Ecosphere Technologies, Inc. - 11 shares authorized; 9 and 9 shares...


	September 30, 2007		December 31, 2006
	(Unaudited)
Current Assets
Cash and equivalents	$	20,178	$	1,989,758
Accounts receivable		7,158		20,923
Inventories of spare parts		165,890		187,910
Prepaid expenses and other current assets		170,048		66,880
Total current assets		363,274		2,265,471
Property and equipment, net		581,726		1,244,086
Equipment held for sale, net		2,198,465		—
Patents, net		63,997		69,118
Debt acquisition costs, net		190,007		232,156
Other Assets		5,000		5,000
Total assets	$	3,402,469	$	3,815,831
Liabilities, Redeemable Convertible Cumulative Preferred Stock and Stockholders’ Deficit
Current Liabilities
Accounts payable	$	891,416	$	330,733
Accounts payable - related parties		45,521		28,380
Accrued liabilities		1,278,029		748,548
Capital lease obligations		1,000,586		—
Due to related party company		130,000		—
Notes payable – related parties – current portion		516,847		259,072
Notes payable – third parties (net of discount) – current portion		2,961,820		2,069,614
Total current liabilities		6,824,220		3,436,347
Capital lease obligations – less current portion		399,001		—
Notes payable to related parties – less current portion		99,153		558,310
Notes payable to third parties – less current portion (net of discount)		3,243,615		3,429,536
Total Liabilities		10,565,989		7,424,193
Redeemable convertible cumulative preferred stock series A 11 shares authorized; 9 and 9 shares issued and outstanding, respectively, $25,000 per share redemption amount plus dividends in arrears		1,120,994		1,095,681
Redeemable convertible cumulative preferred stock series B 484 shares authorized; 429 and 464 shares issued and outstanding, respectively, $2,500 per share redemption amount plus dividends in arrears		2,701,552		2,707,811
Commitments and Contingencies (Note 11)
Stockholders’ Deficit
Common stock, $0.01 par value; 150,000,000 shares authorized; 61,115,800 and 56,487,639 shares issued and outstanding, respectively		611,158		564,877
Additional paid-in capital		41,380,105		38,762,072
Accumulated deficit		(52,977,328)		(46,738,803	)
Total stockholders’ deficit		(10,986,065)		(7,411,854	)
Total liabilities, redeemable convertible cumulative preferred stock, and stockholders’ deficit	$	3,402,469	$	3,815,831

See accompanying notes to the unaudited consolidated financial statements.

ECOSPHERE TECHNOLOGIES, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

(UNAUDITED)


	For Three Months Ended September 30,						For The Nine Months Ended September 30,
	2007			2006			2007			2006
Revenues	$	6,789		$	1,382,368		$	668,588		$	2,075,324

Cost of revenues		33,805			732,108			888,645			1,408,834

Gross profit (loss)		(27,016	)		650,260			(220,057	)		666,490

Operating expenses		940,761			1,263,037			3,510,898			3,785,691

Loss from operations		(967,778	)		(612,777	)		(3,730,955)			(3,119,201	)

Other income (expense):
Other income		2			1,732			11,663			8,286
Gain (loss) on conversion		(44,245	)		—			(44,245	)		—
Interest expense		(1,071,070	)		(318,327	)		(2,474,988	)		(1,673,142	)

Total other income (expense)		(1,115,312	)		(316,595	)		(2,507,570	)		(1,664,856	)

Minority Interest in net income of affiliates		—			—			—			(40,951)

Net loss		(2,083,090	)		(929,372	)		(6,238,525	)		(4,743,106	)

Preferred stock dividends		(34,661	)		(39,312	)		(106,553	)		(159,390	)

Net loss applicable to common stock	$	(2,117,751	)	$	(968,684	)	$	(6,345,078	)	$	(4,902,496	)

Net loss per common share applicable to common stock (basic and diluted)	$	(0.04)		$	(0.02	)	$	(0.11	)	$	(0.09	)

Weighted average number of common shares outstanding		61,099,834			54,985,523			59,378,161			54,203,563

See accompanying notes to the unaudited consolidated financial statements.

ECOSPHERE TECHNOLOGIES, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(UNAUDITED)


	For The Nine Months Ended September 30,
	2007			2006
Cash flows from operating activities:

Net cash used in operating activities	$	(1,705,701	)	$	(1,343,370	)

Cash flows from Investing activities:

Purchase of equipment		(393,646	)		(1,085,933	)

Net cash used in investing activities		(393,646	)		(1,085,933	)

Cash flows from financing activities:
Proceeds from issuance of notes payable and warrants to related parties		350,000			349,000
Capital lease payments		(210,000	)		—
Repayments of notes payable		(126,233	)		(26,551	)
Repayment of notes payable to related parties		(14,000	)		(931,237	)
Proceeds from issuance of bridge loans		—			2,793,000
Proceeds from exercise of warrants		—			102,813
Return of investment from affiliate		—			21,493
Distribution to partners of affiliate		—			(45,201	)
Proceeds from loans from related parties		130,000			—

Net cash used in provided by financing activities		129,767			2,263,317

Net decrease in cash		(1,969,580	)		(165,986	)

Cash and equivalents, beginning of period		1,989,758			167,956

Cash and equivalents, end of period	$	20,178		$	1,970

See accompanying notes to the unaudited consolidated financial statements.

SUPPLEMENTAL CASH FLOW INFORMATION


	For The Nine Months Ended September 30,
	2007		2006
Cash paid for interest	$	144,745	$	92,129

Non-cash investing and financing activities:
Accrued preferred stock dividends	$	106,553	$	159,390
Warrants issued in connection with financing	$	705,368	$	743,148
Common stock issued to settle debt obligations	$	525,000	$	1,078,000
Common stock issued as payment of accrued interest	$	318,412	$	—
Series A Redeemable Convertible Cumulative Preferred Stock converted to common stock	$	—	$	425,000
Series B Redeemable Convertible Cumulative Preferred Stock converted to common stock	$	87,500	$	1,475,000
Purchase of equipment financed with capital lease and common stock	$	1,890,000	$	—

Conversion of accounts payable and accrued expenses to debt	$	—	$	615,109
Cashless exercise of warrants into common stock	$	—	$	182,000

See accompanying notes to the unaudited consolidated financial statements.

ECOSPHERE TECHNOLOGIES, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

FOR THE THREE MONTHS AND NINE MONTHS ENDED SEPTEMBER 30, 2007 AND 2006

SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Basis of Presentation

We were incorporated under the name UltraStrip Systems, Inc. in April 1998 in Florida. We reincorporated on September 8, 2006, in Delaware under the name Ecosphere Technologies, Inc. Ecosphere’s mission is to become a globally branded company known for developing and introducing patented innovative clean technologies to the world marketplace. We invent, patent, develop and expect to license and/or sell clean technologies with the potential for practical, economical and sustainable applications across industries throughout the world. In addition, if we obtain sufficient capital, we may acquire other patents which are not being exploited, develop the products and/or services, initiate the commercialization and then seek to license and/or sell the patents to large companies.

The accompanying unaudited consolidated financial statements include the accounts of Ecosphere Technologies, Inc. (“Ecosphere” or the “Company”), its 90%-owned subsidiary, Ecosphere Systems, Inc. (“ESI”), and its wholly-owned subsidiaries UltraStrip Envirobotic Solutions, Inc. (“UES”), and Ecosphere Energy Solutions, Inc. (“EES”) and appropriate periods of its affiliates UltraStrip Japan, Ltd. (“USJ”) and Robotics Investment Group, LLC (“RIG”). ESI was formed during the first quarter of 2005 and markets the Company’s mobile water filtration technologies for disaster relief, homeland security and military applications. UES was formed in October 2005 to pursue the sale of UHP robotic coating removal equipment, technology and to perform contract services in the maritime coating removal industry that demonstrated the capabilities of the underlying technology. EES was organized in November 2006. It develops and markets water filtration systems to the oil and gas exploration industry using the Company’s patent pending Ozonix^TM Process. USJ was formed in April 2004 to market and service the maritime coating removal needs of the Japanese ports and RIG was formed to help finance the purchase of equipment to USJ.

The Company has been associated with two entities which have been consolidated into the Company’s financial statements prior to this report in accordance with the provisions of Financial Accounting Standards Board Interpretation No. 46R, Consolidation of Variable Interest Entities.

The first entity, USJ, was formed in April 2004 under Japanese law as a joint venture between the Company (49.9% ownership) and five Japanese companies (50.1% ownership): Kamimura International Associates, LLC, Ihara Company, Ltd., Kyokuto Boeki Kaisha, Ltd., Shuwa Kaiun Kaisha, Ltd., and Chiba Marine Yokohama Co., Ltd. The Company contributed $50,000 to the joint venture in 2004, provided a two year term loan of $32,000 during the first quarter of 2005, and provided an additional capital contribution of $44,222 in the third quarter of 2005. On September 28, 2006, the Company sold all but 5% of its shares to the other partners in USJ. Based upon this transaction and the lack of the Company’s ability to control USJ, USJ’s financial statements are not consolidated with the Company after September 28, 2006.

The second entity, RIG, was organized in December 2004. The purpose of RIG was to purchase a M3500 robotic vehicle from the Company and lease the M3500 to USJ. That lease is now terminated and the M3500 was sold to an unaffiliated Japanese joint venture in February 2006. Given these transactions, the associated rationale for RIG being considered a variable interest entity no longer exists and RIG’s financial statements have not been consolidated with the Company after March 31, 2006.

The accompanying unaudited consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and with Item 310 of Regulation S-B. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States of America for complete financial statements. The unaudited 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. Certain prior period amounts have been reclassified to conform to the current period presentation. The information included in these unaudited consolidated financial statements should be read in

ECOSPHERE TECHNOLOGIES, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

FOR THE THREE MONTHS AND NINE MONTHS ENDED SEPTEMBER 30, 2007 AND 2006

SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

conjunction with Management’s Discussion and Analysis and Plan of Operation contained in this report and the audited consolidated financial statements and accompanying notes included in the Company’s Annual Report on Form 10-KSB for the year ended December 31, 2006.

GOING CONCERN

The accompanying unaudited consolidated financial statements were prepared assuming that the Company will continue as a going concern. This basis of accounting contemplates the realization of assets and the satisfaction of liabilities in the normal course of operations. During the nine months ended September 30, 2007, the Company incurred losses of approximately $6.2 million, had a working capital deficiency of approximately $6.5 million, and had outstanding convertible preferred stock that is redeemable under limited circumstances for approximately $3.8 million (including accrued dividends). The Company has not attained a level of revenues sufficient to support recurring expenses, and the Company does not presently have the resources to settle previously incurred obligations. These factors, among others, raise substantial doubt about the Company’s ability to continue as a going concern.

The Company’s continued existence is dependent upon its ability to resolve its liquidity problems. The Company has arranged the availability of limited short-term debt funding to provide immediate liquidity. Following the closing of the sale of the ship stripping assets of the Company’s subsidiary, UES, as more particularly disclosed in Note 16, additional funds will be advanced by the Founder and President, Dennis E. McGuire, or short term debt is expected to be issued to provide necessary operating capital. The Company is also seeking interim equity financing following the UES asset sale. As a result of limited liquidity, the Company’s management has temporarily deferred some of its compensation and only critical vendor payments are being made to conserve cash resources. Working capital limitations may impinge on day-to-day operations. The continued support and forbearance of its creditors and preferred shareholders will be required, although this is not assured.

The unaudited consolidated financial statements do not include any adjustments to reflect the possible future effects on the recoverability and classification of assets or the amounts and classification of liabilities that may result from the inability of the Company to continue as a going concern. There are no assurances that the Company will be successful in achieving the above plans, or that such plans, if consummated, will enable the Company to obtain profitable operations or continue as a going concern.

PREPAID EXPENSES AND OTHER CURRENT ASSETS

Prepaid expenses and other current assets are summarized as follows:


	September 30, 2007		December 31, 2006
Vendor deposits	$	50,172	$	29,000
Prepaid consulting fees		50,300		15,562
Prepaid interest expense		5,775		—
Short-term deposits		14,342		9,527
Other		49,459		12,791
Total prepaid expenses and other current assets	$	170,048	$	66,880

ECOSPHERE TECHNOLOGIES, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

FOR THE THREE MONTHS AND NINE MONTHS ENDED SEPTEMBER 30, 2007 AND 2006

PROPERTY AND EQUIPMENT

Property and equipment consists of the following:


	Est. Useful Lives		September 30, 2007			December 31, 2006
Plant and machinery		5 years	$	20,925		$	717,954
Water filtration equipment		5 years		865,487			1,331,816
Furniture and fixtures		7 years		277,250			277,250
Automobile and trucks		5 years		41,233			41,233
Leasehold improvements		5 years		214,116			214,116
Office equipment		5 years		398,680			162,306

				1,817,691			2,744,675
Less accumulated depreciation				(1,235,965	)		(1,500,589	)

			$	581,726		$	1,244,086

Equipment held for sale consists of the following:


	Est. Useful Lives		September 30, 2007
Plant and machinery		5 years	$	339,693
Coating removal equipment		5 years		2,315,351

				2,655,044
Less accumulated depreciation				(456,579	)

			$	2,198,465

The Company entered into two capital leases during the nine months ended September 30, 2007, expiring at various dates through March 2010. The leased assets are included in the balance sheet as part of property and equipment and equipment held for sale at their initial costs at inception of $107,015 and $2,100,000, respectively. Amortization of the assets held under capital leases is included in depreciation expense and was approximately $137,485 for the nine months ended September 30, 2007.

ACCRUED EXPENSES

The major components of accrued expenses are summarized as follows:


	September 30, 2007		December 31, 2006
Accrued payroll and related benefits	$	524,835	$	149,081
Accrued interest		478,536		237,593
Accrued consulting		—		236,000
Other accrued expenses		274,658		85,874
Accrued professional fees		—		40,000
Total accrued expenses	$	1,278,029	$	748,548

ECOSPHERE TECHNOLOGIES, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

FOR THE THREE MONTHS AND NINE MONTHS ENDED SEPTEMBER 30, 2007 AND 2006

NOTES PAYABLE

(a.)

Related Parties

Notes payable to related parties consist of the following:


	September 30, 2007		December 31, 2006

Unsecured notes payable to Director, interest at prime plus 2% (9.75% at September 30, 2007). Effective January 1, 2007, the Company and Director modified the note whereby the Company agreed to pay Director $40,000 per quarter beginning on March 31, 2007, until all amounts currently owed to Director (this $240,000 note, plus accrued interest and commissions earned, totaling $341,412) are paid in full. Per the agreement, payments will first be applied to accrued interest, then accrued commissions and then the principal balance of the note. The March 31, 2007, June 30, 2007 and September 30, 2007 payments have not been made. The director has waived the default status on this past due note.	$	240,000	$	240,000

Unsecured note payable to shareholder, interest at 18%, due upon demand. This note was reclassified as payable to an unrelated party during the nine months ended September 30, 2007.		—		50,000