UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

____________

FORM 10-Q

____________

Commission file number: 000-25663

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.

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

TABLE OF CONTENTS

PART I – FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS.

ECOSPHERE TECHNOLOGIES, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

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

1

ECOSPHERE TECHNOLOGIES, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)

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

2

ECOSPHERE TECHNOLOGIES, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

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

3

ECOSPHERE TECHNOLOGIES, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

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

4

ECOSPHERE TECHNOLOGIES, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

MARCH 31, 2013

(UNAUDITED)

1.

 DESCRIPTION OF THE BUSINESS, BASIS OF PRESENTATION

Description of the Business

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

Since 2008, Ecosphere has enabled oil and gas customers to treat, recycle and reuse over 3 billion gallons of water on more than 700 oil and natural gas wells in major shale plays around the United States. Ecosphere was chosen by Bloomberg as a 2013 New Energy Pioneer and selected by IHS CERAWeek as a 2013 Energy Innovation Pioneer. Ecosphere is also a recipient of the 2012 Frost & Sullivan North American Product Leadership Award in Disinfection Equipment for Shale Oil and Gas Wastewater Treatment.

Basis of Presentation

The accompanying unaudited condensed consolidated financial statements include the accounts of Ecosphere and its subsidiaries, including its 52.6% owned subsidiary Ecosphere Energy Services, LLC (“EES”). All intercompany account balances and transactions have been eliminated.

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, 2012.

The Company has two operating segments that (i) engage in similar operating activities, (ii) have similar economic characteristics and, (iii) can be expected to have essentially the same future prospects. As such, based on guidance provided by the FASB ASC Topic 280, Segment Reporting, the Company has aggregated its operating segments into one reportable segment thus negating the need for the disclosure of segment data.

Going Concern and Liquidity

The Company’s unaudited condensed consolidated financial statements have been prepared on a going concern basis, which implies the Company will continue to realize its assets and discharge its liabilities in the normal course of business. Historically, the Company’s revenue was generated pursuant to the Exclusive Product Purchase and Sub-License Agreement (the “Agreement”) with Hydrozonix, LLC (“Hydrozonix”) and EES, which required Hydrozonix to purchase, and fund the manufacture of a minimum number of units each quarter in order to maintain exclusivity to the U.S. onshore oil and gas industry. During the first quarter of 2013, Hydrozonix failed to place a binding order for the minimum number of units and fund the build-out of the units as required by the agreement and subsequently lost its exclusivity. As a result, the Company’s working capital has declined significantly. Anticipated cash flows from existing sources other than Hydrozonix will not be sufficient to sustain operations through 2013. These uncertainties create substantial doubt about the Company’s ability to continue as a going concern.

Management believes that the following actions will allow the Company to continue operations beyond 2013 and into the foreseeable future:

·

As a result of EES regaining exclusivity to the U.S. oil and gas industry, the Company has begun to implement an aggressive sales and marketing program to offer its patented Ozonix® products and services to the U.S. oil and gas industry. Management expects that these efforts will generate cash from operations.

5

ECOSPHERE TECHNOLOGIES, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

MARCH 31, 2013

(UNAUDITED)

·

The Company expects to initiate a pilot program with a partner in the precious metal mining industry and has been demonstrating its technology to a leading coal mine operator and expects that profitable operations will result from these relationships.

·

Management could issue additional debt or equity securities, and is exploring the sale of a portion of its interest in EES.

Since 2008, the Company’s technology has been successfully utilized on over 700 oil and natural gas wells around the United States. Management believes that the value of its technology has been sufficiently demonstrated to market participants to allow the Company to more accurately communicate the value of its technologies to potential strategic partnerships and alliances. Management believes that, based on the success of its technologies to date, the fair market value of the rights to the global energy market segments granted to its majority-owned subsidiary, EES, significantly exceeds the market capitalization of the Company based on the publicly quoted market prices for its common stock. The Company believes that the realization of this excess fair market value will allow it to obtain additional equity or debt financing, on favorable terms, to fund its increasing penetration of the global energy markets and development of other segments, such as mining and waste water treatment.

The Company’s exclusive arrangement with Hydrozonix provided significant cash flows from operations in 2012, allowing EES to pay dividends in excess of $6.7 million. Management believes that EES will again generate significant positive cash from operations from the U.S. oil and natural gas market segment, through aggressive marketing and sales efforts focused on the top U.S. oil and gas operators and service companies. Because of the exclusivity Hydrozonix enjoyed until April 15, 2013, EES was extremely limited in the permitted activities it could undertake related to the U.S. oil and natural gas market segment. Management has been developing a strategic marketing and sales program for the U.S. oil and natural gas market segment, which it began to implement immediately proceeding the lapse of Hydrozonix’s exclusivity, which occurred on April 15, 2013. Management believes that as a result of EES regaining rights to the U.S. oil and gas market, there will be opportunities for strategic partnerships that have the potential to accelerate market penetration within the U.S., and increased potential for financing through the sale of a portion of the Company’s interest in EES.

The Company, through EES, has entered into discussions with potential partners and strategic alliances in the Middle East, Canada and with various offshore exploration entities. Management believes that the successful execution of any of these alliances will provide additional sources of cash flows from operations. The Company is also in discussions with these potential partners regarding the utilization of Ecosphere’s patented Ozonix® technology for solutions outside of oil and natural gas exploration.

There can be no assurance that any of the above anticipated events will occur and that the Company will be able to continue as going concern. Theses unaudited condensed consolidated financial statements have not been adjusted to reflect this uncertainty.

2.

SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Principles of Consolidation

The accompanying unaudited condensed consolidated financial statements include the accounts of Ecosphere and its subsidiaries, including its 52.6% owned subsidiary EES. All intercompany account balances and transactions have been eliminated in consolidation.

Noncontrolling Interest

The Company accounts for its less than 100% interest in consolidated subsidiaries in accordance with ASC Topic 810, Consolidation, and accordingly the Company presents noncontrolling interests as a component of equity on its unaudited condensed consolidated balance sheets and reports 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.

6

ECOSPHERE TECHNOLOGIES, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

MARCH 31, 2013

(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 unaudited condensed consolidated financial statements include the allowance for doubtful accounts receivable, valuation of inventory, estimates of depreciable lives and valuation of property and equipment, estimates of amortization periods for intangible assets, restructuring charges, valuation of beneficial conversion features in convertible debt, valuation of equity based instruments issued for other than cash, warranty reserve, valuation of derivatives 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, 2013 represents a $25,000 compensating balance held pursuant to certain of the Company's short-term financing arrangements.

Accounts Receivable and Allowance for Doubtful Accounts

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

Inventory

Inventory is primarily comprised of raw materials and finished goods representing two Ozonix® EF80 units completed 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 3.

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. As of March 31, 2013 the Company capitalized $64,743 in debt issuance costs.

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, 2013 and December 31, 2012 have either been acquired from a related Company or assigned to the Company by the Company's founder. Patents are recorded at the historical cost basis.

7

ECOSPHERE TECHNOLOGIES, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

MARCH 31, 2013

(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.

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.

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.

8

ECOSPHERE TECHNOLOGIES, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

MARCH 31, 2013

(UNAUDITED)

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

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.

Product Warranties

The Company accrues for product warranties when the loss is probable and can be reasonably estimated. At March 31, 2013 and December 31, 2012, the Company has no product warranty accrual given its lack of long-term historical warranty experience and the fact that prior year warranty repair experience related to what we believe are non-recurring issues and are therefore, not indicative of future warranty estimates. The warranty period on the first unit constructed ends September 22, 2013.

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.

9

ECOSPHERE TECHNOLOGIES, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

MARCH 31, 2013

(UNAUDITED)

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, 2013, tax years since 2009 remain open for IRS audit. The Company has received no notice of audit from the Internal Revenue Service for any of the open tax years.

Net Income (Loss) Per Share

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

For the three months ended March 31, 2013, no potential common shares were included in the calculation of diluted loss per share because they were anti-dilutive. Basic and diluted net income per share, for the three months ended March 31, 2012 were calculated as follows:

10

ECOSPHERE TECHNOLOGIES, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

MARCH 31, 2013

(UNAUDITED)

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

Anti-Dilutive Potential Common Shares

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.

3.

INVENTORY

Inventory consists of the following at March 31, 2013 and December 31, 2012:

4.

PROPERTY AND EQUIPMENT

Property and equipment consists of the following at March 31, 2013 and December 31, 2012:

During the three months ended March 31, 2013, additions to property and equipment included the construction in progress of a piece of equipment for the treatment of wastewater outside of oil and gas exploration that has continued to be manufactured and assembled which is reflected in the caption "Construction in Progress." Depreciation expense amounted to approximately $0.5 million for the three months ended March 31, 2013.

11

ECOSPHERE TECHNOLOGIES, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

MARCH 31, 2013

(UNAUDITED)

5.

NOTES PAYABLE AND OTHER DEBT

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

Convertible Notes Payable

12

ECOSPHERE TECHNOLOGIES, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

MARCH 31, 2013

(UNAUDITED)

A summary of convertible notes payable and the related discounts as of March 31, 2013 and December 31, 2012 is as follows:

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 $204,299 was outstanding at December 31, 2012 and March 31,2013 from related party debt due to lack of on-going affiliation with the lender. The note is payable in quarterly payments of $17,025. Accordingly, $85,125 is included as a current liability in the accompanying unaudited condensed consolidated financial statements.

Financing Obligations

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, 2013, by fiscal year, are as follows:

13

ECOSPHERE TECHNOLOGIES, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

MARCH 31, 2013

(UNAUDITED)

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

6.

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 approximately 1.0 million warrants with repricing options outstanding at March 31, 2013. The majority of these derivative instruments expire during the second quarter of 2013.

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, 2013 was $0.46, compared to $0.37 at December 31, 2012. Volatility, expected term and risk free interest rates used to estimate the fair value of derivative liabilities at March 31, 2013, are indicated in the table that follows (BSM inputs only). 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

During the three month period ended March 31 2013, based upon the estimated fair value, the Company increased its liability for warrant derivative instruments by $85,968 which was recorded as "Loss from change in fair value of derivative instruments" in the other expense section of the Company's unaudited condensed consolidated statement of operations.

7.

FAIR VALUE MEASUREMENTS

We currently measure and report at fair value the liability for warrant derivative instruments. The fair value liabilities for price adjustable warrants have been recorded as determined utilizing the BSM option pricing model and Monte Carlo simulations. See Note 6. The following tables summarize our financial assets and liabilities measured at fair value on a recurring basis as of March 31, 2013:

14

ECOSPHERE TECHNOLOGIES, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

MARCH 31, 2013

(UNAUDITED)

The following is a rollforward for the three months ended March 31, 2013 of the fair value liability of price adjustable warrant derivative instruments:

The Company had no non-financial assets or liabilities measured at fair value at March 31, 2013.

8.

REDEEMABLE CONVERTIBLE CUMULATIVE PREFERRED STOCK

Series A

At March 31, 2013, and December 31, 2012, there were 6 shares of Series A Redeemable Convertible Cumulative 15% Preferred Stock outstanding. The shares are redeemable at the option of the Company at $27,500 per share plus accrued dividends or redeemable at the option of the holder upon a change of control event at $25,000 per share plus accrued dividends. A Change of Control event means a transfer of greater than fifty percent of the shares of common stock of the Company. The shares are convertible each into 24,000 common shares. Accrued dividends totaled $1,036,619 and $1,030,994 on March 31, 2013, and December 31, 2012, respectively. There was no Series A Preferred Shares activity during the three months ended March 31, 2013. Annual dividends accrue at a rate of $3,750 per share.

Series B

At March 31, 2013, and December 31, 2012, 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 835 common shares. Accrued dividends totaled $1,869,324 and $1,854,281 on March 31, 2013, and December 31, 2012, respectively. Annual dividends accrue at a rate of $250 per share.

9.

COMMON STOCK

Shares issued and issuable during the three months ended March 31, 2013 are summarized below.

———————

(a)

issued upon exercise of warrants at an exercise price of $0.25 per share resulting in proceeds to the Company of $20,000.

(b)

issued upon cashless exercises of 4,000,000 options at an exercise price of $0.30 per share based upon market prices of the Company’s common stock ranging from $0.46 to $0.50 per share.

(c)

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

15

ECOSPHERE TECHNOLOGIES, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

MARCH 31, 2013

(UNAUDITED)

10.

RESTRICTED STOCK

During the three months ended March 31, 2013, the Company recognized $10,000 of expense related to 80,000 shares of restricted stock that is expected to vest on July 1, 2013. No restricted stock was issued, vested or forfeited during the three months ended March 31, 2013.

Total unrecognized share-based compensation expense from unvested restricted stock as of March 31, 2013 was $10,000 which is expected to be recognized through June 2013.

11.

STOCK OPTIONS AND WARRANTS

Option Grants to Directors Under a Consulting Agreement

In January 2013, the Company granted five-year options to purchase 1,000,000 shares of common stock with an exercise price of $0.40 per share to a director who is also serving as a consultant for a one year period. The fair value of these options amounted to $135,890, calculated using the BSM method and will be expensed over the vesting period. As of March 31, 2013 the Company revalued the unvested options in accordance with ASC 505-50-30, Initial Measurement (“ASC 505-50-30). The subsequent re-measurement produced a value of $201,821 which is being amortized over the service period.

In January 2013, the Company granted five-year options to purchase 3,000,000 shares of common stock with an exercise price of $0.37 per share to a director of the Company who is also serving as a consultant for a three year period. The fair value of these options amounted to $482,391, calculated using the BSM method and will be expensed over the requisite service period. As of March 31, 2013 the Company revalued the unvested options in accordance with ASC 505-50-30. The subsequent re-measurement produced a value of $638,014 which is being amortized over the service period.

Issuance of Warrants with Convertible Debt

In February 2013, the Company issued 937,500 five-year warrants exercisable at $0.40 per share in connection with a $750,000 convertible note. The fair value of the warrants amounted to $265,133, calculated using the BSM method. See Note 5.

Issuance of Warrants as Finder Fee

In February 2013, the Company issued 75,000 five-year warrants exercisable at $0.40 per share to a third party in conjunction with the financing. The fair value of the warrants amounted to $21,211, calculated using the BSM method. The warrant value and $43,533 in cash paid to a third party are recorded as a deferred asset and being amortized over the term of the note.

Option and Warrant Exercises

Cash Exercises

During the three months ended March 31, 2013, the Company issued 80,000 shares of common stock in exchange for cash of $20,000 upon the exercise of warrants with an exercise price of $0.25 per share.

Cashless Exercises

In March 2013, the Company issued 1,495,652 shares of common stock to a related party trust upon the cashless exercise of 4,000,000 options with an exercise price of $0.30 per share based upon market price of the Company’s common stock ranging from $0.46 to $0.50 per share.

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ECOSPHERE TECHNOLOGIES, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

MARCH 31, 2013

(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, 2013:

Stock-based compensation expense related to options for the three months ended March 31, 2013 was $226,796. At March 31, 2013, total unrecognized compensation cost related to unvested options granted under the Company’s option plans totaled $1,332,681. This unrecognized compensation cost is expected to be recognized over the next 24 months.

12.

RELATED PARTY TRANSACTIONS

Related Party Option Grants

In January 2013, the Company granted five-year options to purchase 150,000 shares of common stock with an exercise price of $0.48 per share to its Director of Business Development. The fair value of these options amounted to $24,841, calculated using the BSM method and will be expensed over the vesting period.

In January 2013, the Company granted five-year options to purchase 5,000,000 shares of common stock with an exercise price of $0.40 per share to its former Chief Executive Officer. These options were forfeited when he resigned on March 12, 2013.

See Note 11 for 4 million options issued to two directors under consulting agreements.

13.

COMMITMENTS AND CONTINGENCIES

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 $300 million in 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.

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.

The Company had a long term relationship with Kamimura International Associates ("KIA"), a Washington D.C. based organization, whereby the principals at KIA agreed to assist the Company in developing the coating removal market in the Far East. The relationship resulted in the establishment of UltraStrip Japan, Ltd., a company whose purpose was to market and deliver ship stripping services in Japan. The agreement with KIA was never formalized. In February 2007, KIA filed a lawsuit against the Company. In March 2007, the Company filed a Motion to Dismiss, Motion to Strike, and Motion for More Definite Statement. The Company intends to vigorously defend itself in this litigation; the Company believes that the plaintiff will not prevail. In 2008, the Company filed a counter claim to which KIA responded by filing a motion to dismiss. The motion to dismiss was rejected by the court. The Company expensed and accrued an amount it reasonably estimated would be required to resolve any outstanding issues between the Company and KIA. In December 2012, the Company reached a settlement with KIA 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 accrue 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, 2013 the Company had an accrued balance of $118,750 which is comprised of the $150,000 obligation less $31,250 in payments.

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ECOSPHERE TECHNOLOGIES, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

MARCH 31, 2013

(UNAUDITED)

In March 2011, a former vendor obtained a judgment against the Company for a number of disputed billings. As of March 31, 2013 the Company has accrued $70,000 which is anticipated to be the amount of payment due to the vendor plus attorney’s fees.

14.

CONCENTRATIONS OF RISK

Concentration of Accounts Receivable and Revenues

At March 31, 2013, accounts receivable of approximately $0.5 million was comprised primarily of two major customer balances amounting to 71% and 25% of the total receivable balance. In addition, two customers accounted for 47% and 40% of revenues, respectively.

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, 2013. As of March 31, 2013, the Company had no 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.

Major Suppliers

The Company purchases products from a limited number of manufacturers, however, management believes that other suppliers could adapt to provide similar products or components on comparable terms.

15.

NONCONTROLLING INTEREST IN CONSOLIDATED SUBSIDIARY

In July 2009, the Company formed EES and contributed the assets and liabilities of EES Inc. in exchange for a 67% ownership interest in EES. In November EES received $7,850,000 in exchange for a 21.5% interest in EES. After the November transaction, the Company owns 52.6% of EES. EES reported a net loss of $743,417 during the period from inception, July 16, 2009 through December 31, 2009 and a net loss of $528,277 for the year ended December 31, 2010, both of which were allocated to the other EES members in accordance with the LLC operating agreement. For fiscal 2011, EES had net income of $3,217,407 of which the first $1,271,694 was allocated entirely to the noncontrolling interest to allow them recovery of previously allocated losses, in accordance with the LLC operating agreement, after which income was allocated to ETI and certain noncontrolling interests based on a formula stipulated in the LLC operating agreement, as amended. On a net basis, $1,690,075 of income was allocated to noncontrolling interests in fiscal 2011. During 2012, of EES’s $3,780,472 of net income, $815,054 was allocated to noncontrolling interest. During the three months ended March 31, 2013, the Company allocated $170,496 of EES net loss to its noncontrolling members.

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

The following provides a summary of activity in the noncontrolling interest in consolidated subsidiary account for the three months ended March 31, 2013:

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ECOSPHERE TECHNOLOGIES, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

MARCH 31, 2013

(UNAUDITED)

16.

SUBSEQUENT EVENTS

Related Party Option Grant

Effective April 26, 2013, the Company granted five-year options to purchase 6,000,000 shares of common stock with an exercise price of $0.36 per share to its Chief Executive Officer and Chief Technology Officer. The fair value of the options amounted to $844,507, calculated using the BSM method. One third of the options vested April 26, 2013 and the remaining two-thirds vest in equal increments on January 1, 2014 and 2015.

Stock Issuances

In May 2013, the Company issued 651,000 shares of common stock upon the exercise of warrants with exercise prices of $0.15 to $0.20 per share, resulting in proceeds to the Company of $108,150.

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

Company Overview

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

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

1. Identify a major environmental water challenge

2. Invent technologies and file new patents

3. Partner with industry leaders

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

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

6. Create shareholder value

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

2013 Highlights

·

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

·

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

·

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

·

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

·

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

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ECOSPHERE TECHNOLOGIES, INC. AND SUBSIDIARIES

·

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

·

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

·

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

·

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

CRITICAL ACCOUNTING ESTIMATES

Use of Estimates

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

Revenue Recognition

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

Equipment and Component Sales

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

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

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

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ECOSPHERE TECHNOLOGIES, INC. AND SUBSIDIARIES

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

Field Services

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

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

Aftermarket Part Sales

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

Royalties

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

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

Stock-Based Compensation

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

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

Fair Value of Liabilities for Warrant Derivative Instruments

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

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ECOSPHERE TECHNOLOGIES, INC. AND SUBSIDIARIES

Results of Operations

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

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

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

Revenues

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

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

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ECOSPHERE TECHNOLOGIES, INC. AND SUBSIDIARIES

Cost and Expenses

Equipment Sales and Licensing Costs (exclusive of depreciation)

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

Field Services Costs (exclusive of depreciation)

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

Aftermarket Part Costs (exclusive of depreciation)

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

Salaries and Employee Benefits

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

Professional Fees

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

(Loss) Income from Operations

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

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

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

LIQUIDITY AND CAPITAL RESOURCES

A summary of our cash flows is as follows: