Quarterly Report

10-Q 1 esph_10q.htm QUARTERLY REPORT Quarterly Report

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

____________

FORM 10-Q

____________


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

For the quarterly period ended March 31, 2014

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 of		(I.R.S. Employer
incorporation or organization)		Identification No.)

3515 S.E. Lionel Terrace, Stuart, Florida		34997
(Address of principal executive offices)		(Zip Code)

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

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 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 (Do not check if a smaller reporting company)	Smaller reporting company	o

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


Class		Outstanding at May 8, 2014
Common Stock, $0.01 par value per share		164,147,155 shares

TABLE OF CONTENTS


		Page

	PART I – FINANCIAL INFORMATION

Item 1.	Condensed Consolidated Financial Statements (unaudited)	1

	Condensed Consolidated Balance Sheets	1

	Condensed Consolidated Statements of Operations (unaudited)	2

	Condensed Consolidated Statements of Cash Flows (unaudited)	3

	Notes to Condensed Consolidated Financial Statements (unaudited)	5

Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	22

Item 3.	Quantitative and Qualitative Disclosures about Market Risk	29

Item 4.	Controls and Procedures	29

	PART II – OTHER INFORMATION

Item 1.	Legal Proceedings	30

Item 1A.	Risk Factors	30

Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	30

Item 3.	Defaults Upon Senior Securities	30

Item 4.	Mine Safety Disclosures	30

Item 5.	Other Information	30

Item 6.	Exhibits	30


SIGNATURES	31

PART I – FINANCIAL INFORMATION

ITEM 1.

FINANCIAL STATEMENTS.

ECOSPHERE TECHNOLOGIES, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS


	March 31, 2014			December 31, 2013
	(Unaudited)
Assets
Current assets
Cash	$	1,174,443		$	1,059,651
Restricted cash		25,044			25,000
Current portion of accounts receivable-related party		381,831			1,210,445
Inventory		353,519			219,278
Prepaid expenses and other current assets		206,773			121,480
Total current assets		2,141,610			2,635,854
Investment in unconsolidated investee		14,053,115			14,369,439
Accounts receivable-related party, net of current portion		571,628			2,268,406
Property and equipment, net		1,882,242			1,857,601
Debt issuance costs, net		28,914			37,007
Patents, net		135,729			138,034
Deposits		14,840			14,840
Total assets	$	18,828,078		$	21,321,181

Liabilities, Redeemable Convertible Cumulative Preferred Stock and Stockholders’ Equity
Current liabilities
Accounts payable	$	618,226		$	410,402
Accrued liabilities		572,199			843,893
Current portion of convertible notes payable, net of discounts		971,297			271,176
Current portion of note payable		85,125			85,125
Warrant derivatives fair value		1,764			3,671
Current portion of financing obligations		208,617			163,746
Current portion of capital lease obligation		15,542			15,347
Total current liabilities		2,472,770			1,793,360
Convertible note payable, net of discounts and current portion		275,535			510,984
Note payable, net of current portion		51,074			68,099
Financing obligations, net of current portion		96,726			108,265
Capital lease obligation, net of current portion		37,970			41,929
Total liabilities		2,934,075			2,522,637

Redeemable convertible cumulative preferred stock
Series A - 11 shares authorized; 6 shares issued and outstanding at March 31, 2014 and December 31, 2013; $25,000 per share redemption amount plus dividends in arrears		1,209,119			1,203,494
Series B - 484 shares authorized; 241 shares issued and outstanding at March 31, 2014 and December 31, 2013; $2,500 per share redemption amount plus dividends in arrears		2,532,096			2,517,033
Total redeemable convertible cumulative preferred stock		3,741,215			3,720,527

Commitments and contingencies (Note 13)

Stockholders’ Equity
Common stock, $0.01 par value; 300,000,000 shares authorized; 164,147,155 and 164,033,139 shares issued and outstanding at March 31, 2014, and December 31, 2013, respectively		1,641,471			1,640,330
Common stock issuable, $0.01 par value; 0 and 105,263 issuable at March 31, 2014, and December 31, 2013, respectively		—			1,053
Additional paid-in capital		111,867,742			111,417,253
Accumulated deficit		(101,356,425	)		(97,980,619	)
Total stockholders’ equity		12,152,788			15,078,017
Total liabilities, redeemable convertible cumulative preferred stock and stockholders’ equity	$	18,828,078		$	21,321,181

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

ECOSPHERE TECHNOLOGIES, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)


	For the Three Months Ended March 31,
	2014			2013
Revenues
Equipment sales and licensing, related party	$	107,925		$	—
Field services		—			751,684
Aftermarket part sales		—			109,935
Aftermarket part sales, related party		26,324			—
Total revenues		134,249			861,619

Costs and expenses
Equipment sales and licensing costs (exclusive of depreciation shown below)		33,925			—
Field services costs (exclusive of depreciation shown below)		—			446,596
Aftermarket part costs (exclusive of depreciation shown below)		21,916			109,543
Selling, general and administrative		1,765,120			2,078,453
Restructuring charge		—			6,491
Depreciation and amortization		103,949			545,011
Loss on sale of notes receivable		730,260			—
Total costs and expenses		2,655,170			3,186,094

Loss from operations		(2,520,921	)		(2,324,475	)

Loss on investment in unconsolidated investee		(316,324	)		—

Other income (expense)
Interest income		36,572			—
Interest expense		(577,040	)		(92,505	)
Gain (loss) on change in fair value of derivative instruments		1,907			(85,968)
Total other expense, net		(538,561	)		(178,473	)

Net loss		(3,375,806	)		(2,502,948	)

Preferred stock dividends		(20,688	)		(20,688	)


Net loss applicable to common stock before allocation to non controlling interest		(3,396,494	)		(2,523,636	)

Less: net loss applicable to non controlling interest in consolidated subsidiary		—			170,496

Net loss applicable to Ecosphere Technologies, Inc. common stock	$	(3,396,494	)	$	(2,353,140	)

Net loss per common share applicable to common stock
Basic	$	(0.02	)	$	(0.02	)
Diluted	$	(0.02	)	$	(0.02	)

Weighted average number of common shares outstanding
Basic		164,142,876			161,518,161
Diluted		164,142,876			161,518,161

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

ECOSPHERE TECHNOLOGIES, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)


	For the Three Months Ended March 31,
	2014			2013

Operating Activities:
Net loss applicable to Ecosphere Technologies, Inc. common stock	$	(3,396,494	)	$	(2,353,140	)
Adjustments to reconcile net loss applicable to Ecosphere Technologies, Inc. common stock to net cash used in operating activities:
Preferred stock dividends		20,688			20,688
Depreciation and amortization		103,949			545,011
Non-controlling interest in loss of consolidated subsidiary		—			(170,496	)
Amortization of debt issue costs		8,093			3,457
Accretion of discount on notes payable		491,315			43,847
Stock-based compensation expense		199,622			236,796
(Income) loss from change in fair value of warrant derivative liability		(1,907	)		85,968
Loss on investment in unconsolidated investee		316,324			—
Loss on sale of notes receivable		730,260			—
Changes in operating assets and liabilities:
Decrease in accounts receivable		195,132			688,562
Increase in prepaid expenses and other current assets		(3,865	)		(153,841	)
Increase in inventory		(134,241	)		(3,295,324	)
Increase in accounts payable		207,824			2,398,155
Decrease in accrued liabilities		(271,694	)		(217,114	)
Decrease in restructuring reserve		—			(5,909	)
Decrease in customer deposits		—			(23,196	)
Net cash used in operating activities		(1,534,994	)		(2,196,536	)
Investing Activities:
Construction in process purchases		—			(500,693	)
Purchase of property and equipment		(126,285	)		(41,046	)
Transfer from restricted cash		—			35,168
Interest on restricted cash		(44	)		—
Net cash used in investing activities		(126,329	)		(506,571	)
Financing Activities:
Proceeds from issuance of convertible notes payable and warrants, net of debt issue costs		245,000			706,468
Proceeds from warrant and option exercises		—			20,000
Proceeds from sale of notes receivable		1,600,000			—
Repayments of note payable		(17,025	)		(30,000	)
Repayments of capital lease obligations		(3,764	)		(3,579	)
Repayments of vehicle and equipment financing		(48,096	)		(20,999	)
Net cash provided by financing activities		1,776,115			671,890
Net increase (decrease) in cash		114,792			(2,031,217	)
Cash at beginning of period		1,059,651			2,464,911
Cash at end of period	$	1,174,443		$	433,694

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

ECOSPHERE TECHNOLOGIES, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)


	For the Three Months Ended March 31,
	2014		2013
Supplemental disclosures of cash flow information:
Cash paid for interest	$	21,968	$	34,046
Cash paid for income taxes	$	—	$	—

Non-cash investing and financing activities
Accrued preferred stock dividends	$	20,688	$	20,688
Common stock issued as settlement of note and accrued interest	$	—	$	6,000
Cashless exercise of options and warrants	$	88	$	14,957
Beneficial conversion feature on convertible debt charged to additional paid in capital	$	234,211	$	391,771
Modification of warrants	$	37,432	$	—
Warrants issued as debt issue cost	$	—	$	21,211
Insurance premium finance contract recorded as a prepaid asset	$	104,299	$	168,859

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

ECOSPHERE TECHNOLOGIES, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

March 31, 2014

(UNAUDITED)

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 Awards - New Energy Pioneer;

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.

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 and March 31, 2014, ETI and FNF owned 30.6% and 39% of FNES, respectively.

The Company plans to further leverage its commercially proven Ozonix® technology via widespread partnering and licensing to achieve substantial technology deployment and the corresponding revenue and profit growth. In addition to FNES, 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 include; 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.

ECOSPHERE TECHNOLOGIES, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

March 31, 2014

(UNAUDITED)

Accordingly, in 2013, Ecosphere retained Navigant Consulting, Inc. (NYSE:NCI), a leading company in the field of intellectual property valuation, to perform an analysis to value 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 approximately 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.

During 2013, Ecosphere received notice of approval from the United States Patent & Trademark Office for Patent No. 8,593,102 for Ecosphere's revolutionary Ecos PowerCube®, a portable, self-contained micro-utility that uses solar power to provide electricity in the most remote, off-grid locations. Designed to meet the growing demand for off-grid energy, with a unique array of stacked solar panels, the patented Ecos PowerCube® maximizes the total amount of solar power generation possible in 10', 20' and 40' standard ISO shipping container footprints. With power generation capabilities up to 15 KW, the Ecos PowerCube® can be transported by land, air or sea and is ideally suited to support off-grid military, disaster relief, humanitarian and mobile communication efforts. The Company is currently manufacturing the very first Ecos PowerCube® and we estimate we will have a working prototype available for demonstration purposes in Q3 2014.

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

Basis of Presentation

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with Generally Accepted Accounting Principles (“GAAP”) in the United States of America (“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 interim financial information. The unaudited condensed consolidated financial statements reflect all normal recurring adjustments, which, in the opinion of management, are considered necessary for a fair presentation of the results for the periods shown. The results of operations for the periods presented are not necessarily indicative of the results expected for the full fiscal year or for any future period. The information included in these unaudited condensed consolidated financial statements should be read in conjunction with Management’s Discussion and Analysis and Results of Operations contained in this report and the audited consolidated financial statements and accompanying notes included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2013.

Going Concern

As of May 6, 2014, Ecosphere had cash on hand of approximately $0.4 million. 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 are described below.

In March 2014, Ecosphere sold the FNES note payable for the Unit sold in July 2013 in exchange for $1 million in cash. The buyer of the note is an FNES member and director. The Company also sold 50% of the FNES note payable for the Unit sold in November 2013 in exchange for $0.6 million in cash. Since December 18, 2013, Ecosphere has raised approximately $1.95 million through the sale of Convertible Notes and Warrants. The Notes are convertible at $0.30 per share and the Warrants exercisable at $0.35 per share. Ecosphere is seeking to raise up to another $3.05 million from the sale of Convertible Notes and Warrants. See Note 6 to the unaudited condensed consolidated financial statements for details on this financing. Management believes that its current plans will provide sufficient liquidity for the next 12 months.

ECOSPHERE TECHNOLOGIES, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

March 31, 2014

(UNAUDITED)

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, although due to our current stock price it may be difficult to achieve any liquidity from these notes.

The FNES note with $29,861 per month of payments as described above. Ecosphere is seeking to sell the remaining portion of this note.

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, 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. No funds have been received to date.

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.

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 unaudited condensed 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 that became due in March 2014 and $712,500 due in February 2015. The maturity dates of the Notes that became due in March 2014 have been extended to September 2014 for $50,000 of principal and March 2015 for $245,000 of principal.

SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Principles of Consolidation

The accompanying unaudited condensed 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 Note 3). 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 FNES 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 unaudited condensed consolidated statements of operations.

ECOSPHERE TECHNOLOGIES, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

March 31, 2014

(UNAUDITED)

Use of Estimates

The preparation of the unaudited condensed 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, valuation of derivatives, valuation of remaining interest in FNES upon deconsolidation and the valuation allowance on deferred tax assets.

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 March 31, 2014, represents a $25,044 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 natural gas industry. No allowance was deemed necessary at March 31, 2014 and December 31, 2013.

Inventory

Inventory is primarily comprised of raw materials to manufacture water treatment equipment and work-in-process representing a mobile solar power system and water treatment equipment 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 4.

Property, Equipment and Capitalized 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 March 31, 2014 and December 31, 2013 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.

ECOSPHERE TECHNOLOGIES, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

March 31, 2014

(UNAUDITED)

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.

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.

ECOSPHERE TECHNOLOGIES, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

March 31, 2014

(UNAUDITED)

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 3)

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.

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.

ECOSPHERE TECHNOLOGIES, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

March 31, 2014

(UNAUDITED)

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.

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 March 31, 2014, 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 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.

For the three months ended March 31, 2014 and 2013, no potential common shares were included in the calculation of diluted loss per share because they were anti-dilutive.

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 Stock


	For the Three Months Ended
	March 31,
	2014		2013
Convertible debt		9,091,146		3,761,250
Convertible preferred stock		362,497		362,497
Options and warrants to purchase common stock		74,063,888		71,650,525
Unvested stock grants		—		84,000
Total Anti-Dilutive Potential Common Stock		83,517,531		75,858,272

ECOSPHERE TECHNOLOGIES, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

March 31, 2014

(UNAUDITED)

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 unaudited condensed consolidated financial statements.

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 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 and March 31, 2014. Condensed unaudited summary financial information for FNES as of March 31, 2014 and for the three months ended March 31, 2014 is as follows:


	March 31, 2014
	(Unaudited)
ASSETS
Cash	$	1,451,144
Accounts receivable		594,789
Property and equipment		5,951,690
Inventory		291,123
Prepaid Expenses		141,035
Intangible Assets		1,840,278
Deposits		4,200

Total Assets	$	10,274,259

LIABILITIES AND MEMBERS' EQUITY
Accounts payable and accrued expenses	$	314,364
Accounts payable, related party		61,203
Debt		133,678
Debt, related party		3,175,789
Members' equity		6,589,225

Total liabilities and members' equity	$	10,274,259


	For the three months ended March 31, 2014
	(Unaudited)
STATEMENT OF OPERATIONS
Revenues	$	1,722,531
Cost of sales		967,861
Gross profit		754,670
Operating expenses		1,744,328
Operating loss		(989,658	)
Other expense		44,339
Net loss		(1,033,997	)
Ownership interest (average)		31	%
Share of net loss	$	(316,324	)
Total equity interest loss recorded	$	(316,324	)
Investment	$	14,053,115

ECOSPHERE TECHNOLOGIES, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

March 31, 2014

(UNAUDITED)

INVENTORY

Inventory consists of the following at March 31, 2014 and December 31, 2013:


	2014		2013
Raw materials	$	175,408	$	178,982
Work in process		178,111		40,296
	$	353,519	$	219,278

PROPERTY AND EQUIPMENT

Property and equipment consists of the following at March 31, 2014, and December 31, 2013:


	Estimated Useful
	Lives in Years	2014			2013
Machinery and equipment	5	$	2,381,203		$	2,329,731
Furniture and fixtures	5 to 7		314,576			303,026
Automobiles and trucks	3 to 5		142,141			142,141
Leasehold improvements	5		524,263			469,230
Office equipment	5		616,863			608,633
			3,979,046			3,852,761
Less total accumulated depreciation			(2,096,804	)		(1,995,160	)
Property and equipment, net		$	1,882,242		$	1,857,601

During the three months ended March 31, 2014, additions to property and equipment included computer equipment and software, a Company manufactured fixture to house the Company’s raw metals inventory and additions to a mobile operations vehicle originally purchased during the fourth quarter of 2013. The Company also had additions to leasehold improvements and office equipment relating to the build out of the mining office in Park City, Utah. Depreciation expense amounted to approximately $0.1 million for the three months ended March 31, 2014.

ECOSPHERE TECHNOLOGIES, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

March 31, 2014

(UNAUDITED)

NOTES PAYABLE AND OTHER DEBT

Long-term debt consists of the following at March 31, 2014, and December 31, 2013:

Convertible Notes Payable


	March 31, 2014		December 31, 2013
In January 2014, the Company issued convertible notes in the aggregate principal amount of $245,000. The notes accrue interest at an annual rate of 10%, mature 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. The Company recorded a discount related to the warrants and beneficial conversion feature of $234,211 based upon the relative fair value of the warrants calculated using the Black Scholes valuation method and the following assumptions: volatility ranging between 78.01% and 78.26%, an expected term of five years, a risk-free discount rate ranging between 1.61% and 1.77% and no dividends. As of March 31, 2014, the unamortized amount of the discount was $209,704 and accrued interest was $5,236.	$	35,296	$	—

In December 2013, the Company issued 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 March 31, 2014, the unamortized amount of the discount was $1,459,761 and accrued interest was $48,125.		240,239		11,096

In February 2013, the Company issued 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 were 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. As a result of the December 2013 financing, the Company was in violation of certain covenants included in the securities purchase agreements with the investors. In March 2014, the investors agreed to waive their rights under securities purchase agreements in exchange for a reduction in the conversion price of the notes and exercise price of the warrants to $0.30 per share. The Company also agreed to issue additional warrants to acquire 265,625 shares of common stock at an exercise price of $0.30 per share. As a result of the modification, the Company recorded an additional debt discount of $37,432 for the increase in the fair value of the warrants. The modification was accounted for as a debt extinguishment in accordance with ASC 470-50-40 and reissuance of the existing debt, resulting in the immediate expensing of the remaining discount of $164,503. There was no beneficial conversion feature on the exchanged debt. As of March 31, 2014, the unamortized amount of the discount was $36,203 and accrued interest was $15,137. The Company began making quarterly interest payments on October 1, 2013, for accrued interest on these convertible notes.		676,297		499,888

ECOSPHERE TECHNOLOGIES, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

March 31, 2014

(UNAUDITED)


	March 31, 2014			December 31, 2013
In 2010 and 2011, the Company issued 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 $0.42 and issued warrants to purchase 368,467 shares of common stock for $0.42 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 was being amortized through the extended maturity of the notes. Subsequent to March 31, 2014, the holders of the notes due in March 2014 agreed to extend the maturity dates of the notes to September 2014 for $50,000 of principal and March 2015 for $245,000 of principal. As of March 31, 2014, there was no unamortized amount of the discounts. Accrued interest at March 31, 2014 was $96,589.	$	295,000		$	271,176

Total		1,246,832			782,160
Less Current Portion, net of discounts		(971,297	)		(271,176	)
Convertible notes payable, long term, net of discounts	$	275,535		$	510,984

A summary of convertible notes payable and the related discounts as of March 31, 2014, and December 31, 2013 is as follows:


	March 31, 2014			December 31, 2013
Principal amount of convertible notes payable	$	2,952,500		$	2,707,500
Unamortized discount		(1,705,668	)		(1,925,340	)
Convertible notes payable, net of discount		1,246,832			782,160
Less: current portion		(971,297	)		(271,176	)
Convertible notes payable, net of discount, less current portion	$	275,535		$	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 $136,199 and $153,224 was outstanding at March 31, 2014, and December 31, 2013, respectively, from related party debt due to lack of on-going affiliation with the lender. The note is non-interest bearing and payable in quarterly payments of $17,025. Accordingly, $85,125 is included as a current liability in the accompanying unaudited condensed consolidated financial statements.

ECOSPHERE TECHNOLOGIES, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

March 31, 2014

(UNAUDITED)

Financing Obligations


	March 31, 2014			December 31, 2013
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%	$	88,009		$	102,321

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%.		52,574			54,690

Financing for insurance premiums payable in nine monthly installments of $11,810 accruing interest at 4.56%. The final payment is due in October 2014.		81,428			—

Secured non-interest bearing, equipment notes payable in monthly installments of $8,333 over 12 months, maturing in December 2014.		83,332			115,000

Total		305,343			272,011
Less Current Portion		(208,617	)		(163,746	)
Financing obligations, long-term portion	$	96,726		$	108,265

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 March 31, 2014, by fiscal year, are as follows:


For the year ended December 31,	Payment
2014	$	13,414
2015		17,888
2016		17,888
2017		8,946
Total		58,136
Less implied interest		(4,624	)
Capital lease obligation		53,512
Less current potion		(15,542	)
Long-term portion	$	37,970

Third Party Debt

Aggregate annual maturities of third party debt are as follows as of March 31, 2014:


For the year ended December 31,	Amount
2014	$	572,035
2015		2,543,049
2016		294,546
2017		19,004
2018		11,219
2019		7,701
Total debt- face value		3,447,554
Less: unamortized discount		(1,705,668	)
Net debt	$	1,741,886

ECOSPHERE TECHNOLOGIES, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

March 31, 2014

(UNAUDITED)

DERIVATIVE FINANCIAL INSTRUMENTS

The Company applies the provisions of ASC Topic 815-40, Contracts in Entity’s Own Equity (“ASC Topic 815-40”), under which convertible instruments and warrants, which contain terms that protect holders from declines in the stock price (reset provisions), may not be exempt from derivative accounting treatment. As a result, warrants are recorded as a liability and are revalued at fair value at each reporting date. Further, under derivative accounting, the warrants are recorded at their fair value. If the fair value of the warrants exceeds the face value of the related debt, the excess is recorded as change in fair value in operations on the issuance date. The Company has 26,250 warrants with repricing options outstanding at March 31, 2014.

The Company calculates the estimated fair values of the liabilities for warrant derivative instruments at each quarter-end using the BSM option pricing model and Monte Carlo simulations. The closing price of the Company’s common stock at March 31, 2014 was $0.21, compared to $0.28 at December 31, 2013. Volatility, expected term and risk free interest rates used to estimate the fair value of derivative liabilities at March 31, 2014, are indicated in the table that follows. The volatility was based on historical volatility, the expected term is equal to the remaining term of the warrants and the risk free rate is based upon rates for treasury securities with the same term.

Warrants


	March 31, 2014
Volatility	80,86%
Expected Term in years	0.02
Risk Free Interest Rate	0.003%
Expected dividend yield	none

During the three month period ended March 31, 2014, based upon the estimated fair value, the Company decreased its liability for the remaining warrant derivative instruments by $1,907 which was recorded as "Gain from change in fair value of derivative instruments" in the other expense section of the Company's unaudited condensed consolidated statement of operations.

FAIR VALUE MEASUREMENTS

Recurring Basis

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 7. The following tables summarize our financial assets and liabilities measured at fair value on a recurring basis as of March 31, 2014:

Quoted Prices

Significant

Balance at

in Active

Other

Significant

March 31,

Markets for

Observable

Unobservable

2014

Identical Assets

Inputs

(Level 1)

(Level 2)

(Level 3)

Fair value of liability for warrant derivative instruments

1,764

—

1,764

The following is a roll forward for the three months ended March 31, 2014 of the fair value liability of price adjustable warrant derivative instruments:


	Fair Value of
	Liability for
	Warrant
	Derivative
	Instruments

Balance at December 31, 2013	$	3,671
Fair value of warrants exercised or expired		—
Change in fair value included in statement of operations		(1,907	)
Balance at March 31, 2014	$	1,764

ECOSPHERE TECHNOLOGIES, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

March 31, 2014

(UNAUDITED)

REDEEMABLE CONVERTIBLE CUMULATIVE PREFERRED STOCK

Series A

At March 31, 2014, and December 31, 2013, 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 25,200 common shares. Accrued dividends totaled $1,059,494 and $1,053,494 on March 31, 2014, and December 31, 2013, respectively. There was no Series A Preferred Shares activity during the three months ended March 31, 2014. Annual dividends accrue at a rate of $3,750 per share.

Series B

At March 31, 2014, and December 31, 2013, there were 241 shares 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 event at $2,500 per share plus accrued dividends. The shares are convertible each into 876 common shares. Accrued dividends totaled $1,929,596 and $1,914,533 on March 31, 2014, and December 31, 2013, respectively. There was no Series B Preferred Shares activity during the three months ended March 31, 2014. Annual dividends accrue at a rate of $250 per share.

10.

COMMON STOCK

Shares issued and issuable during the three months ended March 31, 2014 are summarized below.


Shares outstanding and issuable at December 31, 2013			164,138,402
Cashless exercise of options (a)			8,753
Total common shares outstanding at March 31, 2014			164,147,155

———————

(a)

issued upon cashless exercises of 44,546 options by a director at an exercise price of $0.229 per share based upon market prices of the Company’s common stock of $0.285 per share.

11.

STOCK OPTIONS AND WARRANTS

Issuance of Warrants with Convertible Debt

In January 2014, the Company issued 1,633,328 five-year warrants exercisable at $0.35 per share in connection with the issuance of convertible notes in the aggregate principal amount of $245,000.

As a result of the modification of the February 2013 convertible notes (See Note 6), the Company reduced the exercise price of warrants to acquire 984,375 shares of common stock from $0.381 to $0.30 per share. The company also agreed to issue additional warrants to acquire 265,625 shares of common stock at an exercise price of $0.30 per share.

Option Exercise

Cashless Exercise

In February 2014, the Company issued 8,753 shares of common stock to a director 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.

ECOSPHERE TECHNOLOGIES, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

March 31, 2014

(UNAUDITED)

The fair value of each option and warrant is estimated on the date of grant using the BSM option-pricing model. The Company used the following assumptions for options and warrants issued or valued during the three months ended March 31, 2014:


Risk-free interest rate	0.90% to 1.77%
Expected option life in years	3.92 to 5.0
Expected stock price volatility	64.67% to 78.26%
Expected dividend yield	None

Stock-based compensation expense related to options for the three months ended March 31, 2014 was $199,622. At March 31, 2014, total unrecognized compensation cost related to unvested options granted under the Company’s option plans totaled $316,248. This unrecognized compensation cost is expected to be recognized over the next 21 months.

12.

RELATED PARTY TRANSACTIONS

Related Party Consulting Agreements

In January 2013, the Company entered into a three year consulting agreement at the rate of $250,000 per year that may be terminated with 30 days’ notice with one of the Company’s board members. For the three months ended March 31, 2014, the Company has incurred $62,499 pursuant to the consulting agreement.

Related Party Cashless Option Exercise

Related Party Equipment Sales

In January 2014, FNES sold one Ozonix® EF10M to Hydrosphere Energy Solutions that was purchased by FNES from the Company in 2013. The sale to Hydrosphere resulted in equipment sales of approximately $0.1 million to the Company.

Related Party Service Fee

The Company has been receiving a service fee for its continued accounting, executive, 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 services fee are offset against various expense accounts on the statement of operations. The Company had an accounts receivable balance at March 31, 2014 of $56,360 relating to March 2014 services performed for FNES.

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 owed on two Ozonix® EF80 units purchased in July and November 2013. In March 2014, Ecosphere sold the FNES note payable for the Unit sold in July 2013 in exchange for $1 million in cash. The buyer of the note is an FNES member and director. The Company also sold 50% of the FNES note payable for the Unit sold in November 2013 in exchange for $0.6 million in cash. As of March 31, 2014 the Company had an accounts receivable balance of approximately $0.95 million in connection to the note payable for the Ozonix® EF80 unit sold in November 2013.

At March 31, 2014, the Company had an accounts receivable balance of approximately $1.0 million due from FNES. The $1.0 million accounts receivable balance consisted of a $56,360 service fee, $4,843 in aftermarket parts and the $0.9 million remaining balance FNES owes the Company on the Ozonix® EF80 unit purchased in November 2013.

ECOSPHERE TECHNOLOGIES, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

March 31, 2014

(UNAUDITED)

13.

COMMITMENTS AND CONTINGENCIES

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. 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.

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, 2019. The Company has an obligation of $217,009 relating to this five-year lease agreement.

Legal

The Company has an extensive intellectual property portfolio which management believes has substantial value not reflected on the Condensed 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. For the three months ended March 31, 2014, the Company has incurred $182,576 in connection with the arbitration. The hearing concluded in March 2014 with decision reserved by the panel.

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 March 31, 2014 the Company had an accrued balance of $93,750 which is comprised of the $150,000 obligation less $56,250 in payments. Upon final payment in accordance with the settlement, the Company will record a $50,000 gain.

In March 2011, a former vendor obtained a judgment against the Company for a number of disputed billings. As of March 31, 2014 the Company has accrued $70,000 which is anticipated to be the amount of payment due to the vendor plus attorney’s fees.

ECOSPHERE TECHNOLOGIES, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

March 31, 2014

(UNAUDITED)

14.

CONCENTRATIONS OF RISK

Concentration of Accounts Receivable and Revenues

At March 31, 2014, 100% of the Company’s accounts receivable of approximately $1.0 million was due from one customer and that same customer accounted for 100% of revenues, respectively, being FNES our equity method investee.

Concentration of Credit Risk

Financial instruments that potentially subject the Company to significant concentrations of credit risk consist primarily of cash and cash equivalents and accounts receivable. 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 March 31, 2014. As of March 31, 2014, the Company had approximately $1.0 million in cash equivalent balances held in a corporate checking account that were not insured. The Company performs ongoing credit evaluations of its customers and generally does not require collateral for accounts receivable. The Company’s payment terms are generally upon receipt or 30 days from delivery of products, but may fluctuate depending on the terms of each specific contract. The Company’s customers are in the oil and gas industry.

ECOSPHERE TECHNOLOGIES, INC. AND SUBSIDIARIES

ITEM 2:

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

The following discussion and analysis should be read in conjunction with our unaudited condensed consolidated financial statements and related notes appearing elsewhere in this report. In addition to historical information, this discussion and analysis contains forward-looking statements that involve risks, uncertainties, and assumptions. Our actual results may differ materially from those anticipated in these forward-looking statements as a result of certain factors, including but not limited to those set forth under “Risk Factors” in our Form 10-K for the year ended December 31, 2013.

Company Overview

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

Business Model

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

Identify a major environmental challenge,

Invent new technologies and file patents,

Partner with industry leaders,

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

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

Create recurring revenues and increase shareholder value.

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

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

Intellectual Property Portfolio

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

ECOSPHERE TECHNOLOGIES, INC. AND SUBSIDIARIES

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

In 2013, Ecosphere has received $10 million from FNF for the sale of our 20% interest in FNES, which reduced our ownership interest in FNES to 30.6%. Ecosphere expects to monetize the remaining balance of its 30.6% ownership in FNES. In 2014 Ecosphere has formed six new subsidiaries which it expects will obtain exclusive sublicenses for global, industry-specific fields-of-use to its patented Ozonix® technology. See Note 1 to our unaudited condensed consolidated financial statements contained herein.

Recent Success

In 2009, Ecosphere formed EES, now 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.

In 2013, Ecosphere also received notice of approval from the United States Patent & Trademark Office for Patent No. 8,593,102 for Ecosphere's revolutionary Ecos PowerCube®, a portable, self-contained micro-utility that uses solar power to provide electricity in the most remote, off-grid locations. Designed to meet the growing demand for off-grid energy, with a unique array of stacked solar panels, the patented Ecos PowerCube® maximizes the total amount of solar power generation possible in 10', 20' and 40' standard ISO shipping container footprints. With power generation capabilities up to 15 KW, the Ecos PowerCube® can be transported by land, air, or sea and is ideally suited to support off-grid military, disaster relief, humanitarian and mobile communication efforts. The Company is currently manufacturing the very first Ecos PowerCube® and estimate we will have a working prototype available for demonstration purposes in Q3 2014.

Growth Strategy

Ecosphere’s strategy is to further leverage its patented Ozonix® water treatment 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 Ozonix® field-of-use licenses to numerous industry-specific Ecosphere subsidiaries.

In late 2013, Ecosphere launched a private placement with our investment banker, Ladenburg Thalmann, seeking to sell a 20% minority position in Ecosphere Mining, LLC for $10 million. No funds have been invested as of the date of this Report. In furtherance of our strategy, we have opened an office in Park City, Utah, near much of the mining activity in the United States and have produced equipment to demonstrate how Ecosphere Mining can help mining companies deal with wastewater created by mining operations and enhance their recovery of valuable minerals.

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

ECOSPHERE TECHNOLOGIES, INC. AND SUBSIDIARIES

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

CRITICAL ACCOUNTING ESTIMATES

There were no changes in the Company’s critical accounting estimates during the period covered by this report.

Results of Operations

Comparison of the Three Months ended March 31, 2014 with the Three Months Ended March 31, 2013

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


	For the Three Months Ended March 31,
	2014			2013			Change
	(Unaudited)
Revenues
Equipment sales and licensing, related party	$	107,925		$	—		$	107,925
Field services		—			751,684			(751,684	)
Aftermarket part sales		—			109,935			(109,935	)
Aftermarket part sales, related party		26,324			—			26,324
Total revenues		134,249			861,619			(727,370	)
Costs and expenses
Equipment sales and licensing (exclusive of depreciation shown below)		33,925			—			33,925
Field services (exclusive of depreciation shown below)		—			446,596			(446,596	)
Aftermarket part costs (exclusive of depreciation shown below)		21,916			109,543			(87,627	)
Salaries and employee benefits		927,959			1,132,818			(204,859	)
Administrative and selling		222,633			370,636			(148,003	)
Professional fees		534,012			566,515			(32,503	)
Depreciation and amortization		103,949			545,011			(441,062	)
Research and development		80,516			8,484			72,032
Restructuring charge		—			6,491			(6,491	)
Loss on sale of notes		730,260			—			730,260
Total costs and expenses		2,655,170			3,186,094			(530,924	)
Loss from operations		(2,520,921	)		(2,324,475	)		(196,446	)
Loss on investment in unconsolidated investee		(316,324	)		—			(316,324	)
Other income (expense)
Interest income		36,572			—			36,572
Interest expense		(577,040	)		(92,505	)		(484,535	)
Change in fair value of derivative instruments		1,907			(85,968	)		87,875
Total other expense, net		(538,561	)		(178,473	)		(360,088	)
Net loss		(3,375,806	)		(2,502,948	)		(872,858	)
Preferred stock dividends		(20,688	)		(20,688	)		—
Net loss applicable to common stock		(3,396,494	)		(2,523,636	)		(872,858	)
Net loss applicable to noncontrolling interest of consolidated subsidiary		—			170,496			(170,496	)
Net loss applicable to Ecosphere Technologies, Inc. common stock	$	(3,396,494	)	$	(2,353,140	)	$	(1,043,354	)

The Company reported net loss applicable to Ecosphere Technologies, Inc. common stock of $3.4 million during the three months ended March 31, 2014 (the "2014 Quarter") as compared to a net loss applicable to Ecosphere Technologies, Inc. common stock of $2.4 million for the three months ended March 31, 2013 (the "2013 Quarter"). The drivers of the $0.9 million quarter-over-quarter change are discussed below.

ECOSPHERE TECHNOLOGIES, INC. AND SUBSIDIARIES

Revenues

Revenues for the 2014 Quarter decreased $0.7 million from the 2013 Quarter due to the Company no longer reporting field services revenue or expenses of FNES on its Statements of Operations since it no longer consolidates FNES operations.

In addition, FNES sold its Ozonix® EF10M to Hydrosphere Energy Solutions (“Hydrosphere”), resulting in equipment sales of $0.1 million.

Cost and Expenses

Equipment Sales and Licensing Costs (exclusive of depreciation)

The equipment sales and licensing costs for the 2014 Quarter were de minimis.

Field Services Costs (exclusive of depreciation)

Due to the deconsolidation of FNES in May 2013, there were no field services costs for the 2014 Quarter as compared to $0.4 million for the 2013 Quarter. All field services costs are related to the services business of FNES and since deconsolidation, the Company has not incurred field services costs. Included in these costs for the 2013 period are payroll related expenses for field personnel and parts and supplies used in support of the operation of Ozonix® water treatment systems and Ecos-Frac® products.

Aftermarket Part Costs (exclusive of depreciation)

The costs associated with the sale of aftermarket parts for Ozonix® water treatment equipment were de minimis for the 2014 Quarter as compared to $0.1 million for the 2013 Quarter.

Salaries and Employee Benefits

The decrease in salaries and employee benefits of $0.2 million was primarily the result of the Company no longer reporting the costs and expenses of FNES on its Statements of Operations since it no longer consolidates FNES operations.

Professional Fees

The decrease in professional fees for the 2014 Quarter were de minimis.

Loss from Operations

Loss from operations for the 2014 Quarter was $2.5 million compared to loss from operations of $2.3 million for the 2013 Quarter. See discussion above under "Revenues," "Cost and Expenses" for details.

Loss on investment in unconsolidated investee

On May 24, 2013, the Company sold a 12% interest in FNES and transferred an additional 1.5% interest to a board member of FNES, reducing the Company’s ownership in FNES from 52.6% to 39.1%. Since May 24, 2013, the Company accounts for its investment in FNES under the equity method. Furthermore, in July 2013, the Company sold an additional 8% interest in FNES and transferred an additional 0.5% interest in FNES reducing the Company’s ownership in FNES from 39.1% to 30.6%. During the 2014 Quarter, the loss on investment in unconsolidated investee was $0.3 million.

Net Loss Applicable to Noncontrolling Interest in Consolidated Subsidiary

The Company no longer has net loss (income) applicable to noncontrolling interest in our FNES consolidated majority-owned subsidiary due to the deconsolidation of FNES in May 2013.

ECOSPHERE TECHNOLOGIES, INC. AND SUBSIDIARIES

LIQUIDITY AND CAPITAL RESOURCES

A summary of our cash flows is as follows:


	Three Months Ended
	March 31,
	2014			2013
	(Unaudited)
Net cash used in operating activities	$	(1,534,994	)	$	(2,196,536	)
Net cash used in investing activities	$	(126,329	)	$	(506,571	)
Net cash provided by financing activities	$	1,776,115		$	671,890

2014 Period

Operating Activities

Net cash used in operating activities was $1.5 million for the 2014 Quarter, compared to net cash used in operating activities of $2.2 million for the 2013 Quarter. For the 2014 Quarter, cash used in operating activities of $1.5 million resulted for the net loss applicable to Ecosphere common stock of $3.4 million and was offset by the loss on sale of notes receivable of $0.7 million in connection with the two Ozonix® EF80 units sold in 2013 to FNES, an accretion of discounts of Notes payable of $0.5 million and the Company’s loss on investment in unconsolidated investee, or FNES of $0.3 million.

Investing Activities

Net cash used in investing activities of $0.1 million was primarily from additions to property and equipment. This included computer equipment and software, a Company manufactured fixture to house the Company’s raw metals inventory and additions to a mobile operations vehicle originally purchased during the fourth quarter of 2013. The Company also had additions to leasehold improvements and office equipment relating to the build out of the mining office in Park City, Utah.

Financing Activities

The Company’s net cash provided by financing activities of $1.8 million consisted primarily of proceeds from the sale of convertible notes and warrants as well as proceeds from the sale of notes receivable.

2013 Period

Operating Activities

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

Investing Activities

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

Financing Activities

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

Liquidity

ECOSPHERE TECHNOLOGIES, INC. AND SUBSIDIARIES

In March 2014, Ecosphere sold a FNES note payable for a Unit sold in July in exchange for $1 million in cash. The buyer of the note is an FNES member and director. In March 2014, the Company sold a second FNES note payable for a Unit sold in November 2013 in exchange for $0.6 million in cash. 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, although the current stock price may be an impediment. See Note 6 to the unaudited condensed consolidated financial statements contained herein for details on this financing. Management believes that its current plans will provide sufficient liquidity for the next 12 months.

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 $29,861 per month of payments as described above. Ecosphere is seeking to sell the remaining portion of this note.

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.

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.

ECOSPHERE TECHNOLOGIES, INC. AND SUBSIDIARIES

Contractual Obligations:

Our principal commitments consist of obligations for long term debt, capital and operating leases. The following table summarizes our commitments to settle contractual obligations in cash as of March 31, 2014.


From To	Total		Less Than 1 Year		1-3 Years		3-5 Years		More than 5 Years
Long Term Debt Obligations (1)	$	3,229,281	$	1,136,481	$	2,066,145	$	21,931	$	4,724
Capital Lease Obligations (2)		53,512		15,542		33,535		4,435		—
Operating Lease Obligation (3)		217,009		43,217		90,355		83,437		—
Purchase Obligations (4)		83,332		83,332		—		—		—
Other Long Term Liabilities Reflected on the Registrant's Balance Sheet under GAAP		—		—		—		—		—
Total	$	3,583,134	$	1,278,572	$	2,190,035	$	109,803	$	4,724

———————

(1)

Long Term Debt Obligations relates to approximately $2.95 million in convertible notes payable, $0.14 million in notes payable and the remaining $0.14 million in equipment and vehicle financing.

(2)

The Capital Lease Obligations relates to the purchase of a forklift in July 2012 costing $78,896.

(3)

The Operating Lease Obligations relates to a five-year lease agreement commencing January 1, 2014 for an office located in Park City, UT.

(4)

The Purchase Obligation relates to a certain machining piece of equipment that was purchased and delivered in December 2013 for $125,000. The Company agreed to make a down payment of $10,000 upon signing the purchase contract, $15,000 due January 1, 2014 and the remaining $100,000 balance due in 12 monthly payments of approximately $8,333.

RELATED PARTY TRANSACTIONS

For information on related party transactions and their financial impact, see Note 12 to the unaudited condensed consolidated financial statements.

RESEARCH AND DEVELOPMENT

Research and development costs were approximately $0.1 million during the three months ended March 31, 2014 and during the three months ended March 31, 2013 research and development costs were de minimis.

RECENTLY ISSUES ACCOUNTING PRONOUNCEMENTS

For information on recently issued accounting pronouncements, see Note 2 to the unaudited condensed consolidated financial statements.

CAUTIONARY NOTE REGARDING FORWARD LOOKING STATEMENTS

This report contains forward-looking statements including expanding our technology into other industries, replicating the success of FNES, our former subsidiary, the value of subsidiaries in other verticals, anticipated and potential revenue, working capital and liquidity. Forward looking statements can be identified by words such as “anticipates,” “intends,” “plans,” “seeks,” “believes,” “estimates,” “expects” and similar references to future periods.

Forward-looking statements are based on our current expectations and assumptions regarding our business, the economy and other future conditions. Because forward-looking statements relate to the future, they are subject to inherent uncertainties, risks and changes in circumstances that are difficult to predict. Our actual results may differ materially from those contemplated by the forward-looking statements. We caution you therefore against relying on any of these forward-looking statements. They are neither statements of historical fact nor guarantees or assurances of future performance. Important factors that could cause actual results to differ materially from those in the forward-looking statements include the condition of the credit and financial markets, our ability to raise short-term and long-term work capital, the effects of the global recession, the future price of natural gas, future legislation and regulations which affect hydraulic fracturing, the ability to find purchasers and investors for our technologies, FNES’ ability with Ecosphere’s assistance to market our Ozonix® technology to exploration companies and sell units to third parties and the general reluctance of businesses to utilize new technology.

ECOSPHERE TECHNOLOGIES, INC. AND SUBSIDIARIES

Further information on our risk factors is contained in its filings with the Securities and Exchange Commission (the “SEC”) including our Form 10-K for the year ended December 31, 2013. Any forward-looking statement made by us in this report speaks only as of the date on which it is made. Factors or events that could cause our actual results to differ may emerge from time to time, and it is not possible for us to predict all of them. We undertake no obligation to publicly update any forward-looking statement, whether as a result of new information, future developments or otherwise, except as may be required by law.

ITEM 3.

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.

The primary objective of our investment activities is to preserve principal while at the same time maximizing yields without significantly increasing risk. Our cash balances of $1.2 million as of March 31, 2014 were held in insured depository accounts, $1.0 million of which exceeded insurance limits.

ITEM 4.

CONTROLS AND PROCEDURES.

Evaluation of Disclosure Controls and Procedures. Our management carried out an evaluation, with the participation of our Principal Executive Officer and Principal Financial Officer, required by Rule 13a-15 of the Securities Exchange Act of 1934 (the “Exchange Act”) of the effectiveness of our disclosure controls and procedures as defined in Rule 13a-15(e) under the Exchange Act. Based on their evaluation, our Principal Executive Officer and Principal Financial Officer concluded that our disclosure controls and procedures were effective as of the end of the period covered by this report to ensure that information required to be disclosed by us in the reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified under SEC rules and forms and is accumulated and communicated to our management, including our Principal Executive Officer and Principal Financial Officer, as appropriate to allow timely decisions regarding required disclosure.

Changes in Internal Control Over Financial Reporting. There were no changes in our internal control over financial reporting as defined in Rule 13a-15(f) under the Exchange Act that occurred during the period covered by this report that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

ECOSPHERE TECHNOLOGIES, INC. AND SUBSIDIARIES

PART II – OTHER INFORMATION

ITEM 1.

LEGAL PROCEEDINGS.

From time to time, we are party to certain legal proceedings that arise in the ordinary course and are incidental to our business. During the period covered by this report, there were no material changes to any pending legal proceedings to which we are a party.

ITEM 1A.

RISK FACTORS.

There were no material changes during the period covered by this report to the risk factors disclosed in the Company's Form 10-K for the year ended December 31, 2013.

ITEM 2.

UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS.

In addition to those unregistered securities previously disclosed in reports filed with the SEC, we have sold securities without registration under the Securities Act of 1933, which we refer to as the “Securities Act.” Unless stated, all securities were issued in reliance upon the exemptions provided by Section 4(a)(2) and Rule 506(b) under the Securities Act.

ITEM 3.

DEFAULTS UPON SENIOR SECURITIES.

None

ITEM 4.

MINE SAFETY DISCLOSURES.

Not applicable.

ITEM 5.

OTHER INFORMATION.

None

ITEM 6.

EXHIBITS.

See the Exhibit Index.

ECOSPHERE TECHNOLOGIES, INC. AND SUBSIDIARIES

SIGNATURES

Pursuant to the requirements 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.

May 12, 2014		/s/ Dennis McGuire
		Dennis McGuire
		Chief Executive Officer
		(Principal Executive Officer)

May 12, 2014		/s/ David Brooks
		David Brooks
		Chief Financial Officer
		(Principal Financial Officer)

ECOSPHERE TECHNOLOGIES, INC. AND SUBSIDIARIES

EXHIBIT INDEX


Exhibit		Incorporated by Reference			Filed or Furnished
No.	Exhibit Description	Form	Date	Number	Herewith

3.1	Certificate of Incorporation, as amended				Filed
3.2	Bylaws, as amended				Filed
31.1	Certification of Principal Executive Officer (Section 302)				Filed
31.2	Certification of Principal Financial Officer (Section 302)				Filed
32.1	Certification of Principal Executive Officer and Principal Financial Officer (Section 906)				Furnished**
101.INS	XBRL Instance Document				Filed
101.SCII	XBRL Taxonomy Extension Schema Document				Filed
101.CAL	XBRL; Taxonomy Extension Calculating 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

———————

This exhibit is being furnished rather than filed and shall not be deemed incorporated by reference into any filing, in accordance with Item 601 of Regulation S-K.

Copies of this report (including the financial statements) and any of the exhibits referred to above will be furnished at no cost to our shareholders who make a written request to Ecosphere Technologies, Inc., 3515 S.E. Lionel Terrace, Stuart, Florida 34997 Attention: Jacqueline McGuire, Corporate Secretary.