 2014, was 164,147,155.

 

 

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EXPLANATORY NOTE

This Amendment No. 1 on Form 10-K/A (the “Amendment”) amends our Annual Report on Form 10-K for the year ended December 31, 2013 (“2013 Form 10-K”), as filed with the Securities and Exchange Commission (the “SEC”) on March 17, 2014. We are filing this Amendment to include disclosure regarding our internal control framework under Item 8. “Financial Statements” and Item 9A. “Controls and Procedures”.  In connection with the filing of this Amendment and pursuant to the rules of the SEC, we are including with this Amendment new certifications by our principal executive and principal financial officers. Accordingly, Item 15 of Part IV has also been amended to reflect the filing of these new certifications.

Except as described above, no other changes have been made to the 2013 Form 10-K. The 2013 Form 10-K continues to speak as of the date of the 2013 Form 10-K, and we have not updated the disclosures contained therein to reflect any events which occurred at a date subsequent to the filing of the 2013 Form 10-K other than as expressly indicated in this Amendment.

 

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ITEM 8.

FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.

 

See pages F-1 through F-55.

 

ITEM 9A.

CONTROLS AND PROCEDURES.

Disclosure Controls

 

We carried out an evaluation required by Rule 13a-15 of the Securities Exchange Act of 1934, or the Exchange Act, under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures, as such term is defined in Exchange Act Rule 13a–15(e). Disclosure controls and procedures are designed with the objective of ensuring that (i) information required to be disclosed in an issuer's reports filed under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC rules and forms and (ii) information is accumulated and communicated to management, including our Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosures.

The evaluation of our disclosure controls and procedures included a review of our objectives and processes and effect on the information generated for use in this report. This type of evaluation is done quarterly so that the conclusions concerning the effectiveness of these controls can be reported in our periodic reports filed with the SEC. We intend to maintain these controls as processes that may be appropriately modified as circumstances warrant.

Based on their evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that our disclosure controls and procedures are effective in timely alerting them to material information which is required to be included in our periodic reports filed with the SEC as of the end of the period covering this report.

Management’s Report on Internal Control Over Financial Reporting

Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Exchange Act Rule 13a-15(f). Under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, we conducted an evaluation of the effectiveness of our internal control over financial reporting as of December 31, 2013 based on the criteria set forth in Internal Control — Integrated Framework (1992) issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on that evaluation, our management concluded that our internal control over financial reporting was effective as of December 31, 2013.

However, a control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Management necessarily applied its judgment in assessing the benefits of controls relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the company have been detected. The design of any system of controls is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions, regardless of how remote. Because of the inherent limitations in a control system, misstatements due to error or fraud may occur and may not be detected.

The effectiveness of our internal controls over financial reporting as of December 31, 2013, has been audited by Salberg & Co. P.A., an independent registered public accounting firm, as stated in their report which appears in Item 8 of this Annual Report on Form 10-K.

Changes in Internal Control Over Financial Reporting

During our most recent fiscal quarter, there has not been any change in our internal control over financial reporting as such term is defined in Exchange Act Rule 13a-15(f) that has materially affected, or is reasonably likely to affect, our internal control over financial reporting.

1

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PART IV

 

ITEM 15.

EXHIBITS, FINANCIAL STATEMENT SCHEDULES.

 

(a) Documents filed as part of the report.

 

(1)

Financial Statements. See Index to Consolidated Financial Statements, which appears on page F-1 hereof. The financial statements listed in the accompanying Index to Consolidated Financial Statements are filed herewith in response to this Item.

(2)

Financial Statements Schedules. Financial statements of subsidiary not consolidated see index on page F-46. No other financial statement schedules are required.

 

(3)

Exhibits

 

Exhibit				Incorporated by Reference						Filed or Furnished
No.		Exhibit Description		Form		Date		Number		Herewith
3.1		Certificate of Incorporation		10-QSB		12/11/06		3.1
3.2		Certificate of Amendment		10-K		3/25/09		3.2
3.3		Certificate of Correction		10-K		3/25/09		3.3
3.4		Certificate of Correction		10-Q		11/12/13		3.4
3.5		Bylaws		10-QSB		12/11/06		3.2
3.6		Amendment to the Bylaws Adopted June 17, 2008		10-Q		11/13/08		3.3
3.7		Amendment to the Bylaws Adopted August 12, 2010		10-Q		8/16/10		3.6
3.8		Third Amendment to the Bylaws Adopted October 20, 2011		10-K		4/2/13		3.7
4.1		Amended and Restated 2006 Equity Incentive Plan*		10-Q		8/16/10		10.1
4.2		Amendment to the Amended and Restated 2006 Equity Incentive Plan*		S-8		3/25/11		4.2
4.3		Second Amendment to the Amended and Restated 2006 Equity Incentive Plan*		10-K		4/2/13		4.3
10.1		Hydrozonix Exclusive Product Purchase and Sublicense Agreement**		10-Q/A		12/1/11		10.3
10.2		EES Side Letter Agreement – Hydrozonix**		10-Q		5/10/11		10.6
10.3		Second Amendment to EES LLC Agreement		10-Q/A		12/1/11		10.7
10.4		Southwest Energy Services Agreement**		10-Q/A		3/16/11		10.16
10.5		Newfield Exploration Services Agreement		10-Q/A		3/16/11		10.17
10.6		Newfield Subsidiary Agreement**		10-K		3/16/11		10.39
10.7		Bledsoe Contribution Agreement dated July 15, 2009		10-Q		11/16/09		10.6
10.8		Amended and Restated Bledsoe Credit Agreement dated July 15, 2009		10-Q		11/16/09		10.5
10.9		Amended and Restated EES Limited Liability Company Agreement		10-Q		11/16/09		10.4
10.10		First Amendment to the Amended and Restated EES Limited Liability Company Agreement (Exhibit A to the Fidelity Unit Purchase Agreement dated November 9, 2009 filed herein as Exhibit 10.12)		10-K		3/31/10		10.20
10.11		Second Amended and Restated EES LLC Agreement		10-Q		8/9/13		10.5
10.12		Fidelity Unit Purchase Agreement dated November 9, 2009		10-K		3/31/10		10.21
10.13		Fidelity Unit Purchase Agreement dated May 24, 2013		10-Q		8/9/13		10.3
10.14		Fidelity Unit Purchase Agreement dated July 26, 2013		S-1		1/21/14		10.14
10.15		EES Amended and Restated Replacement Secured Note dated November 1, 2009 (Exhibit C to the Fidelity Unit Purchase Agreement dated November 9, 2009 filed herein as Exhibit 10.12)		10-K		3/31/10		10.22
10.16		First Amendment to Amended and Restated Credit Agreement dated December 8, 2010		10-K		3/16/11		10.19
10.17		Second Amendment to Amended and Restated Replacement Secured Note dated December 8, 2010		10-K		3/16/11		10.20

2

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10.18		Form of Executive Option Agreement dated December 22, 2009*		10-Q		8/16/10		10.4
10.19		Form of Executive Option Agreement dated July 1, 2009*		10/Q		8/16/10		10.5
10.20		Form of Director Option Agreement dated July 1, 2009		10-Q		8/16/10		10.6
10.21		Form of Director Option Agreement dated July 1, 2010		10-Q		11/22/10		10.6
10.22		Form of Director Restricted Stock Agreement dated July 1, 2009		10-Q		8/16/10		10.13
10.23		Form of Director Restricted Stock Agreement dated July 1, 2010		10-Q		11/22/10		10.5
10.24		Form of Director Option Agreement – Initial Grant		10-Q		8/16/10		10.14
10.25		Form of Director Restricted Stock Agreement – Initial Grant		10-Q		8/16/10		10.15
10.26		Form of Executive Option Agreement dated December 23, 2010*		10-K		3/16/11		10.30
10.27		Form of Executive Option Agreement dated December 23, 2010*		10-K		3/16/11		10.31
10.29		Technology License Agreement		10-Q		8/16/10		10.12
10.30		First Amendment to the Technology License Agreement		10-Q		8/9/13		10.4
10.31		Assignments of Technology		10-Q		11/22/10		10.10
10.32		Form of 8.5% Convertible Note (CIM)		10-Q		5/21/13		10.5
10.33		Form of Warrant (CIM)		10-Q		5/21/13		10.6
10.34		Dennis McGuire Employment Agreement*		S-1		1/21/14		10.35
10.35		Dennis McGuire Royalty Agreement *		S-1		1/21/14		10.36
10.36		Vinick Consulting Agreement*		S-1		1/21/14		10.37
10.37		Becker Consulting Agreement*		S-1		1/21/14		10.38
10.38		Form of Convertible Note (2013 Offering)								Filed ^
10.39		Form of Warrant (2013 Offering)								Filed ^
10.40		Form of Registration Rights Agreement (2013 Offering)								Filed ^
21.1		List of Subsidiaries		10-K		4/2/13		21.1
23.1		Consent of Salberg & Co. PA								Filed ^
31.1		Certification of Principal Executive Officer (302)								Filed
31.2		Certification of Principal Financial Officer (302)								Filed
32.1		Certification of Principal Executive and Principal Financial Officer (906)								Furnished
101.INS		XBRL Taxonomy Extension Instance Document								Filed
101.SCH		XBRL Taxonomy Extension Schema Document								Filed
101.CAL		XBRL Taxonomy Extension Calculation Linkbase Document								Filed
101.DEF		XBRL Taxonomy Extension Definition Linkbase Document								Filed
101.LAB		XBRL Taxonomy Extension Label Linkbase Document								Filed
101.PRE		XBRL Taxonomy Extension Presentation Linkbase Document								Filed

———————

*

Management compensatory agreement

**

Filed pursuant to a confidential treatment request for certain portions of this document.

^

Filed or furnished, as applicable, to the Form 10-K filed on March 17, 2014.

3

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SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

 

	Ecosphere Technologies, Inc.
Date: September 12, 2014	By:	/s/ Dennis McGuire
		Dennis McGuire
		Chief Executive Officer
		(Principal Executive Officer)

Date: September 12, 2014	By:	/s/ David Brooks
		David Brooks
		Chief Financial Officer
		(Principal Financial Officer)

 

 

4

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INDEX TO FINANCIAL STATEMENTS

 

		Page
Report of Independent Registered Public Accounting Firm			F-2
Consolidated Balance Sheets			F-3
Consolidated Statements of Operations			F-4
Consolidated Statements of Changes in Equity (Deficit)			F-5
Consolidated Statements of Cash Flows			F-8
Notes to Consolidated Financial Statements			F-10

 

 

F-1

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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and Stockholders of:

Ecosphere Technologies, Inc.

We have audited the accompanying consolidated balance sheets of Ecosphere Technologies, Inc. and Subsidiaries ("the Company") as of December 31, 2013 and 2012, and the related consolidated statements of operations, changes in equity (deficit), and cash flows for each of the three-years in the period ended December 31, 2013. We also have audited Ecosphere Technologies, Inc. and Subsidiaries internal control over financial reporting as of December 31, 2013, based on criteria established in Internal Control - Integrated Framework (1992) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company's management is responsible for these consolidated financial statements, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Report on Internal Control Over Financial Reporting. Our responsibility is to express an opinion on these consolidated financial statements and an opinion on the Company's internal control over financial reporting based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the consolidated financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall consolidated financial statement presentation. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.

A company's internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Ecosphere Technologies, Inc. and Subsidiaries as of December 31, 2013 and 2012, and the consolidated results of its operations and its cash flows for each of the three-years in the period ended December 31, 2013 in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, Ecosphere Technologies, Inc. and Subsidiaries maintained, in all material respects, effective internal control over financial reporting as of December 31, 2013, based on criteria established in Internal Control - Integrated Framework (1992) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).

The accompanying consolidated financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note 1 to the consolidated financial statements, the Company has a loss from operations and cash used in operations along with an accumulated deficit. These matters raise substantial doubt about the Company's ability to continue as a going concern. Management’s Plan in regards to this matter is also described in Note 1. The consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty.

/s/ Salberg & Company, P.A.

SALBERG & COMPANY, P.A.

Boca Raton, Florida

March 17, 2014

2295 NW Corporate Blvd., Suite 240 • Boca Raton, FL 33431-7328

Phone: (561) 995-8270 • Toll Free: (866) CPA-8500 • Fax: (561) 995-1920

www.salbergco.com • info@salbergco.com

Member National Association of Certified Valuation Analysts • Registered with the PCAOB

Member CPAConnect with Affiliated Offices Worldwide • Member AICPA Center for Audit Quality

F-2

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ECOSPHERE TECHNOLOGIES, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

		December 31,
		2013				2012
Assets
Current assets
Cash		$	1,059,651			$	2,464,911
Restricted cash			25,000				60,168
Accounts receivable			—				1,150,152
Current portion of accounts receivable-related party			1,210,445				—
Inventory			219,278				757,682
Prepaid expenses and other current assets			121,480				107,067
Total current assets			2,635,854				4,539,980
Investment in unconsolidated investee			14,369,439				—
Accounts receivable-related party, net of current portion			2,268,406				—
Property and equipment, net			1,857,601				4,264,125
Debt issuance costs, net			37,007				—
Patents, net			138,034				81,691
Deposits			14,840				22,441
Total assets		$	21,321,181			$	8,908,237
Liabilities, Redeemable Convertible Cumulative Preferred Stock and Equity
Current liabilities
Accounts payable		$	410,402			$	845,241
Accrued liabilities			843,893				1,122,119
Customer deposit			—				23,196
Current portion of convertible notes payable, net of discounts			271,176				1,203,126
Current portion of note payable			85,125				68,100
Warrant derivatives fair value			3,671				197,009
Current portion of financing obligations			163,746				96,548
Current portion of capital lease obligation			15,347				14,593
Total current liabilities			1,793,360				3,569,932
Convertible notes payable, net of discounts and current portion			510,984				—
Note payable, net of current portion			68,099				136,199
Financing obligations, net of current portion			108,265				106,612
Restructuring reserve			—				5,909
Capital lease obligation, net of current portion			41,929				57,276
Total liabilities			2,522,637				3,875,928
Redeemable convertible cumulative preferred stock
Series A - 11 shares authorized; 6 shares issued and outstanding at December 31, 2013 and 2012; $25,000 per share redemption amount plus dividends in arrears			1,203,494				1,180,994
Series B - 484 shares authorized; 241 shares issued and outstanding at December 31, 2013 and 2012, respectively; $2,500 per share redemption amount plus dividends in arrears			2,517,033				2,456,781
Total redeemable convertible cumulative preferred stock			3,720,527				3,637,775
Commitments and contingencies (Note 20)
Equity
Ecosphere Technologies, Inc. stockholders' equity (deficit)
Common stock, $0.01 par value; 300,000,000 shares authorized; 164,033,139 and 160,060,088 shares issued and outstanding at December 31, 2013 and 2012, respectively			1,640,330				1,600,599
Common stock issuable, $0.01 par value; 105,263 and 1,138,724 issuable at December 31, 2013 and 2012, respectively			1,053				11,388
Additional paid-in capital			111,417,253				107,697,370
Accumulated deficit			(97,980,619	)			(117,337,883	)
Total Ecosphere Technologies, Inc. stockholders' equity (deficit)			15,078,017				(8,028,526	)
Noncontrolling interest in consolidated subsidiary			—				9,423,060
Total equity			15,078,017				1,394,534
Total liabilities, redeemable convertible cumulative preferred stock and equity		$	21,321,181			$	8,908,237

The accompanying notes are an integral part of these consolidated financial statements.

F-3

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ECOSPHERE TECHNOLOGIES, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

		For the Years Ended December 31,
		2013				2012				2011
Revenues
Equipment sales and licensing		$	—			$	22,602,408			$	11,460,078
Equipment sales and licensing, related party			4,759,478				—				—
Field services			1,547,786				7,405,266				9,628,081
Aftermarket part sales			287,724				1,124,624				—
Aftermarket part sales, related party			124,827				—				—
Total revenues			6,719,815				31,132,298				21,088,159
Costs and expenses
Equipment sales and licensing costs (exclusive of depreciation shown below)			4,059,136				16,430,617				8,261,524
Field services costs (exclusive of depreciation shown below)			721,214				2,492,397				2,583,911
Aftermarket part costs (exclusive of depreciation shown below)			304,758				773,929				—
Selling, general and administrative			9,033,015				7,951,540				13,407,983
Depreciation and amortization			1,018,146				2,318,605				2,174,983
Total costs and expenses			15,136,269				29,967,088				26,428,401
Income (loss) from operations			(8,416,454	)			1,165,210				(5,340,242	)
Loss on investment in unconsolidated investee			(927,161	)			—				—
Other income (expense)
Gain on deconsolidation			29,474,609				—				—
Interest expense			(455,237	)			(360,031	)			(581,392	)
Loss on conversion, net			—				—				(93,762	)
Gain on change in fair value of derivative instruments			90,531				41,374				152,888
Loss on sale of interest in unconsolidated investee			(600,000	)			—				—
Restructuring charge reversal			3,170				62,000				—
Gain on sale/disposal of fixed assets, net			—				142,457				—
Other, net			—				3,057				909
Total other income (expense)			28,513,073				(111,143	)			(521,357	)
Net income (loss)			19,169,458				1,054,067				(5,861,599	)
Preferred stock dividends			(82,752	)			(102,813	)			(103,000	)
Net income (loss) applicable to common stock before allocation to non-controlling interest			19,086,706				951,254				(5,964,599	)
Less: net (income) loss applicable to non-controlling interest in consolidated subsidiary (See Note 4)			187,806				(815,054	)			(1,690,075	)
Net income (loss) applicable to Ecosphere Technologies, Inc. common stock		$	19,274,512			$	136,200			$	(7,654,674	)
Net income (loss) per common share applicable to common stock
Basic		$	0.12			$	0.00			$	(0.05	)
Diluted		$	0.12			$	0.00			$	(0.05	)
Weighted average number of common shares outstanding
Basic			163,054,587				156,438,773				151,188,996
Diluted			164,415,781				162,296,411				151,188,996

The accompanying notes are an integral part of these consolidated financial statements.

F-4

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ECOSPHERE TECHNOLOGIES, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CHANGES IN EQUITY (DEFICIT)

For the Years Ended December 31, 2013, 2012 and 2011

 

		Ecosphere Technologies, Inc. Stockholders’ Deficit
		Issued								Issuable								Additional								Non-
		Common Stock								Common Stock								Paid-In				Accumulated				controlling
		Shares				Par Value				Shares				Par Value				Capital				Deficit				Interest				Total
Balance at December 31, 2010			144,302,325			$	1,443,023				1,415,311			$	14,153			$	96,709,005			$	(110,025,222	)		$	10,078,306			$	(1,780,735	)
Common stock issued for settlement of note payable and accrued interest			350,000				3,500				—				—				156,500				—				—				160,000
Common stock issued for options and warrants exercised for cash			3,944,015				39,440				—				—				810,381				—				—				849,821
Common stock issued for cashless option exercises			3,509,068				35,091				—				—				(35,091	)			—				—				—
Note discount from warrants			—				—				—				—				415,751				—				—				415,751
Common stock issued/issuable for restricted stock vesting			—				—				160,886				1,609				188,391				—				—				190,000
Issuance of issuable shares, net of cancellations			1,500,640				15,006				(1,500,640	)			(15,006	)			—				—				—				—
Stock options granted and vested to employees, directors and advisors			—				—				—				—				6,478,229				—				—				6,478,229
Restricted stock issued to an employee and then cancelled			(30,574	)			(306	)			—				—				306				—				—				—
Derivative impact of warrant exercises			—				—				—				—				110,519				—				—				110,519
Preferred stock dividends			—				—				—				—				(103,000	)			—				—				(103,000	)
Net (loss) income, 2011			—				—				—				—				—				(7,551,674	)			1,690,075				(5,861,599	)
Balance at December 31, 2011			153,575,474			$	1,535,754				75,557			$	756			$	104,730,991			$	(117,576,896	)		$	11,768,381			$	458,986

 (Continued)

The accompanying notes are an integral part of these consolidated financial statements.

F-5

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ECOSPHERE TECHNOLOGIES, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CHANGES IN EQUITY (DEFICIT)

For the Years Ended December 31, 2013, 2012 and 2011 (CONTINUED)

		Ecosphere Technologies, Inc. Stockholders’ Deficit
		Issued								Issuable								Additional								Non-
		Common Stock								Common Stock								Paid-In				Accumulated				controlling
		Shares				Par Value				Shares				Par Value				Capital				Deficit				Interest				Total
Balance at December 31, 2011			153,575,474			$	1,535,754				75,557			$	756			$	104,730,991			$	(117,576,896	)		$	11,768,381			$	458,986
Common stock issued for options and warrants exercised for cash			1,535,974				15,360				—				—				263,315				—				—				278,675
Common stock issued/issuable for cashless option and warrant exercises			2,202,823				22,028				1,077,678				10,777				(32,805	)			—				—				—
Common stock issued for conversion of convertible notes			1,237,500				12,375				—				—				710,841				—				—				723,216
Common stock issued/issuable for restricted stock vesting			138,825				1,388				61,046				610				(1,998	)			—				—				—
Warrants modified for cash			—				—				—				—				107,400												107,400
Issuance of issuable shares, net of cancellations			75,557				755				(75,557	)			(755	)			—				—				—				—
Stock options granted and vested to employees, directors and advisors			—				—				—				—				1,465,692				—				—				1,465,692
Restricted stock vesting			—				—				—				—				15,000				—				—				15,000
Common stock issued for conversion of Series B preferred stock holdings			1,293,935				12,939				—				—				432,895				—				—				445,834
Reclassification of derivative liability upon exercises of warrants			—				—				—				—				108,852				—				—				108,852
Distribution to noncontrolling partners			—				—				—				—				—				—				(3,160,375	)			(3,160,375	)
Preferred stock dividends			—				—				—				—				(102,813	)			—				—				(102,813	)
Net income, 2012			—				—				—				—				—				239,013				815,054				1,054,067
Balance at December 31, 2012			160,060,088			$	1,600,599				1,138,724			$	11,388			$	107,697,370			$	(117,337,883	)		$	9,423,060			$	1,394,534

 (Continued)

The accompanying notes are an integral part of these consolidated financial statements.

F-6

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ECOSPHERE TECHNOLOGIES, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CHANGES IN EQUITY (DEFICIT)

For the Years Ended December 31, 2013, 2012 and 2011

		Ecosphere Technologies, Inc. Stockholders’ Deficit
		Issued								Issuable												Additional								Non-
		Common Stock								Common Stock												Paid-In				Accumulated				controlling
		Shares				Par Value				Shares						Par Value						Capital				Deficit				Interest				Total
Balance at December 31, 2012			160,060,088			$	1,600,599				1,138,724						$	11,388				$	107,697,370			$	(117,337,883	)		$	9,423,060			$	1,394,534
Common stock issued for options and warrants exercised for cash			1,065,314				10,653				—							—					160,035				—				—				170,688
Common stock issued for cashless option and warrant exercises			1,570,435				15,704				—							—					(15,704	)			—				—				—
Common stock issued for conversion of convertible notes			98,425				984				—							—					36,516				—				—				37,500
Common stock issued/issuable for restricted stock vesting			84,000				840				105,263							1,053					58,107				—				—				60,000
Issuance of issuable shares			1,138,724				11,388				(1,138,724		)					(11,388	)				—				—				—				—
Stock options granted and vested to employees, directors and advisors			—				—				—							—					1,203,785				—				—				1,203,785
Common stock issued for interest payment on convertible note			16,153				162				—							—					5,838				—				—				6,000
Reclassification of derivative upon warrant exercises			—				—				—							—					102,807				—				—				102,807
Warrants issued as finder fees			—				—				—							—					21,211				—				—				21,211
Note discount from warrant			—				—				—							—					2,203,509				—				—				2,203,509
Stock options modification			—				—				—							—					26,532				—				—				26,532
Preferred stock dividends			—				—				—							—					(82,752	)			—				—				(82,752	)
Sale of controlling interest in subsidiary			—				—				—							—					—				—				(9,235,254	)			(9,235,254	)
Net income (loss), 2013			—				—				—							—					—				19,357,264				(187,806	)			19,169,457
Balance at December 31, 2013			164,033,139			$	1,640,330				105,263						$	1,053				$	111,417,253			$	(97,980,619	)		$	—			$	15,078,017

The accompanying notes are an integral part of these consolidated financial statements.

F-7

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ECOSPHERE TECHNOLOGIES, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

		For the Years Ended December 31,
		2013				2012				2011
Operating Activities:
Net income (loss) applicable to Ecosphere Technologies, Inc. common stock		$	19,274,512			$	136,200			$	(7,654,674	)
Adjustments to reconcile net income (loss) applicable to Ecosphere Technologies, Inc. common stock to net cash provided by (used in) operating activities:
Gain on deconsolidation			(29,474,609	)			—				—
Preferred stock dividends			82,752				102,813				103,000
Depreciation and amortization			1,018,146				2,318,605				2,174,983
Amortization of debt issue costs			27,737				—				—
Amortization of discount on notes payable			300,043				189,604				263,767
Restructuring reversal			—				(62,000)				—
Loss on conversion of debt and accrued interest to common stock			—				—				93,762
Stock-based compensation expense			1,290,317				1,480,692				6,668,229
Gain on sale/disposal of fixed assets, net			—				(142,457	)			—
Noncontrolling interest in income (loss) of consolidated subsidiary (See Note 4)			(187,806	)			815,054				1,690,075
Gain from change in fair value of warrant derivative liability			(90,531	)			(41,374	)			(152,888	)
Loss on investment in unconsolidated investee			927,161				—				—
Loss on sale of interest in unconsolidated investee			600,000				—				—
Write-down of inventory			158,650				—				—
Changes in operating assets and liabilities:
Decrease (increase) in accounts receivable			689,865				(277,035	)			(169,642	)
Increase in accounts receivable – related party			(3,478,851	)			—				—
(Increase) decrease in prepaid expenses and other current assets			(27,329	)			102,844				115,353
Increase in inventory			(785,691	)			(348,935	)			(19,189	)
Decrease (increase) in deposits			—				157				(393	)
Decrease in accounts payable			(300,137	)			(335,482	)			(790,166	)
(Decrease) increase in accrued liabilities			(260,594	)			(41,385	)			350,399
Decrease in restructuring reserve			(5,909	)			(51,275	)			(61,935	)
(Decrease) increase in customer deposits			(22,035	)			23,196				—
Net cash provided by (used in) operating activities			(10,264,309	)			3,869,222				2,610,681
Investing Activities:
Net proceeds from sale of interest in subsidiary			9,500,000				—				—
Repayment of amounts due to unconsolidated investee			(1,385,139	)			—				—
Cash held by deconsolidated subsidiary			(247,636	)			—				—
Proceeds from sale of fixed asset			—				206,000				—
Transfers (to) from restricted cash			35,168				(60,168	)			—
Purchase of property and equipment			(446,724	)			(373,386	)			(622,240	)
Payment of patent costs			(65,563	)			—				—
Net cash provided by (used in) investing activities			7,390,106				(227,554	)			(622,240	)
Financing Activities:
Proceeds from issuance of convertible notes payable and warrants, net of debt issuance costs			2,406,467				—				1,575,000
Proceeds from warrant and option exercises			170,688				278,675				849,819
Proceeds from warrant modification			—				107,400				—
Proceeds from equipment and vehicle financing			—				54,287				175,744
Distributions from FNES subsidiary to noncontrolling members			—				(3,160,375	)			—
Repayments of notes payable and insurance financing			(981,075	)			(240,162	)			(151,052	)
Repayments of notes payable to related parties			—				(136,676	)			(2,412,783	)
Repayments of vehicle and equipment financing			(112,544	)			(116,474	)			(27,963	)
Principal payments on capital leases			(14,593)				(7,025	)			—
Net cash (used in) provided by financing activities			1,468,943				(3,220,350	)			8,765
Net increase (decrease) in cash			(1,405,260	)			421,318				1,997,206
Cash at beginning of year			2,464,911				2,043,593				46,387
Cash at end of year		$	1,059,651			$	2,464,911			$	2,043,593

 (Continued)

The accompanying notes are an integral part of these consolidated financial statements.

F-8

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ECOSPHERE TECHNOLOGIES, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)

 

		For the Years Ended December 31,
		2013				2012				2011
Supplemental Cash Flow Information:
Cash paid for interest		$	311,042			$	26,018			$	287,465
Cash paid for income taxes		$	—			$	—			$	—
Non-cash investing and financing activities:
Accrued preferred stock dividends		$	82,752			$	102,813			$	103,000
Discount related to warrants issued with convertible debt		$	—			$	—			$	415,751
Conversion of convertible notes to common stock		$	37,500			$	723,216			$	—
Reduction of derivative liability for warrant derivative instruments from warrant exercises and modifications		$	102,807			$	108,852			$	110,521
Warrants issued as debt issue cost		$	21,211			$	—			$	—
Modification of convertible debt and issuance of common stock warrants for extension of maturity dates		$	111,738			$	—			$	—
Equipment purchased under capital lease		$	—			$	78,896			$	—
Equipment purchased under installment arrangement with vendor		$	—			$	48,000			$	—
Common stock issued as settlement of note and accrued interest		$	6,000			$	—			$	66,328
Series B Redeemable Convertible Cumulative Preferred Stock converted to common stock		$	—			$	2,500			$	—
Conversion of accrued interest to long-term notes payable		$	—			$	—			$	49,089
Conversion of Series B preferred stock to common stock		$	—			$	443,334			$	—
Cashless exercise of options and warrants		$	14,957			$	31,243			$	33,420
Beneficial conversion feature on convertible debt charged to additional paid in capital		$	2,091,771			$	—			$	—
Extension of term of stock options in settlement of accrued interest on convertible debt		$	26,532			$	—			$	—
Vehicle purchased through third party financing arrangement		$	56,802			$	—			$	—
Insurance premium finance contract recorded as prepaid asset		$	168,859			$	171,929			$	151,052

 

The accompanying notes are an integral part of these consolidated financial statements.

F-9

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ECOSPHERE TECHNOLOGIES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

FOR THE YEARS ENDED DECEMBER 31, 2013, 2012 AND 2011

1.

DESCRIPTION OF THE BUSINESS AND BASIS OF PRESENTATION

Description of the Business

Ecosphere Technologies, Inc. (“Ecosphere,” “ETI” or the “Company”), 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.

The Company is a leader in emerging advanced oxidation processes and has an extensive portfolio of intellectual property that includes six approved United States patents and numerous patents pending for the Ecosphere Ozonix® process. The patented Ecosphere Ozonix® process is a revolutionary advanced oxidation process that is currently being used by customers to reduce costs, increase treatment efficiencies and eliminate harmful chemicals from wastewater treatment operations around the United States. Ozonix® can be used to replace chemicals in a wide variety of industries and applications, including but not limited to agriculture, energy, food and beverage, industrial, mining, marine, and municipal wastewater treatment.

In 2009, Ecosphere formed Ecosphere Energy Services, LLC (“EES”), now Fidelity National Environmental Solutions, LLC (“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, protecting $4 billion worth of well assets, and generating over $65 million in revenue; substantially increasing Ecosphere’s revenue over four years to more than $31 million in 2012.

The Company plans to further leverage its 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. The Company has formed six subsidiaries which includes; Ecosphere Agriculture, LLC, Ecosphere Food & Beverage, LLC, Ecosphere Industrial, LLC, Ecosphere Marine, LLC, Ecosphere Mining, LLC and Ecosphere Municipal, LLC. The Company’s strategy is to replicate its experience with FNES by recruiting outside investors in its subsidiaries and then exploiting the sublicenses in each industry specific field-of-use.

On May 24, 2013, ETI sold 12% of FNES to Fidelity National Financial, Inc. (NYSE:FNF) (“FNF”), a Fortune 500 company and an existing FNES member, for $6 million under a Unit Purchase Agreement (the “Agreement”). In consideration for facilitating the transaction, ETI transferred an additional 1.5% interest of FNES to an existing FNES member. Additionally, for a 90-day period, FNF had the option to purchase an additional 8% of FNES from ETI for $4 million. The option was exercised in July 2013. In connection with the July 2013 transaction, ETI transferred an additional 0.5% interest of FNES and paid $250,000 in cash to the same existing FNES member as discussed above and granted to FNF, an option to acquire an additional 12% interest in FNES for $6 million by December 31, 2013. The option was not exercised. As a result, on December 31, 2013 ETI and FNF owned 30.6% and 39% of FNES, respectively.

F-10

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ECOSPHERE TECHNOLOGIES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

FOR THE YEARS ENDED DECEMBER 31, 2013, 2012 AND 2011

Accordingly, in 2013, Ecosphere retained Navigant Consulting, Inc. (NYSE:NCI), a leading company in the field of intellectual property valuation, to perform an analysis for value of our patented Ozonix® technology portfolio. Navigant 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 the Company owns 30.6% interest in FNES. While this valuation is subject to a number of assumptions, the Company believes it illustrates the hidden value that is not recognized on our Balance Sheet or by the investment community.

During 2013, Ecosphere received $10 million in gross proceeds from FNF for the sale of the Company’s 20% interest in FNES. Ecosphere’s management team estimates that this sale represents approximately 2% of the estimated value of the Company’s global Ozonix® intellectual property portfolio. Effective May 24, 2013, ETI recognized a gain on deconsolidation of approximately $29.5 million and began accounting for its investment in FNES using the equity method of accounting. (See Notes 3 and 4)

The Company has formed six subsidiaries which it expects will obtain exclusive sublicenses for global, industry-specific fields-of-use to its patented Ozonix® technology. The Company has hired investment banker Ladenburg Thalmann to assist it with obtaining equity financing for these subsidiaries, but initially will focus on Ecosphere Mining, LLC.

Basis of Presentation

The accompanying consolidated financial statements have been prepared in accordance with Generally Accepted Accounting Principles (“GAAP”) in the U.S. as promulgated by the Financial Accounting Standards Board (“FASB”), Accounting Standards Codification (“ASC”) and with the rules and regulations of the U.S. Securities and Exchange Commission (“SEC”) for financial information.

On June 5, 2013, the Company issued a 5% stock dividend (the “dividend”) to its common stockholders. All common stockholders that owned the Company’s common stock as of the close of trading on June 14, 2013, were entitled to receive the dividend. Each qualifying stockholder received 5 shares for each 100 shares owned. Share and per share information for all periods presented have been retroactively adjusted to reflect the 5% stock dividend.

Going Concern

As of March 14, 2014, Ecosphere had cash on hand of approximately $1.2 million and working capital of $0.8 million as of December 31, 2013. With the sale of our interests in FNES and the resulting reduction of our ownership interest to 30.6%, Ecosphere presently does not have any regularly recurring revenue. These factors raise substantial doubt about the Company’s ability to continue as a going concern. To support its operations, the Company has a number of plans to monetize its intellectual property, which is described below.

In July 2013, Ecosphere sold 8% interest in FNES for gross proceeds of $4 million in addition to $8 million received in early 2013 related to the sale of 12% interest in FNES. In 2013, Ecosphere sold two Ozonix® EF80 units to FNES for $2.4 million a unit, respectively. For the first Ozonix® EF80, FNES paid $500,000 down in July 2013, and agreed to pay the remainder in equal monthly installments of approximately $52,778 over 36 months. For the second Ozonix® EF80, which was sold in November 2013, FNES paid $250,000 down and agreed to pay the remainder in equal monthly installments of approximately $59,722 over 36 months. In March 2014, Ecosphere sold the FNES note payable for the Unit sold in July in exchange for $1 million in cash. The buyer of the note is an FNES member and director. Since December 18, 2013, Ecosphere has raised approximately $1.95 million through the sale of Convertible Notes and Warrants. Ecosphere is seeking to raise up to another $3.05 million from the sale of Convertible Notes and Warrants. See Note 10 to the Consolidated Financial Statements for details on this financing. Management believes that its current plans will provide sufficient liquidity for the next 12 months and beyond.

Ecosphere plans to continue monetizing its intellectual property, and has identified the following liquidity sources that it expects to realize over the next three years:

·

Convertible Notes described above.

·

The FNES note with $59,722 per month of payments as described above. Ecosphere is seeking to sell this note.

F-11

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ECOSPHERE TECHNOLOGIES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

FOR THE YEARS ENDED DECEMBER 31, 2013, 2012 AND 2011

·

Ecosphere plans to sell minority rights to the Ozonix® technology for use in industries outside of oil and gas exploration that management expects will result in similar realization of value as that realized by the development and sale of rights to the technology to FNES. Ecosphere owns 100% of the rights to the Ozonix® technology in the U.S. and globally to all applications outside of the energy industry, including but not limited to agriculture, energy, food and beverage, industrial, mining, marine and municipal wastewater treatment, and any other industry in which water is treated with traditional chemicals to clean and recycle it for human consumption and industrial consumption and industrial disposal or for re-use.

·

In December 2013, Ecosphere launched an offering of a minority interest in Ecosphere Mining, LLC, a newly formed subsidiary, and has retained Ladenburg Thalmann to raise $10 million.

·

Ecosphere’s business model revolves upon the sale of intellectual property. In addition to its 30.6% interest in FNES, Ecosphere has the patent rights to all of its Ozonix® technology outside of energy. All of the various “vertical” applications are available for sale including the 30.6% of FNES. Ecosphere also recently received a patent for its Ecos PowerCube® and is seeking to sell all or a portion of it.

·

The Company expects to begin manufacturing Ozonix® water treatment equipment pursuant to the exclusive technology license and equipment purchase agreement between Hydrosphere Energy Solutions and FNES.

Management believes that the realization of any of the above events will provide sufficient liquidity for the foreseeable future. However, Ecosphere cannot provide any assurance that these plans will be successful. The consolidated financial statements do not include any adjustments relating to the recoverability and classification of recorded asset amounts or the amounts and classification of liabilities that might be necessary should the Company be unable to continue as a going concern.

Ecosphere’s arbitration proceeding against Halliburton is another potential source of liquidity.

In addition to needing capital to support its operations, Ecosphere has $1,007,500 in convertible notes payable due over the next 12 months. This consists of $295,000 due in March 2014 and $712,500 due in February 2015.

2.

SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Principles of Consolidation

The accompanying consolidated financial statements include the accounts of Ecosphere, its wholly-owned subsidiaries and through May 23, 2013, Ecosphere Energy Services, LLC (“EES”), now Fidelity National Environmental Solutions LLC (“FNES”). 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. On July 31, 2013, the Company sold an additional 8% interest in FNES and transferred an additional 0.5% interest to a board member of FNES, reducing the Company’s ownership in FNES from 39.1% to 30.6% (See Notes 3 and 4). The Company continues to account for its investment in FNES under the equity method. All intercompany account balances and transactions have been eliminated.

Noncontrolling Interest

Prior to May 24, 2013, the Company accounted for its less than 100% interest in EES in accordance with ASC Topic 810, Consolidation, and accordingly the Company presented noncontrolling interests as a component of equity on its consolidated balance sheets and reported noncontrolling interest net income or loss under the heading “Net (income) loss applicable to noncontrolling interest in consolidated subsidiary” in the consolidated statements of operations.

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, valuation of beneficial conversion features in convertible debt, valuation of equity based instruments issued for other than cash, warranty reserve, valuation of derivatives, valuation of remaining interest in FNES upon deconsolidation and the valuation allowance on deferred tax assets.

F-12

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ECOSPHERE TECHNOLOGIES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

FOR THE YEARS ENDED DECEMBER 31, 2013, 2012 AND 2011

Cash Equivalents

The Company considers all highly liquid investments with original maturities of three months or less at the date of purchase to be cash equivalents.

Restricted Cash

Restricted cash as of December 31, 2013, represents a $25,000 compensating balance held pursuant to certain of the Company's short-term financing arrangements.

 

Accounts Receivable and Allowance for Doubtful Accounts

Accounts receivable are stated at their estimated net realizable value. The Company reviews its accounts to estimate losses resulting from the inability of its customers to make required payments. Any required allowance is based on specific analysis of past due accounts and also considers historical trends of write-offs. Past due status is based on how recently payments have been received from customers. The Company’s collection experience has been favorable reflecting a limited number of customers, all of which are in the oil and gas industry. No allowance was deemed necessary at December 31, 2013 and 2012.

Inventory

Inventory is primarily comprised of raw materials to manufacture water treatment equipment and work-in-process representing a mobile solar power system being manufactured and assembled for future sale where no binding sales contract exists. Inventory on hand at each respective balance sheet date is stated at the lower of cost or market with cost determined using a weighted average methodology. See Note 7.

Property and Equipment and Capital Leases

Property and equipment is stated at cost. For equipment manufactured for use by the Company, cost includes direct component parts plus direct labor. Depreciation is computed using the straight-line method based on the estimated useful lives generally ranging from three to seven years. Amortization of leasehold improvements is computed using the straight-line method over the lesser of the useful life of the asset or the remaining term of the lease. Expenditures for maintenance and repairs are expensed as incurred.

Debt Issuance Cost

The Company accounts for debt issuance cost in accordance with ASC 470, Debt. The costs associated with the issuance of debt are capitalized and amortized over the life of the underlying debt instrument.

 

Patents

 

Patents are stated at cost and are being amortized on a straight-line basis over the estimated future periods to be benefited. All patents at December 31, 2013 and 2012 have either been acquired from a related Company or assigned to the Company by the Company's founder. Patents are recorded at the historical cost basis. The Company recognized amortization expense of $9,220 $4,470 and $3,981 for the years ended December 31, 2013, 2012 and 2011, respectively.

 

Impairment of Long-Lived Assets

 

The Company accounts for long-lived assets in accordance with the provisions of ASC 360-10, Accounting for the Impairment or Disposal of Long-Lived Assets. This statement requires that long-lived assets and certain identifiable intangibles be reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to future undiscounted net cash flows expected to be generated by the asset. If such assets are considered to be impaired, the impairment to be recognized is measured by the amount by which the carrying amount of the assets exceeds the fair value of the assets. Assets to be disposed of are reported at the lower of the carrying amount or fair value less, costs to sell.

F-13

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ECOSPHERE TECHNOLOGIES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

FOR THE YEARS ENDED DECEMBER 31, 2013, 2012 AND 2011

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.

Derivative Instruments

ASC Topic 815, Derivatives and Hedging (“ASC Topic 815”), establishes accounting and reporting standards for derivative instruments and for hedging activities by requiring that all derivatives be recognized in the balance sheet and measured at fair value. Gains or losses resulting from changes in the fair value of derivatives are recognized in earnings or recorded in other comprehensive income (loss) depending on the purpose of the derivatives and whether they qualify and have been designated for hedge accounting treatment. The Company does not have any derivative instruments for which it has applied hedge accounting treatment.

Fair Value of Financial Instruments and Fair Value Measurements

 

The Company measures its financial and non-financial assets and liabilities, as well as makes related disclosures, in accordance with ASC Topic 820, Fair Value Measurements and Disclosures (“ASC Topic 820”). For certain of our financial instruments, including cash, accounts receivable, accounts payable and accrued liabilities, the carrying amounts approximate fair value due to their short maturities. Amounts recorded for notes payable, net of discount, also approximate fair value because current interest rates available to the Company for debt with similar terms and maturities are substantially the same.

ASC Topic 820 provides guidance with respect to valuation techniques to be utilized in the determination of fair value of assets and liabilities. Approaches include, (i) the market approach (comparable market prices), (ii) the income approach (present value of future income or cash flow), and (iii) the cost approach (cost to replace the service capacity of an asset or replacement cost). ASC Topic 820 utilizes a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value into three broad levels. The following is a brief description of those three levels:

Level 1:

Observable inputs such as quoted prices (unadjusted) in active markets for identical assets or liabilities.

Level 2:

Inputs other than quoted prices that are observable, either directly or indirectly. These include quoted prices for similar assets or liabilities in active markets and quoted prices for identical or similar assets or liabilities in markets that are not active.

Level 3:

Unobservable inputs in which little or no market data exists, therefore developed using estimates and assumptions developed by us, which reflect those that a market participant would use.

F-14

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ECOSPHERE TECHNOLOGIES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

FOR THE YEARS ENDED DECEMBER 31, 2013, 2012 AND 2011

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.

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 (See Note 4)

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.

After Market Part Sales

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

F-15

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ECOSPHERE TECHNOLOGIES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

FOR THE YEARS ENDED DECEMBER 31, 2013, 2012 AND 2011

Royalties

Revenue from technology license royalties will be recorded if and as the royalties are earned. No royalty revenue has been earned to date.

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

Product Warranties

The Company accrues for product warranties when the loss is probable and can be reasonably estimated. At December 31, 2013 and 2012, the Company has no product warranty accrual given its lack of long-term historical warranty experience and the fact that more recent warranty repair experience relates to what we believe are non-recurring issues and are therefore, not indicative of future warranty estimates or material to the Company’s operations. The warranty period on the first unit constructed ended September 22, 2013 and the warranty period on following three units ended during the three months ended December 31, 2013. The remaining eight units have warranty periods ending by December 31, 2014.

Research and Development

In accordance with ASC Topic 730-10, Research and Development – Overall, expenditures for research and development of the Company's products are expensed when incurred, and are included in operating expenses. For the year ended December 31, 2013, the Company’s research and development costs were de minimis. The Company recognized research and development cost of $28,290 and $247,107 for the years ended December 31, 2012, and 2011, respectively.

 

Advertising

 

The Company conducts advertising for the promotion of its products and services. In accordance with ASC 720-35, Advertising Costs, are charged to operations when incurred and totaled $166,952, $181,269 and $20,571 for the years ended December 31, 2013, 2012 and 2011, respectively.

 

Equity-based Compensation

Compensation expense for all stock-based employee and director compensation awards granted is based on the grant date fair value estimated in accordance with the provisions of ASC Topic 718, Stock Compensation (“ASC Topic 718”). The Company recognizes these compensation costs on a straight-line basis over the requisite service period of the award, which is generally the option vesting term. Vesting terms vary based on the individual grant terms.

The Company estimates the fair value of stock-based compensation awards on the date of grant using the Black-Scholes-Merton (“BSM”) option pricing model, which was developed for use in estimating the value of traded options that have no vesting restrictions and are freely transferable. In addition, option valuation models require the input of highly subjective assumptions including the expected stock price volatility. The BSM option pricing model considers, among other factors, the expected term of the award and the expected volatility of the Company’s stock price. Expected terms are calculated using the Simplified Method, volatility is determined based on the Company's historical stock price trends and the discount rate is based upon treasury rates with instruments of similar expected terms. Warrants granted to non-employees are accounted for in accordance with the measurement and recognition criteria of ASC Topic 505-50, Equity Based Payments to Non-Employees.

Income Taxes

The Company uses the asset and liability method in accounting for income taxes. Under this method, deferred income tax assets and liabilities are determined based on difference between financial reporting and tax bases of assets and liabilities and are measured using the enacted tax rates and laws that will be in effect when the differences are expected to reverse. A valuation allowance is provided to offset any net deferred tax assets for which management believes it is more likely than not that the net deferred asset will not be realized.

F-16

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ECOSPHERE TECHNOLOGIES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

FOR THE YEARS ENDED DECEMBER 31, 2013, 2012 AND 2011

Accounting for Uncertainty in Income Taxes

The Company applies the provisions of ASC Topic 740-10-25, Income Taxes – Overall – Recognition (“ASC Topic 740-10-25”) with respect to the accounting for uncertainty of income tax positions. ASC Topic 740-10-25 clarifies the accounting for uncertainty in income taxes recognized in a company’s financial statements and prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. ASC Topic 740-10-25 also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure and transition. As of December 31, 2013, tax years since 2009 remain open for IRS audit. The Company has received no notice of audit from the Internal Revenue Service for any of the open tax years.

Net Income (Loss) Per Share

The Company displays earnings per share in accordance with ASC 260, Earnings Per Share (“ASC 260”). ASC 260 requires dual presentation of basic and diluted earnings per share (“EPS”). Basic earnings per share is computed by dividing net (loss) income attributable to common stockholders by the weighted average number of common shares outstanding for the period. Diluted earnings per share includes the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock.

The computation of basic and diluted earnings per share is as follows:

		For the year ended December 31, 2013
		Basic				Diluted
Numerator
Net (loss) income applicable to common stock		$	19,274,512			$	19,274,512
Denominator
Weighted average common shares outstanding			163,054,587				163,054,587
Warrants and options			—				1,361,194
			163,054,587				164,415,781
Net (loss) income per share		$	0.12			$	0.12

		For the year ended December 31, 2012
		Basic				Diluted
Numerator
Net (loss) income applicable to common stock		$	136,200			$	136,200
Denominator
Weighted average common shares outstanding			156,438,773				156,438,773
Warrants and options			—				5,836,003
Restricted stock			—				21,635
			156,438,773				162,296,411
Net (loss) income per share		$	0.00			$	0.00

For the year ended December 31, 2011, the computation of diluted loss per share was the same as basic loss per share because all outstanding potentially dilutive instruments were anti-dilutive.

F-17

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ECOSPHERE TECHNOLOGIES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

FOR THE YEARS ENDED DECEMBER 31, 2013, 2012 AND 2011

Securities that could potentially dilute basic EPS in the future, that were not included in the computation of diluted EPS because to do so would have been anti-dilutive for the periods presented, consist of the following:

Anti-Dilutive Potential Common Shares
		December 31,
		2013				2012				2011
Convertible debt			8,274,479				2,171,107				3,075,189
Convertible preferred stock			362,497				432,900				433,514
Options and warrants to purchase common stock			70,915,167				58,570,398				77,566,750
Unvested stock grants			—				62,366				333,267
Total Anti-Dilutive Potential Common Shares			79,551,909				61,236,771				81,408,720

New Accounting Standards

Management does not believe that any recently issued, but not yet effective accounting standards, if currently adopted, would have a material effect on the consolidated financial statements.

3.

GAIN ON SALE OF INTEREST IN SUBSIDIARY

As a result of the Company selling a 12% interest in FNES in May 2013, the Company recognized a gain on deconsolidation on the sale of FNES of $29,474,609 during the year ended December 31, 2013, consisting of the following:

Net cash consideration		$	5,850,000
Retained investment			19,546,600
Carrying value of non-controlling interest			9,235,254
Net assets of EES			(5,157,245	)
Gain on deconsolidation		$	29,474,609

4.

INVESTMENT IN UNCONSOLIDATED INVESTEE

As a result of its sale of a 12% interest in FNES on May 24, 2013, the Company deconsolidated FNES and accounts as noted in Note 3 for its investment using the equity method of accounting. The Company sold an additional 8% interest in FNES in July 2013, reducing its ownership interest in FNES to 30.6% as of December 31, 2013. Financial information for FNES as of December 31, 2013 and for the period from May 24, 2013 through December 31, 2013, which is derived from the FNES audited financial statements is summarized below and full financials are included elsewhere in the 10-K for fiscal year ended December 31, 2013  in accordance with Regulation S-X rule 3-09:

		December 31, 2013
ASSETS
Cash		$	1,462,397
Accounts receivable			431,978
Property and equipment			6,702,562
Inventory			474,261
Prepaid Expenses			1,984
Intangible Assets			1,875,000
Deposits			4,200
Total Assets		$	10,952,382
LIABILITIES AND MEMBERS' EQUITY
Accounts payable and accrued expenses		$	196,933
Debt			9,142
Debt, related party			3,470,709
Members' equity			7,275,598
Total liabilities and members' equity		$	10,952,382

F-18

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ECOSPHERE TECHNOLOGIES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

FOR THE YEARS ENDED DECEMBER 31, 2013, 2012 AND 2011

		For the three months ended December 31, 2013			For the period May 24, 2013 through December 31, 2013
		(Unaudited)
STATEMENT OF OPERATIONS
Revenues		$	1,318,587		$	3,789,722
Cost of sales			675,279			1,551,011
Gross profit			643,308			2,238,711
Operating expenses			1,588,681			4,284,576
Operating loss			(945,373	)		(2,045,865	)
Other expense			(29,130	)		(44,302	)
Net loss			(974,503	)		(2,090,167	)
Ownership interest (average)			31	%		31	%
Share of net loss		$	(298,123	)	$	(627,572	)
Elimination of intra-entity profit		$	(145,440	)	$	(299,589	)
Total equity interest loss recorded		$	(443,563	)	$	(927,161	)
Investment		$	14,369,439		$	14,369,439

Transactions with FNES:

The Company sold two Ozonix® EF80 units to FNES during the year ended December 31, 2013. A portion of the profits from the sale reflects the Company’s ownership share and is eliminated through an adjustment to “Loss on investment in unconsolidated investee.” The table below sets forth the revenues and gross profits recognized by the Company and the calculation of the amounts eliminated in the “Loss on investment in unconsolidated investee” line on the Statement of Operations:

Revenue recognized on sales to FNES		$	4,509,478
Cost of sales on sales to FNES			3,530,183
Approximate ownership interest in FNES			31	%
Elimination of the Company’s share of profits on sales to FNES		$	299,589

 

5.

ACCOUNTS RECEIVABLE

 

As of December 31, 2013, accounts receivable in the amount of $3,478,851 consisted of amounts due from one related party customer, FNES, in connection with the sale of Ozonix® equipment. The Company sold two Ozonix® EF80 units in July and November 2013 to FNES, pursuant to which FNES paid the Company $500,000 and $250,000 and agreed to pay 36 monthly payments of $52,778 and $59,722, respectively. Note 21, Concentration of Risk.

As of December 31, 2012, accounts receivable in the amount of $1,150,152 consisted of amounts due from three customers, one for providing Ecos-Frac® services to treat water without the use of chemicals prior to fracturing natural gas wells, one for processing frac flowback water for reuse in fracturing natural gas wells and one for ancillary revenue related to equipment sales. See Note 21, Concentration of Risk.

As of December 31, 2011, accounts receivable in the amount of $873,117 consisted of amounts due from three customers, one for providing Ecos-Frac® services to treat water without the use of chemicals prior to fracturing natural gas wells, one for processing frac flowback water for reuse in fracturing natural gas wells and one for ancillary revenue related to equipment sales. See Note 21, Concentration of Risk.

F-19

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ECOSPHERE TECHNOLOGIES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

FOR THE YEARS ENDED DECEMBER 31, 2013, 2012 AND 2011

6.

PREPAID EXPENSES AND OTHER CURRENT ASSETS

 

Prepaid expenses and other current assets are summarized as follows:

		December 31,
		2013				2012
Prepaid insurance		$	28,436			$	38,173
Vendor advances			42,500				1,055
Prepaid professional fees			39,000				44,000
Other			11,544				23,839
Total prepaid expenses and other current assets		$	121,480			$	107,067

7.

INVENTORY

Inventory consists of the following:

		December 31,
		2013				2012
Raw materials		$	178,982			$	609,557
Work in process			40,296				148,125
Total		$	219,278			$	757,682

8.

PROPERTY AND EQUIPMENT

 

Property and equipment consists of the following:

		Estimated Useful			December 31,
		Lives in Years			2013				2012
Machinery and equipment		5			$	2,329,731			$	10,698,094
Furniture and fixtures		5 to 7				303,026				342,918
Automobiles and trucks		3 to 5				142,141				241,834
Leasehold improvements		5				469,230				415,281
Office equipment		5				608,633				582,156
Construction in progress						—				183,693
						3,852,761				12,463,976
Less total accumulated depreciation						(1,995,160)				(8,199,851	)
Property and equipment, net					$	1,857,601			$	4,264,125

During the year ended December 31, 2013, additions to property and equipment included the purchase of a work truck, mobile operations vehicle, computer equipment and software, and additional construction in progress of a piece of equipment for the treatment of wastewater outside of oil and gas exploration. The unit was completed in the third quarter and the amounts were reclassified from construction in progress to machinery and equipment. In addition, the Company has additions to leasehold improvements in connection with the new Ecosphere Mining office in Park City, UT and the addition of one Ozonix® Ore Recovery Equipment to machinery and equipment to be used in the mining application.

With the deconsolidation of FNES, the Company removed assets with a net book value of approximately $3.0 million.

In September 2012, the Company sold a water treatment unit that had been part of its historical fixed assets. The net book value of such unit was previously written off pursuant to a September 2010 impairment charge. The Company received proceeds of $206,000 for the unit, incurred costs of $33,933 to bring the unit to saleable condition and recognized a gain on sale of $172,067 on the transaction. Partially offsetting this gain was the write off of the costs of certain demo equipment amounting to $29,610.

During the year ended December 31, 2012, additions to property and equipment included certain equipment obtained under a capital lease arrangement with a value of approximately $79,000 along with equipment acquired through a financing arrangement in the amount of approximately $48,000 which is reflected in the caption “Machinery and Equipment.” See Note 10.

F-20

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ECOSPHERE TECHNOLOGIES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

FOR THE YEARS ENDED DECEMBER 31, 2013, 2012 AND 2011

Depreciation expense for the years ended December 31, 2013, 2012 and 2011 amounted to $1,008,926, $2,314,135 and $2,171,002, respectively.

9.

ACCRUED LIABILITIES

 

The major components of accrued liabilities are summarized as follows:

 

		December 31,
		2013				2012
Accrued payroll and related benefits		$	318,139			$	443,023
Accrued interest			277,560				396,325
Accrued professional fees			22,538				40,000
Other accrued liabilities (See Note 20)			225,656				242,771
Total accrued liabilities		$	843,893			$	1,122,119

10.

NOTES PAYABLE AND OTHER DEBT

Long-term debt consists of the following at December 31, 2013, and December 31, 2012:

Convertible Notes Payable

		December 31, 2013				December 31, 2012
Convertible notes in the aggregate principal amount of $1,700,000. The notes accrue interest at an annual rate of 10%, mature in December 2015 and are convertible into common stock at a conversion rate of $0.30 per share. In connection with the issuance of the notes, the Company issued to the investors five-year warrants to purchase 11,333,328 shares of common stock at an exercise price of $0.35 per share. The Company recorded a discount related to the warrants and beneficial conversion feature of $1,700,000 based upon the relative fair value of the warrants calculated using the Black Scholes valuation method and the following assumptions: volatility ranging between 78.23% and 78.47%, an expected term of five years, a risk-free discount rate ranging between 1.55% and 1.71% and no dividends. As of December 31, 2013, the unamortized amount of the discount was $1,688,904 and accrued interest was $5,625.		$	11,096			$	—
Convertible notes in the aggregate principal amount of $750,000. The notes accrue interest at an annual rate of 8.5%, mature in February 2015 and are convertible into common stock at a conversion rate of $0.381 per share. In connection with the issuance of the notes, the Company issued to the investors five-year warrants to purchase 984,375 shares of common stock at an exercise price of $0.381 per share. The Company recorded a discount related to the warrants and beneficial conversion feature of $391,771 based upon the relative fair value of the warrants calculated using the Black Scholes valuation method and the following assumptions: volatility of 92.82%, an expected term of five years, a risk-free discount rate of 0.86%, and no dividends. In December 2013, $37,500 of the outstanding principal was converted into 98,425 shares of common stock. As of December 31, 2013, the unamortized amount of the discount was $212,612 and accrued interest was $15,890. The Company began making quarterly interest payments on October 1, 2013, for accrued interest on these convertible notes.			499,888				—

F-21

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ECOSPHERE TECHNOLOGIES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

FOR THE YEARS ENDED DECEMBER 31, 2013, 2012 AND 2011

		December 31, 2013				December 31, 2012
Convertible notes in the aggregate principal amount of $1,225,000. The notes accrue interest at an annual rate of 10%, matured in the quarter ended March 31, 2013 and were convertible into common stock at a conversion rate of $0.70 per share. In connection with the issuance of the notes, the Company issued to the investors five-year warrants to purchase 875,000 shares of common stock at an exercise price of $0.70 per share. The Company recorded a discount related to the warrants of $302,387 based upon the relative fair value of the warrants calculated using the Black Scholes valuation method and the following assumptions: volatility of 100.73% to 112.55%, an expected term of five years, a risk-free discount rates of 1.74% to 2.06%, and no dividends. During the second quarter of 2013, the Company repaid an aggregate of approximately $1.1 million of principal and interest on the notes. Holders of an aggregate of $295,000 of principal agreed to extend the maturity of their notes to March 2014. As consideration of the extensions the Company reduced the conversion price of the extended notes to $0.40 and issued warrants to purchase 368,467 shares of common stock for $0.40 per share over five years. As a result of extending the notes, the Company recorded additional discounts for beneficial conversion feature and relative fair value of the warrants totaling $111,738, which is being amortized through the extended maturity of the notes. As of December 31, 2013, and December 31, 2012, the unamortized amount of the discounts was $23,824 and $21,874, respectively. Accrued interest at December 31, 2013 and December 31, 2012 was $87,908 and $228,189, respectively.			271,176				1,203,126
Total			782,160				1,203,126
Less Current Portion, net of discounts			(271,176	)			(1,203,126	)
Convertible notes payable, long term, net of discounts		$	510,984			$	—

A summary of convertible notes payable and the related discounts as of December 31,:

		2013				2012
Principal amount of convertible notes payable		$	2,707,500			$	1,225,000
Unamortized discount			(1,925,340	)			(21,874	)
Convertible notes payable, net of discount			782,160				1,203,126
Less: current portion			(271,176	)			(1,203,126	)
Convertible notes payable, net of discount, less current portion		$	510,984			$	—

Note Payable

On January 1, 2012, the Company reclassified a non-interest bearing unsecured note payable to a former director totaling $272,399 of which $153,224 and $204,299 were outstanding at December 31, 2013, and December 31, 2012, respectively, from related party debt due to lack of on-going affiliation with the lender. The note is payable in quarterly payments of $17,025. Accordingly, $85,125 is included as a current liability in the accompanying consolidated financial statements.

F-22

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ECOSPHERE TECHNOLOGIES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

FOR THE YEARS ENDED DECEMBER 31, 2013, 2012 AND 2011

Financing Obligations

		December 31, 2013				December 31, 2012
Secured equipment notes payable in monthly installments of $3,406 over 60 months, maturing in July 2016 and accruing interest at an annual rate of 6.75%		$	102,321			$	132,430
Secured vehicle notes payable in monthly installments of $1,046 over 72 months, maturing in September 2019 and accruing interest at an annual rate of 9.65%.			54,690				—
Secured non-interest bearing, equipment notes payable in monthly installments of $8,000 over 6 months, matured in February 2013.			—				16,000
Secured vehicle notes payable in monthly installments totaling $878 over 60 months accruing interest at an annual rate of 9.0%. The vehicle notes payable were repaid during 2013.			—				18,368
Secured non-interest bearing, equipment notes payable in monthly installments of $8,333 over 12 months, maturing in December 2014 with a $15,000 deposit due January 1, 2014.			115,000				—
Secured non-interest bearing, software notes payable in monthly installments totaling $4,215 over 12 months with a $1 purchase option at the end of the lease agreement in August 2013.			—				36,362
Total			272,011				203,160
Less Current Portion			(163,746	)			(96,548	)
Financing obligations, long-term portion		$	108,265			$	106,612

Capital Lease Obligation

The Company entered into a capital lease to purchase a forklift costing $78,896 in July of 2012. The lease is payable in 60 monthly installments of $1,491 including interest at an implied rate of 5.05% through July 2017. The Company is entitled to buy the equipment for a bargain purchase price of $1 at the end of the lease.

Future minimum lease payments under this capital lease obligation as of December 31, 2013, by fiscal year, are as follows:

For the year ended December 31,		Payment
2014		$	17,888
2015			17,888
2016			17,888
2017			8,946
Total			62,610
Less implied interest			(5,334	)
Capital lease obligation			57,276
Less current potion			(15,347	)
Long-term portion		$	41,929

F-23

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ECOSPHERE TECHNOLOGIES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

FOR THE YEARS ENDED DECEMBER 31, 2013, 2012 AND 2011

Third Party Debt

Aggregate annual maturities of third party debt are as follows as of December 31, 2013:

For the year ended December 31,		Amount
2014		$	559,218
2015			2,543,047
2016			49,546
2017			19,005
2018			10,242
2019			8,953
Total debt- face value			3,190,011
Less: unamortized discount			(1,925,340	)
Net debt		$	1,264,671

11.

RESTRUCTURING RESERVE

 

In June 2009, the Board of Directors approved an exit strategy to close the Company’s New York office in order to reduce operating costs. The Company recognized aggregate restructuring charges related to the office closing in the amount of $548,090 consisting of future lease commitments and employee severance costs in the amount of $246,920 and $301,170, respectively.

 

The fair market value of the future lease payments was calculated based upon the amount of future rents due as of September 30, 2009 of approximately $710,000 spread over 44 payments less estimated sublease income of $10,000 per month, and discounted conservatively at 3.5%, the current prime lending rate resulting in a charge to restructuring of $246,920 in accordance with ASC 420-10-15, Exit or Disposal Cost Obligations. The lease expired on April 30, 2013.

Based upon a review of the reserve performed during 2012, the Company determined that the reserve was in excess of the amount required by approximately $62,000. The Company adjusted the reserve accordingly.

The following table summarizes the activity in the restructuring reserve during the three years ended December 31,:

Restructuring Reserve:

		2013				2012				2011
Balance, beginning of year		$	5,909			$	119,184			$	181,119
Accrual adjustments			10,621				(62,000	)			—
Rental payments			(63,808	)			(187,416	)			(181,091	)
Sublease payments received			47,278				136,141				119,156
Balance, end of year		$	—			$	5,909			$	119,184

12.

DERIVATIVE FINANCIAL INSTRUMENTS

 

 Under the provisions of ASC 815-40, convertible instruments and warrants, which contain terms that protect holders from declines in the stock price (“reset provisions”), are subject to derivative accounting treatment under ASC 815-10, Derivatives and Hedging. Warrants and embedded conversion features of convertible notes, that contain re-pricing features are recorded as a liability which is revalued at fair value each reporting date. Further, under derivative accounting, the warrants are valued at their fair value, rather than their relative fair value. If the fair value of the warrants exceeds the face value of the related debt, the excess is recorded as a change in fair value on the issuance date. Embedded conversion features are valued at their fair value, rather than by the intrinsic value method. The fair value of the embedded conversion feature is added to the loan discount, in an amount which is the lesser of, the fair value of the embedded conversion feature or the excess of the face value of the debt over the fair value of the attached warrants or any other applicable debt discounts. If the amount of the fair value of the embedded conversion feature applied to the discount is less than the total fair value of the embedded conversion feature, the remainder will be recorded as a change in fair value on the issuance date.

F-24

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ECOSPHERE TECHNOLOGIES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

FOR THE YEARS ENDED DECEMBER 31, 2013, 2012 AND 2011

2011

The Company calculated the estimated fair values of the liabilities for warrant derivative instruments at December 31, 2011 with the BSM option pricing model using the closing price of the Company’s common stock of $0.44 and the ranges for volatility, expected term and risk free interest indicated in Table 1 that follows. As a result, for the year ended December 31, 2011, the Company recognized a gain from the change in derivative liability of $152,888 in other income related to the warrant derivative instruments.

Table 1		BSM Inputs
Warrants
		During the Year Ended December 31, 2011		As of December 31, 2011
Volatility		62.11% - 74.24%		63.85%
Expected Term		0.08 - 2.0 years		1.22 - 2.27
Risk Free Interest Rate		0.01% - 0.43%		0.17% - 0.28%

2012

The Company calculated the estimated fair values of the liabilities for warrant derivative instruments at December 31, 2012 with the BSM option pricing model and Monte Carlo simulations using the closing price of the Company’s common stock of $0.37 and the ranges for volatility, expected term and risk free interest indicated in Table 2 that follows (BSM inputs only). As a result, for the year ended December 31, 2012, the Company recognized a gain from the change in derivative liability of $41,374 in other income related to the warrant derivative instruments.

Table 2		BSM Inputs
Warrants
		During the Year Ended December 31, 2012		As of December 31, 2012
Volatility		52.10% - 64.10%		50.05%
Expected Term		0.46 – 1.93 years		0.37 – 1.27 years
Risk Free Interest Rate		0.08% - 0.24%		0.06% - 0.18%

2013

The Company calculated the estimated fair values of the liabilities for warrant derivative instruments at December 31, 2013 with the BSM option pricing model and Monte Carlo simulations using the closing price of the Company’s common stock of $0.28 and the ranges for volatility, expected term and risk free interest indicated in Table 3 that follows (BSM inputs only). As a result, for the year ended December 31, 2013, the Company recognized a gain from the change in derivative liability of $90,531 in other income related to the warrant derivative instruments.

Table 3		BSM Inputs
Warrants
		During the Year Ended December 31, 2013		As of December 31, 2013
Volatility		45.99% - 86.82%		86.82%
Expected Term		0.13 – 1.02 years		0.27 years
Risk Free Interest Rate		0.02% - 0.14%		0.04%

F-25

---

ECOSPHERE TECHNOLOGIES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

FOR THE YEARS ENDED DECEMBER 31, 2013, 2012 AND 2011

13.

FAIR VALUE MEASUREMENTS

We currently measure and report at fair value the liability for warrant derivative instruments. The fair value liabilities for price adjustable warrants have been recorded as determined utilizing the BSM option pricing model and Monte Carlo simulations. See Note 12. The following tables summarize our financial assets and liabilities measured at fair value on a recurring basis as of December 31, 2013 and 2012:

 

		Balance at December 31, 2013				Quoted Prices in Active Markets for Identical Assets				Significant Other Observable Inputs				Significant Unobservable Inputs
						(Level 1)				(Level 2)				(Level 3)
Liabilities:
Fair value of liability for warrant derivative instruments		$	3,671			$	—			$	—			$	3,671

		Balance at December 31, 2012				Quoted Prices in Active Markets for Identical Assets				Significant Other Observable Inputs				Significant Unobservable Inputs
						(Level 1)				(Level 2)				(Level 3)
Liabilities:
Fair value of liability for warrant derivative instruments		$	197,009			$	—			$	—			$	197,009

 

The following is a roll forward through December 31, 2013 of the fair value liability of warrant derivative instruments and embedded conversion option derivative instruments:

 

		Fair Value of
		Liability for
		Warrant
		Derivative
		Instruments
Balance at December 31, 2010		$	610,642
Fair value of warrants exercised			(110,519	)
Change in fair value included in other (income) loss			(152,888	)
Balance at December 31, 2011			347,235
Fair value of warrants exercised			(108,852	)
Change in fair value included in other (income) loss			(41,374	)
Balance at December 31, 2012			197,009
Fair value of warrants exercised			(102,807	)
Change in fair value included in other (income) loss			(90,531	)
Balance at December 31, 2013		$	3,671

14.

REDEEMABLE CONVERTIBLE CUMULATIVE PREFERRED STOCK

 

Series A

 

At December 31, 2013 and 2012 there were 6 shares of Series A Redeemable Convertible Cumulative 15% Preferred Stock outstanding. The shares are redeemable at the option of the Company at $27,500 per share plus accrued dividends or redeemable at the option of the holder upon a change of control event at $25,000 per share plus accrued dividends. A Change of Control ("CoC") event means a transfer of greater than fifty percent of the shares of common stock of the Company. The shares are convertible each into 24,000 common shares. Our Series A preferred stock provides for annual cash dividends at the rate of $3,750 per share. Accrued dividends totaled $1,053,494 and $1,030,994 on December 31, 2013 and 2012 respectively.

 

F-26

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ECOSPHERE TECHNOLOGIES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

FOR THE YEARS ENDED DECEMBER 31, 2013, 2012 AND 2011

Series B

 

At December 31, 2013 and 2012 there were 241, respectively, of Series B Redeemable Convertible Cumulative 10% Preferred Stock outstanding. The shares are redeemable at the option of the Company at $3,000 per share plus accrued dividends or redeemable at the option of the holder upon a Change of Control (“CoC”) event at $2,500 per share plus accrued dividends. The shares are convertible each into 835 common shares. Our Series B preferred stock provides for annual cash dividends at the rate of $250 per share. Accrued dividends totaled $1,914,533 and $1,854,281 on December 31, 2013 and 2012, respectively. During the year ended December 31, 2012, one holder converted one share of Series B preferred stock into 835 shares of common stock. In addition, in order to settle a dispute with a shareholder and former director, the Company issued 1,231,484 shares of common stock and the shareholder and former director converted his 80 Series B shares and accrued dividends.

 

15.

COMMON STOCK

 

The Company is authorized to issue up to 300,000,000 shares of its $0.01 par value common stock as of December 31, 2013.

Shares Issued for Cash

2013

1,065,314 shares of common stock were issued for $170,688 in cash through the exercise of warrants with exercise prices between $0.14 and $0.24 per share.

2012

1,535,974 shares of common stock were issued for $278,675 in cash through the exercise of warrants and options with exercise prices between $0.14 and $0.57 per share.

2011

 

3,944,015 shares of common stock were issued for $849,821 in cash through the exercise of warrants and options with exercise prices between $0.14 and $0.27 per share.

 

 

Shares Issued in Cashless Option Exercises

2013

The Company issued 1,570,435 shares of common stock in connection with the cashless exercise of options to purchase 4,200,000 shares of the Company’s common stock exercisable at $0.29 per share and based upon the market values of the Company’s common stock ranging from $0.46 to $0.50 per share.

2012

The Company issued 642,960 shares of common stock in connection with the cashless exercise of options to purchase 1,192,450 shares of the Company’s common stock exercisable at $0.14 to $0.34 per share and based upon the market values of the Company’s common stock ranging from $0.60 to $0.63 per share.

2011

The Company issued 1,235,295 shares of common stock in connection with the cashless exercise of options to purchase 2,100,000 shares of the Company’s common stock exercisable at $0.27 per share and based upon the market value of the Company’s common stock of $0.68 per share.

The Company issued 44,798 shares of common stock in connection with the cashless exercise of options to purchase 84,000 shares of the Company’s common stock exercisable at $0.27 per share and based upon the market value of the Company’s common stock of $0.60 per share.

F-27

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ECOSPHERE TECHNOLOGIES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

FOR THE YEARS ENDED DECEMBER 31, 2013, 2012 AND 2011

The Company issued 2,228,975 shares of common stock in connection with the cashless exercise of options to purchase 4,196,850 shares of the Company’s common stock exercisable at $0.14 and $0.29 per share and based upon the market value of the Company’s common stock of $0.54 per share.

Shares Issued in Conversion of Preferred Stock

2012

 

1,293,058 shares of common stock were issued upon conversion of 80 shares of Series B Preferred Stock and accrued dividends. The total value of the preferred shares converted was $445,834.

878 shares of common stock were issued upon conversion of one share of Series B Preferred Stock.

Shares Issued in Payment of Accrued Interest

 

2013

 

In January 2013, the Company issued 16,153 shares of common stock with a value of $6,000 based on the quoted trading price of $0.39 per share were issued as payment for accrued interest in the same amount.

 

Shares Issued Upon Conversion of Debt and Other Liabilities

 

2013

98,425 shares of common stock were issued to lenders upon conversion of secured original issue discount notes in the amount of $37,500 at a conversion rate of $0.381 per share.

2012

1,237,500 shares of common stock were issued to lenders upon conversion of secured original issue discount notes in the amount of $825,000 at a conversion rate of $0.67 per share.

2011

The Company issued 350,000 shares of common stock in connection with the conversion of a note payable and accrued interest in the amount of $66,238. The trading value of the stock on the conversion date was $0.48 and the Company recorded a loss on conversion of $93,762 related to this transaction.

Shares Issued in Cashless Warrant Exercise

2012

 

2,637,541 shares of common stock were issued for 8,299,395 warrants to purchase common stock at exercise prices between $0.14 and $0.57 per share, based upon market values for the Company’s common stock at between $0.349 and $0.65 per share.

F-28

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ECOSPHERE TECHNOLOGIES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

FOR THE YEARS ENDED DECEMBER 31, 2013, 2012 AND 2011

16.

RESTRICTED STOCK

The Company recognized share-based compensation expense related to stock grants, issued per the terms of the 2006 Equity Incentive Plan, as amended, of $60,000, $15,000 and $190,000 for the years ended December 31, 2013, 2012 and 2011, respectively net of cancellations/forfeitures. The following table summarizes non-vested restricted stock and the related activity for the years ended December 31, 2013, 2012 and 2011:

		Shares				Weighted Average Grant- Date Fair Value
Non-vested at December 31, 2010			282,979			$	0.85
Granted			272,221			$	0.51
Vested			(221,933	)		$	1.08
Non-vested at December 31, 2011			333,267			$	0.50
Granted			84,000			$	0.48
Vested			(138,824	)		$	0.47
Cancellations and forfeitures			(194,443	)		$	0.51
Non-vested at December 31, 2012			84,000			$	0.45
Granted			105,263			$	0.48
Vested			(189,263	)		$	0.48
Non-vested at December 31, 2013			—			$	—

At December 31, 2013 there was no unrecognized share-based compensation expense from non-vested restricted stock. The above grants relate to various directors and director advisors accepting such grants as outlined in Note 17.

17.

STOCK OPTIONS AND WARRANTS

 

The fair value of option and warrants granted during the periods presented is estimated on the date of grant using the BSM option pricing model. We used the following assumptions for options granted in the following periods:

		For the Year Ended December 31,
		2013		2012		2011
Expected volatility		45.99% - 93.39%		54.75% - 64.15%		69.2% - 112.58%
Expected term		3.5 -5 years		3 - 4 years		3 - 5 years
Risk-free interest rate		0.44% - 1.39%		0.39% - 0.87%		0.39% - 2.06%
Expected dividend yield		None		None		None

Stock-based compensation expense (excluding charges related to restricted stock) for the years ended December 31, 2013, 2012 and 2011 was $1,203,785, $1,465,692 and $6,478,229, respectively net of cancellations/forfeitures. As of December 31, 2013, there was $572,008 of total unrecognized compensation cost related to unvested options granted under the Company’s option plans. This unrecognized compensation cost is expected to be recognized over the next 2 years.

EMPLOYEE FIXED STOCK OPTION PLANS:

 

2000 Long Term Incentive Program

On August 18, 2000, the Company adopted a Long Term Incentive Program, which provides for the granting of 4,000,000 stock options and stock appreciation rights ("SARs") to key employees. Options granted may be either Incentive Stock Options (“ISOs”), pursuant to provisions of the Internal Revenue Code, non-qualified options, or restricted stock awards. The stock options are exercisable for a period no longer than ten years after the date they are granted. Pursuant to the terms of the Plan, no new awards may be granted under the Plan after September 1, 2002. As of December 31, 2011 no options were outstanding under the Plan. Options to purchase 40,000 shares of common stock at $0.28 per share were exercised during 2011. No further grants will be made and the plan has expired.

F-29

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ECOSPHERE TECHNOLOGIES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

FOR THE YEARS ENDED DECEMBER 31, 2013, 2012 AND 2011

2003 Equity Incentive Plan

On November 17, 2003, the Company adopted the 2003 Equity Incentive Plan. The Plan terminated in November 2013. As of December 31, 2013 options to purchase 142,275 shares of common stock at $1.05 per share are outstanding under this Plan.

2003 Stock Option Plan for Outside Directors and Advisory Board Members

On November 17, 2003, the Company adopted the 2003 Stock Option Plan for Outside Directors and Advisory Board Members, which provided for the granting of 2,000,000 stock options, and increased on August 2, 2005 to 4,500,000, stock options to members of these Boards who are not full or part time employees of the Company. At December 31, 2013 options to purchase 766,500 shares of common stock at exercise prices ranging from $1.05 to $1.36 per share are outstanding under this Plan. The Plan shall continue in existence for a term of ten years unless terminated by the Company.

2006 Equity Incentive Plan

In May 2006, the Board approved the 2006 Equity Incentive Plan (the “2006 Plan”), and as part of that approval, agreed to not issue any awards under the 2003 Equity Incentive Plan and 2003 Stock Option Plan for Outside Directors and Advisory Board Members.

This plan, as amended, provides for the Company to issue up to 30,000,000 stock options, stock appreciation rights, restricted stock or restricted stock units to our directors, employees and consultants.

Under the 2006 Plan, all of our Directors who are not employees or 10% shareholders and all Director Advisors automatically receive a grant of restricted stock and options with the number of shares and options based upon market price at the time of grant.

						Restricted
		Options (1)				Stock (1)(2)(3)
Qualifying Event
Initial appointment as Chairman of the Board		$	75,000			$	75,000
Initial election or appointment of non-employee Director		$	40,000			$	40,000
Initial appointment as an Advisory Board member		$	15,000			$	10,000
Annual grant to Chairman of the Board		$	40,000			$	40,000
Annual grant to non-employee Director		$	25,000			$	25,000
Annual grant to Advisory Board Member		$	10,000			$	5,000
Initial appointment and annual grant of and to a non-employee director as Lead Director (4) or Chairman of a member of the following:
Audit Committee, Compensation Committee and other committees at the discretion of the Compensation Committee		$	15,000			$	15,000
Initial appointment of an annual grant to a non-employee Director to the following:
Audit Committee, Compensation Committee and other committees at the discretion of the Compensation Committee		$	10,000			$	10,000

———————

(1)	In the event that the Company does not have authorized capital, these persons will receive grants of cash settled SARs.
(2)	The Director or Director Advisor may elect options instead of restricted stock in order to defer income taxes.
(3)	The Director or Director Advisor may at their option receive restricted stock units in lieu of restricted stock.
(4)	The Board may, when the Chairman is an employee, appoint a Director to act as Lead Director who will have all of the authority customarily associated with such a position. Our Board has appointed a Lead Director.

The initial grants to a Chairman of the Board, Board member and Advisory Board member shall vest in annual installments over three years and all other grants shall vest annually, all subject to the person’s continued service in the same capacity on the applicable vesting date. Generally, common stock may not be sold by our directors for six months after resignation.

F-30

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ECOSPHERE TECHNOLOGIES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

FOR THE YEARS ENDED DECEMBER 31, 2013, 2012 AND 2011

Limitation on Awards

 

The exercise price of options or SARs granted under the 2006 Plan shall not be less than the fair market value of the underlying common stock at the time of grant. In the case of ISOs, the exercise price may not be less than 110% of the fair market value in the case of 10% shareholders. Options and SARs granted under the 2006 Plan shall expire no later than five years after the date of grant. The option price may be paid in United States dollars by check or wire transfer or, at the discretion of the Board or Compensation Committee, by delivery of shares of our common stock having fair market value equal as of the date of exercise to the cash exercise price, or a combination thereof.

A maximum of 30,000,000 shares are available for grant under the 2006 Plan, as amended, and all outstanding options under the Plan provide a cashless exercise feature. The identification of individuals entitled to receive awards, the terms of the awards, and the number of shares subject to individual awards, are determined by our Board of Directors or the Compensation Committee, at their sole discretion. The aggregate number of shares with respect to which options or stock awards may be granted under the 2006 Plan and the purchase price per share, if applicable, shall be adjusted for any increase or decrease in the number of issued shares resulting from a stock dividend, stock split, reverse stock split, recapitalization or similar event. As of December 31, 2013 options to purchase 8,847,839 shares of common stock were outstanding under the 2006 Plan.

 

Expired options relate to options that have terminated because the expiration date has passed or have expired because the employee’s employment has been terminated, and the relevant expiration period has passed.

Employee Fixed Plan Options

		For the Years Ended December 31,
		2013								2012								2011
						Weighted								Weighted								Weighted
						Average								Average								Average
						Exercise								Exercise								Exercise
		Shares				Price				Shares				Price				Shares				Price
Outstanding at beginning of year			10,225,256			$	0.50				8,828,736			$	0.52				12,317,345			$	0.55
Granted			16,681,354			$	0.36				1,716,480			$	0.45				539,586			$	0.50
Exercised			—			$	—				—			$	—				(613,200	)		$	0.27
Forfeited			(5,318,056	)		$	0.38				(272,710	)		$	0.47				(26,250	)		$	0.45
Expired			(1,360,606	)		$	0.47				(47,250	)		$	1.36				(3,388,735	)		$	0.74
Outstanding at end of year			20,227,948			$	0.44				10,225,256			$	0.50				8,828,736			$	0.52
Exercisable at end of year			13,002,821			$	0.29				8,932,275			$	0.51				8,315,400			$	0.52
Outstanding
Weighted average remaining contractual term							3.05								2.35								3.02
Aggregate intrinsic value						$	14,891							$	29,188							$	81,613
Weighted average grant date fair value						$	0.14							$	0.21							$	0.25
Exercisable
Weighted average remaining contractual term							2.45								1.90								2.93
Aggregate intrinsic value						$	14,891							$	29,188							$	81,613

F-31

---

ECOSPHERE TECHNOLOGIES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

FOR THE YEARS ENDED DECEMBER 31, 2013, 2012 AND 2011

2013

Option Grants to Directors under a Consulting Agreement

In January 2013, the Company granted five-year options to purchase 1,050,000 shares of common stock with an exercise price of $0.38 per share to a director who is also serving as a consultant for a one year period. The fair value of these options amounted to $135,890, calculated using the BSM method and will be expensed over the vesting period. As of December 31, 2013 the Company revalued the unvested options in accordance with ASC 505-50-30, Initial Measurement (“ASC 505-50-30). The subsequent re-measurement produced a value of $122,481 which is being amortized over the service period.

In January 2013, the Company granted five-year options to purchase 3,150,000 shares of common stock with an exercise price of $0.35 per share to a director of the Company who is also serving as a consultant for a three year period. The fair value of these options amounted to $482,391, calculated using the BSM method and will be expensed over the requisite service period. As of December 31, 2013 the Company revalued the unvested options in accordance with ASC 505-50-30. The subsequent re-measurement produced a value of $384,420 which is being amortized over the service period.

Annual Director Grants

In July 2013, in accordance with the Plan, the Company’s non-employee directors received an automatic grant of options for board service for the upcoming year. In connection with the automatic grants, non-employee directors were granted a total of 773,854 five-year stock options at an exercise price of $0.40 per share. Of the 773,854 five-year stock options, 325,278 will vest on December 1, 2013 and the remaining 448,576 stock options vest on June 30, 2014. The value of the options, $184,698, calculated using the BSM option pricing model will be recognized as expense over the vesting periods.

Option Grant to Director of Business Development

In January 2013, the Company granted five-year options to purchase 157,500 shares of common stock with an exercise price of $0.46 per share to its Director of Business Development. The fair value of these options amounted to $24,841, calculated using the BSM method and will be expensed over the vesting period.

Related Party Option Grants

In January 2013, the Company granted five-year options to purchase 5,250,000 shares of common stock with an exercise price of $0.38 per share to its former Chief Executive Officer. These options were forfeited when he resigned on March 12, 2013.

On April 26, 2013, the Company granted five-year options to purchase 6,300,000 shares of common stock with an exercise price of $0.34 per share to its Chief Executive Officer and Chief Technology Officer. The fair value of the options amounted to $844,507, calculated using the BSM method. One third of the options vested April 26, 2013 and the remaining two-thirds vest in equal increments on January 1, 2014 and 2015.

2012

Option Grants

In January 2012, the Company granted five year options to purchase 1,113,000 shares of common stock to certain employees at an exercise price of $0.42 per share. The fair value of these options amounted to $225,302, calculated using the BSM method, and will be expensed over a three year period, one-third per year.

In March 2012, upon the appointment of a new board member, the Company granted five year options to purchase 129,230 shares of common stock at exercise prices of $0.62 per share. The fair value of these options amounted to $39,027, calculated using the BSM method, and will be expensed over a three year period, one-third per year.

F-32

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ECOSPHERE TECHNOLOGIES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

FOR THE YEARS ENDED DECEMBER 31, 2013, 2012 AND 2011

In July 2012, in accordance with the 2006 Plan, the Company’s advisory board member received an automatic grant of 31,500 five-year stock options with an exercise price of $0.48 per share for service as an advisory board member for the upcoming year. The options vest on June 30, 2013, subject to the continued service as an advisory board member. The value of the options, $5,528, calculated using the BSM option pricing model, based upon the market value of the Company's common stock on the date of the grant, will be recognized as expense over the one-year vesting period.

In July 2012, in accordance with the 2006 Plan, the Company’s non-employee directors received an automatic grant of options and restricted stock for board service for the upcoming year. In connection with the automatic grants, non-employee directors were granted a total of 399,000 five-year stock options at an exercise price of $0.48 per share. The options vest on June 30, 2013, subject to the continued service of each applicable person as a director. The value of the options, $70,019, calculated using the BSM option pricing model and, will be recognized as expense over the one-year vesting period.

On July 3, 2012, in connection with a non-employee board member’s appointment to the compensation committee, the committee member received an automatic grant under the 2006 Plan of 43,750 five-year stock options at an exercise price of $0.46 per share. The options vest in three equal annual increments over a three year period with the first vesting date being one year from the date of the automatic grant. The value of the options, $8,410, calculated using the BSM option pricing model, based upon the market value of the Company's common stock on the date of the grant, will be recognized as expense over a three-year vesting period.

2011

Option Exercises

During the three months ended March 31, 2011, the Company issued 571,200 shares of common stock in exchange for $152,320 in connection with the exercise of options with exercise prices of $0.27 per share. In addition, the Company issued 22,340 shares of common stock in connection with the cashless exercise of options to purchase 42,000 shares of common stock at an exercise price of $0.27 per share and based upon a market price of the Company’s common stock of $0.60 per share.

Option Grants

In July 2011, the Company granted directors five-year options to purchase 301,389 shares of the Company’s common stock at an exercise price of $0.51 per share as compensation for their board service for the coming year.

In July 2011, the Company granted advisory board members five-year options to purchase 106,947 shares of the Company’s common stock at an exercise price of $0.51 per share as compensation for their advisory board service for the coming year. In August 2011, the Company granted an employee five-year options to purchase 26,250 shares of common stock at an exercise price of $0.45 per share. The options were subsequently forfeited due to termination.

In September 2011, the Company granted an employee five-year options to purchase 105,000 shares of common stock at an exercise price of $0.43 per share. The options vest over a three year period.

F-33

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ECOSPHERE TECHNOLOGIES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

FOR THE YEARS ENDED DECEMBER 31, 2013, 2012 AND 2011

Employee Fixed Non-Plan Options

		For the Years Ended December 31,
		2013								2012								2011
						Weighted								Weighted								Weighted
						Average								Average								Average
						Exercise								Exercise								Exercise
		Shares				Price				Shares				Price				Shares				Price
Outstanding at beginning of year			46,295,435			$	0.54				48,464,734			$	0.53				44,855,435			$	0.48
Granted			—			$	—				—			$	—				10,050,000			$	0.46
Exercised			4,200,000			$	0.29				(1,619,809	)		$	0.18				(6,050,701	)		$	0.22
Forfeited			—			$	—				(549,490	)		$	0.27				(787,500	)		$	0.78
Expired			(7,462,000	)		$	0.42				—			$	—				(52,500	)		$	4.76
Outstanding at end of year			34,633,435			$	0.60				46,295,435			$	0.54				48,464,734			$	0.53
Exercisable at end of year			34,633,435			$	0.60				46,295,435			$	0.54				44,054,739			$	0.53
Outstanding
Weighted average remaining contractual term							1.42								1.87								2.79
Aggregate intrinsic value						$	—							$	386,353							$	1,497,900
Weighted average grant date fair value							N/A							$	N/A							$	0.33
Exercisable
Weighted average remaining contractual term							1.42								1.87								2.71
Aggregate intrinsic value						$	—							$	386,353							$	1,341,900

2013

Cashless Exercise

In March 2013, the Company issued 1,570,435 shares of common stock upon the cashless exercise of 4,200,000 options with an exercise price of $0.29 per share based upon market price of the Company’s common stock ranging from $0.46 to $0.50 per share.

2012

Option Exercises

During the twelve months ended December 31, 2012, the Company issued 976,849 shares of common stock in exchange for $147,050 in connection with the exercise of options with exercise prices ranging from $0.14 to $0.29 per share.

In addition, the Company issued 642,960 shares of common stock in connection with the cashless exercise of options to purchase 1,192,450 shares of common stock at an exercise prices ranging from $0.14 to $0.34 per share and based upon market prices of the Company’s common stock ranging from $0.44 to $0.60 per share.

F-34

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ECOSPHERE TECHNOLOGIES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

FOR THE YEARS ENDED DECEMBER 31, 2013, 2012 AND 2011

2011

Option Grants

On January 2, 2011, the Company granted its Chief Technology Officer five-year options to purchase 9,450,000 issued five-year options at an exercise price of $0.46 per share. The options vested one-third upon the signing of the Hydrozonix Agreement, with the remainder vesting in equal installments on each June 30th and December 31st until either the Company has delivered 16 Ecos-Frac® units to Hydrozonix or on the second anniversary of the Agreement.

On January 18, 2011, coinciding with his appointment as Chief Executive Officer, the Company issued five-year options to purchase 1,050,000 shares of the Company’s common stock with an exercise price of $0.46 per share. The options vested 500,000 immediately, and the remainder vested in equal installments on June 30, 2011 and December 31, 2011, subject to the continued employment of the CEO on those dates. In connection with the issuance, the CEO forfeited five-year options to purchase 750,000 shares of common stock at an exercise price of $0.82 which were granted to him upon his appointment as full-time Executive Chairman in August 2010.

Option Exercises

During the three months ended March 31, 2011, the Company issued 539,951 shares of common stock in exchange for $122,320 in connection with the exercise of options with exercise prices ranging from $0.14 to $0.27 per share. In addition, the Company issued 22,401 shares of common stock in connection with the cashless exercise of options to purchase 42,000 shares of common stock at an exercise price of $0.27 per share and based upon a market price of the Company’s common stock of $0.60 per share.

During the three months ended June 30, 2011, the Company issued 157,500 shares of common stock upon the exercise of options with an exercise price of $0.14 per share resulting in proceeds to the Company of $22,500. In addition the Company issued 2,228,975 shares of common stock upon the cashless exercise of 4,196,850 options with exercise prices of between $0.14 and $0.29 per share based upon a market price of the Company’s common stock of $0.54 per share.

During the three months ended September 30, 2011, the Company issued 399,000 shares of common stock upon the exercise of options with an exercise price of $0.14 per share resulting in proceeds to the Company of $57,000.

In December 2011, the Company issued 715,340 shares of common stock in exchange for $102,200 in connection with the exercise of options with an exercise price of $0.14 per share.

F-35

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ECOSPHERE TECHNOLOGIES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

FOR THE YEARS ENDED DECEMBER 31, 2013, 2012 AND 2011

Non-Employee Fixed Non-Plan

		For the Years Ended December 31,
		2013								2012								2011
						Weighted								Weighted								Weighted
						Average								Average								Average
						Exercise								Exercise								Exercise
		Shares				Price				Shares				Price				Shares				Price
Outstanding at beginning of year			1,507,500				0.50				1,507,500			$	0.50				2,471,400			$	0.31
Granted			—				—				—			$	—				735,000			$	0.61
Exercised			—				—				—			$	—				(1,698,900	)		$	0.27
Forfeited			—				—				—			$	—				—			$	—
Expired			(247,500)				0.40				—			$	—				—			$	—
Outstanding at end of year			1,260,000				0.53				1,507,500			$	0.50				1,507,500			$	0.50
Exercisable at end of year			1,260,000				0.53				1,507,500			$	0.50				1,245,000			$	0.48
Outstanding
Weighted average remaining contractual term							1.36								2.11								3.12
Aggregate intrinsic value						$	—							$	—							$	4,714
Weighted average grant date fair value							N/A							$	N/A								0.50
Exercisable
Weighted average remaining contractual term							1.36								2.11								2.92
Aggregate intrinsic value						$	—							$	—							$	4,714

2011

Option Grants

On January 5, 2011, the Company issued five-year options to purchase 210,000 shares of common stock at an exercise price of $0.58 per share to its legal counsel for past services. The options vested immediately.

On January 20, 2011, the Company issued five-year options to purchase 525,000 shares of common stock at an exercise price of $0.62 per share to an individual as a finder’s fee related to the Hydrozonix Agreement. The options vested 50% upon the signing of the definitive agreement with the remainder vesting upon the completion of the eighth EF80 unit, approximately one year.

Option Exercises

During the three months ended March 31, 2011, the Company issued 438,900 shares of common stock in exchange for $117,040 in connection with the exercise of options with exercise prices of $0.27 per share. In addition, the Company issued 741,177 shares of common stock in connection with the cashless exercise of options to purchase 1,260,000 shares of common stock at an exercise price of $0.27 per share and based upon a market price of the Company’s common stock of $0.68 per share.

F-36

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ECOSPHERE TECHNOLOGIES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

FOR THE YEARS ENDED DECEMBER 31, 2013, 2012 AND 2011

Warrants

The following table summarizes warrant activity for the years ended December 31, 2013, 2012 and 2011:

		For the Years Ended December 31,
		2013								2012								2011
						Weighted								Weighted								Weighted
						Average								Average								Average
						Exercise								Exercise								Exercise
		Shares				Price				Shares				Price				Shares				Price
Outstanding at beginning of year			6,367,709				0.50				18,765,779			$	0.44				20,138,463			$	0.41
Granted			12,764,920				0.35				—			$	—				1,218,750			$	0.67
Exercised			(1,065,314	)			0.16				(8,798,670	)		$	0.17				(1,962,064	)		$	0.26
Forfeited			—				—				—			$	—				—			$	—
Exchanged, net			—				—				—			$	—				—			$	—
Expired			(1,714,717	)			0.59				(3,599,400	)		$	0.71				(629,370	)		$	0.50
Outstanding at end of year			16,352,598				0.37				6,367,709			$	0.55				18,765,779			$	0.44
Exercisable at end of year			16,352,598				0.37				6,367,709			$	0.55				18,756,779			$	0.44
Outstanding and exercisable
Weighted average remaining contractual term							4.10								1.54								1.16
Aggregate intrinsic value						$	180,543							$	557,245							$	2,089,266

A summary of the outstanding warrants previously issued for financing and services as of December 31, 2013 is presented below:

		Shares
Warrants issued for financing			16,288,098
Warrants issued for services			64,500
Outstanding at December 31, 2013			16,352,598

Grants and Exercises

2013

Issuance of Warrants with Convertible Debt

In February 2013, the Company issued 984,375 five-year warrants exercisable at $0.381 per share in connection with a $750,000 convertible note. The fair value of the warrants amounted to $265,133, calculated using the BSM method. (See Note 10).

In December 2013, the Company issued 11,333,338 five-year warrants exercisable at $0.35 per share in connection with $1,700,000 convertible notes. The fair value of the warrants amount to $2,087,934, calculated using the BSM method. (See Note 10).

F-37

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ECOSPHERE TECHNOLOGIES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

FOR THE YEARS ENDED DECEMBER 31, 2013, 2012 AND 2011

Issuance of Warrants as Finder Fee

In February 2013, the Company issued 78,750 five-year warrants exercisable at $0.381 per share to a third party in conjunction with a financing. The fair value of the warrants amounted to $21,211, calculated using the BSM method. The warrant value and $43,533 in cash paid to a third party are recorded as a deferred asset and being amortized over the term of the note.

Issuance of Warrants for Extension of Maturity Dates on Convertible Debt

During the three months ended June 30, 2013, holders of an aggregate of $295,000 of principal agreed to extend the maturity of their notes to March 2014. As partial consideration of the extensions the Company issued warrants to purchase 368,467 shares of common stock for $0.40 per share over five years. (See Note 10)

Warrant Exercises for Cash

In January 2013, the Company issued 84,000 shares of common stock in exchange for cash of $20,000 upon the exercise of warrants with an exercise price of $0.24 per share.

In May 2013, the Company issued 718,814 shares of common stock in exchange for cash of $113,188 upon the exercise of warrants with exercise prices between $0.14 and $0.19 per share.

In December 2013, the Company issued 262,500 shares of common stock in exchange for cash of $37,500 upon the exercise of warrants with an exercise price of $0.14 per share.

2012

Warrant Exercises and Grants

During the year ended December 31, 2012, the Company issued 559,125 shares of common stock in exchange for $131,625 in connection with the exercise of warrants with exercises prices ranging from $0.14 to $0.57 per share. In addition, the Company issued 2,637,541 shares of common stock in connection with the cashless exercise of warrants to purchase 8,299,395 shares of common stock at exercise prices ranging from $0.14 to $0.57 per share based upon market prices of the Company's common stock ranging from $0.349 to $0.648 per share.

In March of 2012, the Company provided an option to extend the expiration date of certain warrants for a period of one year, or surrender the warrants in a cashless exercise. The arrangement called for holders of warrants at exercise prices of $0.57 and $0.71 to extend such warrants for one year at a cost of $0.20 and $0.14, respectively. Holders of 336,000 and 325,500 $0.57 warrants and $0.71 warrants, respectively opted to extend their expiration date for one year at an aggregate cost of $107,400. Given the stock closing price at quarter-end of $0.61, the remainder of the $0.60 warrants were converted in cashless exercises, resulting in the issuance of 73,410 shares of common stock (as discussed above), while warrants to acquire 3,599,400 shares of common stock for $0.71 per share expired.

2011

Warrant Exercises and Grants

During the three months ended March 31, 2011, the Company issued 674,940 shares of common stock in exchange for $179,984 in connection with the exercise of warrants with exercise prices of $0.27 per share. In addition, the Company issued 470,588 shares of common stock in connection with the cashless exercise of options to purchase 840,000 shares of common stock at an exercise price of $0.27 per share and based upon a market price of the Company’s common stock of $0.68 per share.

During the three months ended June 30, 2011, the Company issued 69,999 shares of common stock upon the exercise of warrants with an exercise price of $0.14 per share resulting in proceeds to the Company of $10,000.

During the three months ended September 30, 2011, the Company issued 52,500 shares of common stock upon the exercise of warrants with an exercise price of $0.24 per share resulting in proceeds to the Company of $12,500.

F-38

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ECOSPHERE TECHNOLOGIES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

FOR THE YEARS ENDED DECEMBER 31, 2013, 2012 AND 2011

 

During the three months ended December 31, 2011, the Company issued 324,624 shares of common stock upon the exercise of warrants with exercise prices between $0.14 and $0.24 per share resulting in proceeds to the Company of $73,958.

Issuance of Warrants with Convertible Debt

During the first quarter of 2011, the Company issued five year warrants to purchase 806,250 shares of common stock with an exercise price of $0.67 per share in connection with the issuance of convertible notes with an aggregate principal value of $1,075,000. See Note 10. The warrants were valued using the BSM option pricing model with expected terms of 5 years, volatility ranging from 100.73% to 112.55% and discounts rates from 1.95% to 2.06%. The relative fair value of these warrants, $270,259, was recorded as a debt discount and is being amortized to interest expense over the term of the notes.

In addition, in January 2011, the Company issued five year warrants to purchase 412,500 shares of common stock with an exercise price of $0.67 per share in connection with the issuance of a convertible original issue discount note in the amount of $550,000. See Note 10. The warrants were valued using the BSM option pricing model with an expected term of 5 years, a volatility of 105.08% and a discount rate of 1.97%. The relative fair value of these warrants, $145,492, plus the original issue discount of $50,000 was recorded as debt discount and is being amortized to interest expense over the term of the note.

18.

NONCONTROLLING INTEREST IN CONSOLIDATED SUBSIDIARY

 

In July 2009, the Company formed FNES and contributed the assets and liabilities of EES Inc. in exchange for a 67% ownership interest in FNES. In November FNES received $7,850,000 in exchange for a 21.5% interest in FNES. After the November transaction, the Company owns 52.6% of FNES. FNES reported a net loss of $743,417 during the period from inception, July 16, 2009 through December 31, 2009 and a net loss of $528,277 for the year ended December 31, 2010, both of which were allocated to the other FNES members in accordance with the LLC operating agreement. For fiscal 2011, FNES had net income of $3,217,407 of which the first $1,271,694 was allocated entirely to the noncontrolling interest to allow them recovery of previously allocated losses, in accordance with the LLC operating agreement, after which income was allocated to ETI and certain noncontrolling interests based on a formula stipulated in the LLC operating agreement, as amended. On a net basis, $1,690,075 of income was allocated to noncontrolling interests in fiscal 2011. During 2012, of FNES’s $3,780,472 of net income, $815,054 was allocated to noncontrolling interest. From January 1, 2013 until May 23, 2013, FNES had net income of $873,407, $187,806 of which was allocated to noncontrolling interest. On May 24, 2013, the Company sold its controlling interest in FNES eliminating any noncontrolling interest in FNES.

Pursuant to FNES Board Member resolutions during 2012, cash distributions of $6.7 million were made in accordance with membership interest in FNES. Of this amount, $3.2 million was paid to members comprising the noncontrolling interest and $3.5 million was paid to ETI and, accordingly, was eliminated in consolidation.

The following provides a summary of activity in the noncontrolling interest in consolidated subsidiary account for the three years ended December 31, 2013, 2012 and 2011:

 

Noncontrolling Interest in Subsidiary 

		2013				2012				2011
Balance, beginning of year		$	9,423,060			$	11,768,381			$	10,078,306
Distributions to noncontrolling members			—				(3,160,375	)			—
Sale of controlling interest in subsidiary			(9,235,254	)			—				—
Noncontrolling interest in income (loss)			(187,806	)			815,054				1,690,075
Balance, end of year		$	—			$	9,423,060			$	11,768,381

F-39

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ECOSPHERE TECHNOLOGIES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

FOR THE YEARS ENDED DECEMBER 31, 2013, 2012 AND 2011

19.

INCOME TAXES

 

Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. At December 31, 2013, the Company has a Net Operating Loss (“NOL”) carryforward of approximately $68,000,000. The NOL expires during the years 2013 to 2033. In the event that a significant change in ownership of the Company occurs as a result of the Company’s issuance of common stock, the utilization of the NOL carryforward will be subject to limitation under certain provisions of the Internal Revenue Code. Management does not presently believe that such a change has occurred. Realization of any portion of the $32,097,629 of net deferred tax assets at December 31, 2013 is not considered more likely than not by management; accordingly, a valuation allowance has been established for the full amount. The valuation allowance as of December 31, 2013 was $24,446,438. The change in the valuation allowance during the year ended December 31, 2013 amounted to $7,371,627.

 

Significant components of the Company’s deferred tax assets are as follows:

		Year ended December 31,
		2013				2012
Deferred tax assets:
Organizational costs, accrued liabilities and other		$	559,373			$	450,912
NOL carryforwards			25,588,695				26,007,066
Depreciation			106,118				34,206
Compensation related to equity instruments issued for services			5,843,443				5,357,898
Valuation allowance			(24,446,438	)			(31,818,065)
Net deferred tax assets		$	7,651,191			$	32,017
Deferred tax liabilities:
Investment in unconsolidated investee			(7,619,174	)			—
Other			(32,017	)			(32,017	)
Total deferred tax liabilities			(7,651,191	)			(32,017	)
Total net deferred taxes		$	—			$	—

 

Reconciliation of the differences between income tax benefit computed at the federal and state statutory tax rates and the provision for income tax benefit for the years ended December 31, 2013, 2012 and 2011 is as follows:

		2013				2012				2011
Income tax expense (benefit) at federal statutory rate			34.00	%			34.00	%			(34.00	)%
State taxes, net of federal benefit			3.67				0.51				(4.73	)
Nondeductible items			0.39				(29.26	)			25.45
Change in valuation allowance			(38.06	)			(5.25	)			13.28
			—	%			—	%			—	%

F-40

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ECOSPHERE TECHNOLOGIES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

FOR THE YEARS ENDED DECEMBER 31, 2013, 2012 AND 2011

20.

COMMITMENTS AND CONTINGENCIES

 

Legal

The Company has an extensive intellectual property portfolio which management believes has substantial value not reflected on the Consolidated Balance Sheet. As the pioneer in the field of emerging advanced oxidation processes, the Company has to aggressively defend its intellectual property. Thus, in February 2013, Ecosphere initiated an arbitration proceeding against Halliburton Energy Services, Inc. alleging that Halliburton took and disclosed Ecosphere’s trade secrets proprietary information. Ecosphere is seeking damages and alleges that Halliburton’s breached a Non-Disclosure Agreement with Ecosphere and converted or misappropriated trade secrets. The trade secrets relate to Ecosphere’s green technology business model to treat and recycle wastewater used during hydraulic fracturing of oil and gas wells. As of December 31, 2013, the Company has incurred $299,333 in arbitration fees.

From time to time, we may be involved in litigation relating to claims arising out of our operations in the normal course of business.

 

To our knowledge, except as described below, no legal proceedings, government actions, administrative actions, investigations or claims are currently pending against us or involve us that, in the opinion of our management, could reasonably be expected to have a material adverse effect on our business and financial condition.

 

In December 2012, the Company reached a settlement with KIA, who filed a lawsuit against the Company in 2007, amounting to $100,000 to be paid with an initial $25,000 payment and 36 monthly installments for the remainder of the settlement amount. Should the Company default on any of its required payments, the settlement amount will increase to $150,000. The Company had originally accrued $197,500 in liabilities related to this settlement. As a result of the settlement, the Company reduced legal expense by $47,500 (as the original expense was charged to this account) leaving an accrued balance of $125,000 at December 31, 2012, which was comprised of the $150,000 obligation less the initial $25,000 payment. As of December 31, 2013 the Company had an accrued balance of $100,000 which is comprised of the $150,000 obligation less $50,000 in payments. Upon final payment in accordance with the settlement, the Company will record a $50,000 gain. See Note 9 as this amount is included in other accrued liabilities.

 

In March 2011, a former vendor obtained a judgment against the Company for a number of disputed billings. As of December 31, 2013 the Company has accrued $70,000 which is anticipated to be the amount of payment due to the vendor plus attorney’s fees. See Note 9 as this amount is included in other accrued liabilities.

Leases

 

The Company makes monthly rent payments of $11,789 under a month-to-month agreement for the Company’s Stuart, Florida corporate offices and manufacturing location. During the years ended December 31, 2013, 2012 and 2011 the Company recognized rent expense amounting to $141,468, $141,468 and $141,468, respectively. The Company has been under a month-to-month agreement for the two buildings adjacent to the Stuart facility that holds the Company’s machining equipment. The lease agreements expired in April and May 2012 and the Company continues to make monthly rent payments of $4,955. During the years ended December 31, 2013, 2012 and 2011 the Company recognized rent expense amounting to $59,460, $59,760 and $59,760, respectively.

 

In September 2013, the Company entered into a five-year lease agreement for an office located in Park City, UT to begin developing the mining application. The commencement date for this operating lease is January 1, 2014 with the lease expiring on the day immediately prior to the fifth anniversary of the commencement date, December 31, 2018. The Company has an obligation of $227,734 relating to this five-year lease agreement.

F-41

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ECOSPHERE TECHNOLOGIES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

FOR THE YEARS ENDED DECEMBER 31, 2013, 2012 AND 2011

Future minimum annual rents due under operating leases are as follows:

						Total
Amounts due under operating leases in 2014						$	42,897
Amounts due under operating leases in 2015							44,178
Amounts due under operating leases in 2016							45,503
Amounts due under operating leases in 2017							46,872
Amounts due under operating leases in 2018							48,284
						$	227,734

21.

CONCENTRATION OF RISK

 

During the year ended December 31, 2013, the Company’s revenues were 73%, 14% and 9% from customers A, B and C, respectively, in the oil and gas industry, and were from three revenue sources. Of the three revenue sources, 73% related to the sale of Ozonix® equipment and field services offered in the domestic oil and gas industry, 14% related to mobile, Ozonix® water recycling services provided during hydraulic fracturing operations and the remaining 9% related to onsite, Ozonix® water recycling services provided for the treatment of flowback and produced waters. As of December 31, 2013, 100% of accounts receivable were from customer A, respectively.

During the year ended December 31, 2012, the Company’s revenues were 76%, 19% and 4% from customers A, B and C, respectively, in the oil and gas industry, and were from three revenue sources. Of the three revenue sources, 76% related to the sale of Ozonix® equipment and field services offered in the domestic oil and gas industry, 19% related to mobile, Ozonix® water recycling services provided during hydraulic fracturing operations and the remaining 4% related to onsite, Ozonix® water recycling services provided for the treatment of flowback and produced waters. As of December 31, 2012, 75%, 14% and 10% of accounts receivable were from three customers A, B and C, respectively.

During the year ended December 31, 2011, the Company’s revenues were 54%, 38% and 7% from customers A, B and C, respectively, in the oil and gas industry, and were from three revenue sources. Of the three revenue sources, 54% related to the sale of Ozonix® equipment and field services offered in the domestic oil and gas industry, 28% related to mobile, Ozonix® water recycling services provided during hydraulic fracturing operations and the remaining 7% related to onsite, Ozonix® water recycling services provided for the treatment of flowback and produced waters. As of December 31, 2011, 23%, 63% and 13% of accounts receivable were from three customers A, B and C, respectively.

The Company maintains its cash in bank and financial institution deposits that at times may exceed federally insured limits. The Company has not experienced any losses in such accounts through December 31, 2013. As of December 31, 2013, the Company’s bank balances exceeded FDIC insured amounts by approximately $0.9 million. 

22.

RELATED PARTY TRANSACTIONS

2013 Related Party Transactions

Related Party Option Grants

In January 2013, the Company granted five-year options to purchase 5,250,000 shares of common stock with an exercise price of $0.381 per share to its former Chief Executive Officer. These options were forfeited when he resigned on March 12, 2013. (See Note 17)

On April 26, 2013, the Company’s prior grant of five-year options to purchase 6,300,000 shares of common stock with an exercise price of $0.34 per share to its Chief Executive Officer and Chief Technology Officer became effective. The fair value of the options amounted to $844,507, calculated using the BSM method. One third of the options vested April 26, 2013 and the remaining two-thirds vest in equal increments on January 1, 2014 and 2015. (See Note 17)

In January 2013, the Company granted five-year options to purchase 4,200,000 shares of common stock with exercise prices between $0.38 and $0.35 per share to two directors who also serve as consultants. (See Note 17)

F-42

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ECOSPHERE TECHNOLOGIES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

FOR THE YEARS ENDED DECEMBER 31, 2013, 2012 AND 2011

Related Party Consulting Agreements

In January 2013, the Company entered into a one-year consulting agreement with one of the Company’s board members. As of December 31, 2013 the Company has paid $252,083 pursuant to the consulting agreement. This consulting agreement expired December 31, 2013.

In January 2013, the Company entered into a three year consulting agreement that may be terminated with 30 days’ notice with one of the Company’s board members. As of December 31, 2013 the Company has paid $250,000 pursuant to the consulting agreement.

Related Party Equipment Sales

In July 2013, FNES purchased Ozonix® EF80 unit 14 from the Company, pursuant to which FNES paid the Company $500,000 and agreed to pay 36 monthly payments of approximately $52,778 beginning in August 2013. As of December 31, 2013, FNES owes the Company approximately $1.53 million relating to this arrangement.

In November 2013, FNES purchased one Ozonix® EF80 unit 13 from the Company, pursuant to which FNES paid the Company $250,000 and agreed to pay 36 monthly payments of approximately $59,722 beginning in December 2013. As of December 31, 2013, FNES owes the Company approximately $1.94 million relating to this arrangement.

Related Party Service Fee

The Company has been receiving a service fee for its continued accounting, administrative and other miscellaneous services to FNES. FNES has agreed to pay the $56,360 a month for the Company’s services and will continue to do so in a transitional phase. Once this transitional phase is complete and FNES has taken over all functions listed above, FNES will no longer pay $56,360 as a service fee to the Company. All costs relating to the service fee are offset against various expense accounts on the statement of operations.

Related Party Accounts Receivable

At December 31, 2013, the Company had an accounts receivable balance of approximately $3.5 million due from FNES. The $3.5 million accounts receivable balance primarily consisted of the $3.5 million remaining balance FNES owes on two Ozonix® EF80 units purchased in July and November 2013. (See Note 5)

2012 Related Party Transactions

Related Party Option Grants

In January 2012, the Company granted five-year options to purchase 1,113,000 shares of common stock to certain employees at an exercise price of $0.42 per share. 955,500 of these grants were made to related parties.

In July 2012, the Company issued 197,694 shares of common stock to the Chief Operating Officer in exchange for options to purchase 299,950 shares of common stock in connection with the cashless exercise of options with an exercise price of $0.14 per share and based on a market value of the Company’s common stock of $0.44 per share.

F-43

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ECOSPHERE TECHNOLOGIES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

FOR THE YEARS ENDED DECEMBER 31, 2013, 2012 AND 2011

23.

FNES TRANSACTION

On July 21, 2009, the Company finalized a series of agreements with Clean Water Partners, LLC (“CWP”), an affiliate of Bledsoe Capital Group, LLC ("Bledsoe”). Under the agreements CWP became a 33% owner of EES, in exchange for up to $10 million as described below. As the owner of the remaining 67% of FNES, the Company controlled a majority of the Board of Directors of FNES and controls and manages its daily operations. A supermajority vote is required for major matters including the sale of FNES. The transaction is summarized on a consolidated basis as follows:

Cash contribution from CWP		$	2,500,000
Forgiveness of loan advances from Bledsoe			1,000,000
Future priority distribution to the Company of FNES profits			2,500,000
Other possible future priority distributions to the Company			4,000,000
Total transaction amount		$	10,000,000

The Company contributed to EES the assets and liabilities of EES Inc., which included $3.1 million of debt due to Bledsoe. CWP contributed $2.5 million in cash plus $1.0 million in loan advances due from the Company. In exchange for payment of $1.5 million and forgiveness of the $1.0 million of loan advances, the Company granted EES an exclusive master license of Ecosphere’s patented Ozonix® technologies for global energy fields-of-use. EES is currently serving the domestic onshore oil and gas industry with Ecosphere’s patented Ozonix® technologies and Ecos-Frac® suite of products. In addition, the Company will receive a priority distribution of the first $2.5 million of CWP’s share of EES profits. An additional $4.0 million is due to the Company upon achievement of a significant event relating to EES, such as the sale of EES.

 

Finally, amended option agreements entered into on April 14, 2009, which had no accounting effect, and all previous option agreements between the Company, EES Inc. and Bledsoe through which Bledsoe had the right to acquire a 50% interest in the Ozonix® technology for the energy business have been terminated.

 

On November 9, 2009, EES received $7.5 million from an investor in exchange for a 19% equity interest in EES. In addition, in October 2009, EES received $350,000 from the then Chairman of EES in exchange for a promissory note convertible into a 1% equity interest in EES. On November 9, 2009, the then Chairman converted his note into a 1% equity interest in EES. EES paid a finder’s fee equal to a 1.5% equity interest in EES to the Chairman of EES. Following the transaction, the Company owns 52.6% of EES and continues to be the managing member of EES.

 

For the year ended December 31, 2009 and 2010, the Company allocated 100% of the net loss of EES, $743,417 and $528,277, respectively, to the noncontrolling interests of EES as stipulated in the LLC operating agreement. For fiscal 2011, EES had net income of $3,217,407 of which the first $1,271,694 was allocated entirely to the noncontrolling interest to allow them recovery of previously allocated losses, in accordance with the LLC operating agreement, after which income was allocated to ETI and certain noncontrolling interests based on a formula stipulated in the LLC operating agreement, as amended. On a net basis, $1,690,075 of income was allocated to noncontrolling interests in fiscal 2011 and $815,054 of income was allocated to noncontrolling interests in fiscal 2012.

The Company sold its controlling interest in FNES on May 23, 2013. On a net basis, $873,364 of loss was allocated to noncontrolling interest in fiscal 2013, for the period January 1, 2013 to May 23, 2013 prior to deconsolidation, and $187,806 of loss was allocated to noncontrolling interest in fiscal 2013.

F-44

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ECOSPHERE TECHNOLOGIES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

FOR THE YEARS ENDED DECEMBER 31, 2013, 2012 AND 2011

24.

QUARTERLY DATA (UNAUDITED)

		March 31,								June 30,								September 30,								December 31,
		2013				2012				2013				2012				2013				2012				2013				2012
In thousands, except per share data
Revenues		$	862			$	8,361			$	976			$	8,625			$	2,389			$	7,326			$	2,493			$	6,820
Income (loss) from operations			(2,324	)			1,039				(2,166	)			885				(1,741	)			431				(2,185	)			(1,190	)
Net income (loss) applicable to common stock before noncontrolling interest			(2,524	)			721				27,271				894				(2,812	)			382				(2,848	)			(1,046	)
Net income (loss) applicable to Ecosphere Technologies, Inc. common stock			(2,353	)			365				27,288				506				(2,812	)			316				(2,849	)			(1,051	)
Net income (loss) per common share applicable to common stock
Basic			(0.02	)			—				0.17				—				(0.02	)			—				(0.01	)			—
Diluted			(0.02	)			—				0.17				—				(0.02	)			—				(0.01	)			—

25.

SUBSEQUENT EVENTS

Convertible Note

In January 2014, the Company received $245,000 in connection with the issuance of convertible notes in the aggregate principal amount of $245,000. The notes accrue interest at an annual rate of 10%, maturing in January 2016 and are convertible into common stock at a conversion rate of $0.30 per share. In connection with the issuance of the notes, the Company issued to the investors five-year warrants to purchase 1,633,328 shares of common stock at an exercise price of $0.35 per share.

Stock Issuances

In February 2014, the Company issued 8,753 shares of common stock upon the cashless exercise of options to purchase 44,546 shares of common stock with an exercise price of $0.229 per share and based upon a market price of the Company’s common stock of $0.285 per share.

Sale of FNES Note

In exchange for $1 million, in March 2014, Ecosphere sold to an FNES director, the note payable from FNES in the amount of $1,530,555.

F-45

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INDEX TO FIDELITY NATIONAL ENVIRONMENTAL SOLUTIONS, LLC FINANCIAL STATEMENTS

 

		Page
Report of Independent Registered Public Accounting Firm			F-47
Statement of Financial Condition as of December 31, 2013			F-48
Statement of Operations and Changes in Members’ Equity for the Period from May 24, 2013 through December 31, 2013			F-49
Statement of Cash Flows for the Period from May 24, 2013 through December 31, 2013			F-50
Notes to Financial Statements			F-51

 

 

F-46

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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and Members of

Fidelity National Environmental Solutions, LLC

We have audited the accompanying balance sheet of Fidelity National Environmental Solutions, LLC ("the Company") as of December 31, 2013, and the related statements of operations and changes in members’ equity, and cash flows for the period from May 24, 2013 to December 31, 2013. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audit.

We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.

In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Fidelity National Environmental Solutions, LLC as of December 31, 2013, and the results of its operations and its cash flows, for the period from May 24, 2013 to December 31, 2013, in conformity with accounting principles generally accepted in the United States of America.

/s/ Salberg & Company, P.A.

SALBERG & COMPANY, P.A.

Boca Raton, Florida

March 17, 2014

2295 NW Corporate Blvd., Suite 240 • Boca Raton, FL 33431-7328

Phone: (561) 995-8270 • Toll Free: (866) CPA-8500 • Fax: (561) 995-1920

www.salbergco.com • info@salbergco.com

Member National Association of Certified Valuation Analysts • Registered with the PCAOB

Member CPAConnect with Affiliated Offices Worldwide • Member AICPA Center for Audit Quality

F-47

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FIDELITY NATIONAL ENVIRONMENTAL SOLUTIONS, LLC

STATEMENT OF FINANCIAL CONDITION

DECEMBER 31, 2013

Assets
Current assets
Cash		$		1,462,397
Accounts receivable				431,978
Inventory				474,261
Prepaid expenses and other current assets				1,984
Total current assets				2,370,620
Property and equipment, net				6,702,562
Intangible assets, net				1,875,000
Deposits				4,200
Total assets		$		10,952,382
Liabilities and Members' Equity
Current liabilities
Accounts payable and accrued expenses			$		196,933
Current portion of financing obligations—related party					1,202,304
Current portion of financing obligations					8,400
Total current liabilities					1,407,637
Financing obligations, net of current portion—related party					2,268,405
Financing obligations, net of current portion					742
Total liabilities					3,676,784
Commitments and Contingencies (Note 8)
Members' equity					7,275,598
Total liabilities and members' equity			$		10,952,382

The accompanying notes are an integral part of these financial statements.

F-48

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FIDELITY NATIONAL ENVIRONMENTAL SOLUTIONS, LLC

 STATEMENT OF OPERATIONS

		May 24, 2013
		through
		December 31, 2013
Revenues
Field services		$	3,655,918
Aftermarket part sales			133,804
Total revenues			3,789,722
Cost of sales
Field services costs (exclusive of depreciation shown below)			1,423,449
Aftermarket part costs – related party (exclusive of depreciation shown below)			127,562
Total cost of sales			1,551,011
Gross profit			2,238,711
Costs and expenses
Depreciation and amortization			1,718,331
Personnel (Includes stock-based compensation of $1,432,598)			1,838,664
Professional fees			190,234
Occupancy			136,429
Travel			128,881
Insurance			118,929
Marketing			62,275
Other general and administrative			90,833
Total costs and expenses			4,284,576
Loss from operations			(2,045,865	)
Other expense
Interest expense			(44,302	)
Total other expense			(44,302	)
Net loss		$	(2,090,167	)
Members' equity - May 23, 2013			7,933,167
Equity-based compensation			1,432,598
Members' equity - end of year		$	7,275,598

The accompanying notes are an integral part of these financial statements.

F-49

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FIDELITY NATIONAL ENVIRONMENTAL SOLUTIONS, LLC

 STATEMENT OF CASH FLOWS

		May 24, 2013
		through
		December 31, 2013
OPERATING ACTIVITIES:
Net loss		$	(2,090,167	)
Adjustments to reconcile net loss to net cash provided by operating activities:
Depreciation and amortization			1,718,331
Equity-based compensation			1,432,598
Changes in operating assets and liabilities:
Decrease in accounts receivable			40,972
Decrease in prepaid expenses			24,771
Increase in inventory			(238,508	)
Increase in accounts payable			37,938
Decrease in customer deposits			(11,600	)
Net cash provided by operating activities			914,335
INVESTING ACTIVITIES:
Proceeds from advances to Ecosphere Technologies, Inc.			1,385,139
Purchases of equipment			(799,117	)
Net cash provided by investing activities			586,022
FINANCING ACTIVITIES:
Repayments of vehicle financing			(5,472	)
Repayment of notes payable - related party			(280,124	)
Net cash used in financing activities			(285,596	)
Net increase in cash			1,214,761
Cash, beginning May 24, 2013			247,636
Cash, end of year		$	1,462,397
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid of interest		$	44,302
Cash paid for income taxes		$	—
SCHEDULE OF NON CASH INVESTING AND FINANCING ACTIVITIES:
Purchase of equipment with the issuance of notes payable		$	3,750,833

 

The accompanying notes are an integral part of these financial statements.

F-50

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FIDELITY NATIONAL ENVIRONMENTAL SOLUTIONS, LLC

NOTES TO FINANCIAL STATEMENTS FOR THE PERIOD

MAY 24, 2013 THROUGH DECEMBER 31, 2013

1.

DESCRIPTION OF THE BUSINESS AND BASIS OF PRESENTATION

Description of the Business

Fidelity National Environmental Solutions, LLC (the “Company” or “FNES”) has been deploying Ecosphere Technologies, Inc.’s (“ETI”) patented Ozonix® technology in the North American energy market since 2009. FNES is now the leading water treatment provider to the energy services sector and currently provides non-chemical water recycling technologies and services to energy companies operating in the oil and natural gas industry. FNES 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 in major shale plays around the United States with its diversified Ecos-Frac® line of Ozonix® products.

The Company has been granted an exclusive global “field-of-use” license to Ecosphere’s patented Ozonix® technology for the global energy market including, but not limited to, onshore and offshore oil and gas exploration and production, enhanced oil recovery, power generation, coal-fired power plants and refineries. Since 2009, FNES has been providing energy exploration and production companies with mobile, high-volume, chemical-free water treatment equipment to treat and recycle flowback and produced waters during hydraulic fracturing operations.

The Company was organized in the state of Delaware on July 13, 2009.

Since the inception date of July 13, 2009 through May 23, 2013, the Company was a majority-owned subsidiary of Ecosphere Technologies, Inc. (“ETI”), and its accounts were included in the consolidated financial statements of ETI. On May 24, 2013, ETI sold a 12% interest in FNES to an existing member, Fidelity National Financial (“FNF”), resulting in ETI no longer holding a controlling interest in the Company. Accordingly, since May 24, 2013, the accounts of the Company are no longer included in the consolidated financial statements of ETI.  In July 2013, ETI sold an additional 8% interest in the Company to FNF.

Basis of Presentation

The accompanying financial statements have been prepared in accordance with Generally Accepted Accounting Principles (“GAAP”) in the U.S. as promulgated by the Financial Accounting Standards Board (“FASB”), Accounting Standards Codification (“ASC”). The financial statements presented in this report are from the Period from May 24, 2013 through December 31, 2013 which is the period FNES began being accounting for under the equity method by ETI as noted above. In accordance with Regulation S-X 3-09 these financial statements of FNES should only depict the period of the fiscal year in which it was accounted for by the equity method.

2.

SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Use of Estimates

The preparation of the 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 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, and valuation of equity based instruments issued for other than cash.

Cash Equivalents

The Company considers all highly liquid investments with original maturities of three months or less at the date of purchase to be cash equivalents.

F-51

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FIDELITY NATIONAL ENVIRONMENTAL SOLUTIONS, LLC

NOTES TO FINANCIAL STATEMENTS FOR THE PERIOD

MAY 24, 2013 THROUGH DECEMBER 31, 2013

Accounts Receivable and Allowance for Doubtful Accounts

Accounts receivable are stated at their estimated net realizable value. The Company reviews its accounts to estimate losses resulting from the inability of its customers to make required payments. Any required allowance is based on specific analysis of past due accounts and also considers historical trends of write-offs. Past due status is based on how recently payments have been received from customers. The Company’s collection experience has been favorable reflecting a limited number of customers, all of which are in the oil and gas industry. No allowance was deemed necessary at December 31, 2013.

Inventory

Inventory is primarily comprised of replacement parts for sale to licensed operators of equipment utilizing the Ozonix® technology. Inventory on hand at the balance sheet date is stated at the lower of cost or market with cost determined using a weighted average methodology.

Property and Equipment

Property and equipment is stated at cost. Depreciation is computed using the straight-line method based on the estimated useful lives generally ranging from three to seven years. Expenditures for maintenance and repairs are expensed as incurred.

Impairment of Long-Lived Assets

 

The Company accounts for long-lived assets in accordance with the provisions of ASC 360-10, Accounting for the Impairment or Disposal of Long-Lived Assets. This statement requires that long-lived assets and certain identifiable intangibles be reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to future undiscounted net cash flows expected to be generated by the asset. If such assets are considered to be impaired, the impairment to be recognized is measured by the amount by which the carrying amount of the assets exceeds the fair value of the assets. Assets to be disposed of are reported at the lower of the carrying amount or fair value less, costs to sell.

Intangible Assets

The Company’s intangible assets consist of licensed rights to ETI’s patented Ozonix® technology for the global energy market including, but not limited to, onshore and offshore oil and gas exploration and production, enhanced oil recovery, power generation, coal-fired power plants and refineries. The Company acquired the license in 2009 for cash consideration of $2,500,000, which is being amortized over 18 years which is the remaining term of the patent using the straight-line method. Amortization expense totaled $84,006 for the period from May 24, 2013 through December 31, 2013. As of December 31, 2013, the net carrying value of the licensed rights, net of accumulated amortization of $625,000 was $1,875,000, which will be amortized in annual increments of $138,889 through June 2027.

Fair Value of Financial Instruments and Fair Value Measurements

 

The Company measures its financial and non-financial assets and liabilities, as well as makes related disclosures, in accordance with ASC Topic 820, Fair Value Measurements and Disclosures (“ASC Topic 820”). For certain of our financial instruments, including cash, accounts receivable, accounts payable and accrued liabilities, the carrying amounts approximate fair value due to their short maturities. Amounts recorded for notes payable, net of discount, also approximate fair value because current interest rates available to the Company for debt with similar terms and maturities are substantially the same.

ASC Topic 820 provides guidance with respect to valuation techniques to be utilized in the determination of fair value of assets and liabilities. Approaches include, (i) the market approach (comparable market prices), (ii) the income approach (present value of future income or cash flow), and (iii) the cost approach (cost to replace the service capacity of an asset or replacement cost). ASC Topic 820 utilizes a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value into three broad levels. The following is a brief description of those three levels:

Level 1:

Observable inputs such as quoted prices (unadjusted) in active markets for identical assets or liabilities.

Level 2:

Inputs other than quoted prices that are observable, either directly or indirectly. These include quoted prices for similar assets or liabilities in active markets and quoted prices for identical or similar assets or liabilities in markets that are not active.

Level 3:

Unobservable inputs in which little or no market data exists, therefore developed using estimates and assumptions developed by us, which reflect those that a market participant would use.

F-52

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FIDELITY NATIONAL ENVIRONMENTAL SOLUTIONS, LLC

NOTES TO FINANCIAL STATEMENTS FOR THE PERIOD

MAY 24, 2013 THROUGH DECEMBER 31, 2013

The Company used Level 3 inputs to estimate the fair value of equity-based compensation granted during the year ended December 31, 2013.

Revenue Recognition

 

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

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.

After Market Part Sales

The Company recognizes revenue from the sale of aftermarket parts to customers who have purchased the Company’s equipment during the period in which the parts are delivered to the buyer.

Royalties

Revenue from technology license royalties will be recorded if and as the royalties are earned. No royalty revenue has been earned to date.

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

Advertising

 

The Company conducts advertising for the promotion of its products and services. In accordance with ASC 720-35, Advertising Costs, are charged to operations when incurred and totaled $62,275 for the period May 24, 2013 through December 31, 2013.

 

Equity-based Compensation

Compensation expense for all equity-based employee and director compensation awards granted is based on the grant date fair value estimated in accordance with the provisions of ASC Topic 718, Stock Compensation (“ASC Topic 718”). The Company recognizes these compensation costs on a straight-line basis over the requisite service period of the award, which is generally the option vesting term. None of the Company’s awards to date were subject to vesting requirements. Accordingly, the grant-date fair value of these awards has been recognized as compensation expense on the grant date.

The Company has estimated the fair value of equity-based compensation based on recent transactions involving the Company’s equity interests for cash consideration.

Income Taxes

The Company is treated as a partnership for federal and state income tax purposes. Accordingly, the Company is not obligated to pay income taxes on its taxable income; rather its members are responsible for their respective portions of taxable income.

New Accounting Standards

Management does not believe that any recently issued, but not yet effective accounting standards, if currently adopted, would have a material effect on the financial statements.

F-53

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FIDELITY NATIONAL ENVIRONMENTAL SOLUTIONS, LLC

NOTES TO FINANCIAL STATEMENTS FOR THE PERIOD

MAY 24, 2013 THROUGH DECEMBER 31, 2013

3.

ACCOUNTS RECEIVABLE

 

As of December 31, 2013 accounts receivable in the amount of $431,978 consisted of amounts due from one customer, for providing Ecos-Frac® services to treat water without the use of chemicals prior to fracturing natural gas wells. See Note 9, Concentration of Risk.

4.

INVENTORY

Inventory consists of the following:

		December 31,
		2013
Raw materials		$	224,261
Finished Goods			250,000
Total		$	474,261

Finished goods represent a completed water treatment unit available for sale and raw materials represent spare parts available for sale.

5.

PROPERTY AND EQUIPMENT

 

Property and equipment as of December 31 2013, consists of the following:

		Estimated Useful
		Lives in Years
Machinery and equipment		5				$	17,026,374
Furniture and fixtures		5 to 7					27,212
Automobiles and trucks		3 to 5					171,798
							17,225,384
Less total accumulated depreciation							(10,522,822	)
Property and equipment, net						$	6,702,562

Depreciation expense for the period from May 24, 2013 through December 31, 2013 amounted to $1,634,325.

6.

FINANCING OBLIGATIONS

Financing obligations consisted of the following as of December 31, 2013:

Secured equipment note payable issued as partial consideration for the purchase of equipment from ETI, payable in monthly installments of $52,778 through July 2016. The note is non-interest bearing and carried at the present value of future payments using an implied annual interest rate of 5.05%				$	1,530,869
Secured equipment note payable issued as partial consideration for the purchase of equipment from ETI, payable in monthly installments of $59,722 through November 2016. The note is non-interest bearing and carried at the present value of future payments using an implied annual interest rate of 5.05%					1,939,840
Secured vehicle notes payable in monthly installments totaling $877 over 60 months accruing interest at an annual rate of 8.9%.					9,142
Total					3,479,851
Less Current Portion					(1,210,704	)
Financing obligations, long-term portion				$	2,269,147

F-54

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FIDELITY NATIONAL ENVIRONMENTAL SOLUTIONS, LLC

NOTES TO FINANCIAL STATEMENTS FOR THE PERIOD

MAY 24, 2013 THROUGH DECEMBER 31, 2013

Aggregate annual maturities of debt are as follows as of December 31, 2013:

For the year ended December 31,		Amount
2014		$	1,210,704
2015			1,265,189
2016			1,003,958
Total		$	3,479,851

 

7.

MEMBERS’ EQUITY

 

The Company has one class of membership unit, of which it is authorized up to an aggregate of 1,000,000 units. As of December 31, 2013, there were 127,393 units outstanding. Each member has rights, obligations and other features provided to Members generally.

 

Equity Based Compensation

In July 2013, the Company granted certain members of its board of directors and management options to acquire 10% of membership interests for aggregate consideration of $20,000,000 over a term of 5 years. The options provide for a cashless exercise feature in the event of a change of control. The grant-date fair value of the options, totaling 2,819,619, was estimated using the Black-Scholes Method and the following assumptions: expected term – 7 years; volatility – 94.63%, risk free rate – 2.27%, expected dividends – 0%. One third of the options vested immediately on August 23, 2013 and the remaining two thirds vest on August 23, 2014 and 2015. The Company recognized $1,432,598 of expense related to these options for the period May 24, 2013 through December 31, 2013.

8.

COMMITMENTS AND CONTINGENCIES

 

Legal

 

From time to time, we may be involved in litigation relating to claims arising out of our operations in the normal course of business.

 

To our knowledge, no legal proceedings, government actions, administrative actions, investigations or claims are currently pending against us or involve us that, in the opinion of our management, could reasonably be expected to have a material adverse effect on our business and financial condition.

 

9.

CONCENTRATION OF RISK

 

For the period from May 23, 2013 through December 31, 2013, 77%, 20% and 3% of the Company’s revenues were from customers A, B and C, respectively, in the oil and gas industry. Of the three revenue sources, 77% related to mobile, Ozonix® water recycling services provided during hydraulic fracturing operations, 20% related to onsite, Ozonix® water recycling services provided for the treatment of flowback and produced waters and the remaining 3% related to the sale of aftermarket parts used in Ozonix® water treatment equipment. As of December 31, 2013, approximately 100% of accounts receivable was from customer A.

The Company maintains its cash in bank and financial institution deposits that at times may exceed federally insured limits. The Company has not experienced any losses in such accounts through December 31, 2013. As of December 31, 2013, the Company’s bank balances exceeded FDIC insured amounts by approximately $1.5 million. 

10.

RELATED PARTY TRANSACTIONS

For the period from May 24, 2013 through December 31, 2013, the Company acquired equipment from ETI, a 30.6% member of the Company, for aggregate consideration of $4.8 million, of which $750,000 was paid upon delivery of the equipment, and remaining $4,050,000 balance as of December 31, 2013, is payable in monthly installments of $112,500, comprising of principal plus implied interest with an annual rate of 5.05%. The present value of the remaining payments is $3,470,709 which are included in financing obligations on the accompanying balance sheet. (See Note 6)

For the period from May 24, 2013 through December 31, 2013, as consideration for certain administrative functions, the Company pays ETI a monthly service fee of $56,360, which is included in other general and administrative expenses in the attached statement of operations.

For the period from May 24, 2013 through December 31, 2013, the Company acquired approximately $180,000 in aftermarket parts which is included in inventory and in costs of sales as applicable from ETI.

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