Unassociated Document

10-Q 1 v238232_10q.htm FORM 10-Q Unassociated Document

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

FORM 10-Q

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

For the quarterly period ended September 30, 2011

¨	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 33-46104-FW

THERMOENERGY CORPORATION

(Exact name of registrant as specified in its charter)

Delaware	71-0659511
(State or other jurisdiction of	(I.R.S. Employer Identification No.)
incorporation or organization)

10 New Bond Street,
Worcester, Massachusetts	01606
(Address of Principal Executive Offices)	(Zip Code)

Registrant’s telephone number, including area code: (508) 854-1628

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 x No ¨

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 (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No ¨

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 ¨	Accelerated filer ¨

Non-accelerated filer ¨ (Do not check if a smaller reporting company)	Smaller reporting company x

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

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

Class – Common Stock, $.001 par value Outstanding at November 8, 2011 – 57,467,098 shares

THERMOENERGY CORPORATION

INDEX

			Page No.

Part I.	Financial Information
	ITEM 1.	Financial Statements	3
		Consolidated Balance Sheets as of September 30, 2011 (Unaudited) and December 31, 2010	3
		Consolidated Statements of Operations for the three and nine months ended September 30, 2011 and 2010 (Unaudited)	4
		Consolidated Statements of Cash Flows for the nine months ended September 30, 2011 and 2010 (Unaudited)	5
		Notes to Consolidated Financial Statements (Unaudited)	6
	ITEM 2.	Management's Discussion and Analysis of Financial Condition and Results of Operations	19
	ITEM 3.	Quantitative and Qualitative Disclosures About Market Risk	23
	ITEM 4.	Controls and Procedures	23

Part II.	Other Information
	ITEM 1.	Legal Proceedings	24
	ITEM 1A.	Risk Factors	24
	ITEM 2.	Unregistered Sales of Equity Securities and Use of Proceeds	24
	ITEM 3.	Defaults Upon Senior Securities	26
	ITEM 4.	(Removed and Reserved)	26
	ITEM 5.	Other Information	26
	ITEM 6.	Exhibits	26

Signatures			27

PART I – FINANCIAL INFORMATION

ITEM 1. Financial Statements

THERMOENERGY CORPORATION

CONSOLIDATED BALANCE SHEETS

(in thousands, except share and par value amounts)

	(unaudited) September 30, 2011			December 31, 2010
ASSETS
Current Assets:
Cash	$	1,807		$	4,299
Accounts receivable, net		227			1,043
Costs in excess of billings		329			—
Inventories, net		134			65
Other current assets		1,154			289
Total Current Assets		3,651			5,696

Property and equipment, net		568			560
Other assets		58			61

Total Assets	$	4,277		$	6,317

LIABILITIES AND STOCKHOLDERS' DEFICIENCY
Current Liabilities:
Accounts payable	$	1,820		$	722
Accrued payroll taxes		687			1,470
Billings in excess of costs		3,234			1,880
Other current liabilities		1,426			1,995
Total Current Liabilities		7,167			6,067

Long Term Liabilities:
Derivative liability		2,186			2,852
Convertible debt		1,515			8,892
Other long term liabilities		222			180
Total Long Term Liabilities		3,923			11,924

Total Liabilities		11,090			17,991

Stockholders' Deficiency:
Preferred Stock, $0.01 par value: authorized: 30,000,000 shares at September 30, 2011 and 20,000,000 shares at December 31, 2010:
Series A Convertible Preferred Stock, liquidation value of $1.20 per share: designated: 208,334 shares at September 30, 2011 and 10,000,000 shares at December 31, 2010; issued and outstanding: 208,334 shares at September 30, 2011 and December 31, 2010		2			2
Series B Convertible Preferred Stock, liquidation preference of $2.40 per share: designated: 12,000,000 shares at September 30, 2011 and 6,454,621 shares at December 31, 2010; issued and outstanding: 11,664,993 shares at September 30, 2011 and 5,968,510 shares at December 31, 2010		117			60
Common Stock, $.001 par value: authorized – 425,000,000 shares at September 30, 2011 and 300,000,000 shares at December 31, 2010; issued and outstanding: 56,867,098 shares at September 30, 2011 and 55,681,918 shares at December 31, 2010		57			55
Additional paid-in capital		96,024			79,345
Accumulated deficit		(102,989	)		(91,118	)
Treasury stock, at cost: 133,797 shares at September 30, 2011 and December 31, 2010		(18	)		(18	)
Total ThermoEnergy Corporation Stockholders’ Deficiency		(6,807	)		(11,674	)
Noncontrolling interest		(6	)		—
Total Stockholders’ Deficiency		(6,813	)		(11,674	)

TOTAL LIABILITIES AND STOCKHOLDERS’ DEFICIENCY	$	4,277		$	6,317

See notes to consolidated financial statements.

THERMOENERGY CORPORATION

CONSOLIDATED STATEMENTS OF OPERATIONS

In thousands, except share and per share amounts

(Unaudited)

	Three Months Ended September 30,						Nine Months Ended September 30,
	2011			2010			2011			2010

Revenue	$	1,193		$	641		$	3,575		$	2,054
Less: cost of revenue		1,073			612			3,321			1,923
Gross profit		120			29			254			131

Operating Expenses:
General and administrative		897			1,398			3,592			3,851
Engineering, research and development		132			122			259			559
Sales and marketing		561			299			1,699			900
Total operating expenses		1,590			1,819			5,550			5,310

Loss from operations		(1,470	)		(1,790	)		(5,296	)		(5,179	)

Other income (expense):
Warrant expense		(1,799	)		—			(1,799	)		—
Derivative liability income (loss)		(653	)		2,635			403			(321	)
Loss on extinguishment of debt		(2,042	)		(614	)		(2,042	)		(614	)
Interest and other expense, net		(263	)		(1,150	)		(2,751	)		(2,311	)
Equity in losses of joint venture		(117	)		(3	)		(386	)		(67	)

Net loss		(6,344	)		(922	)		(11,871	)		(8,492	)
Net loss attributable to noncontrolling interest		17			—			57			—

Net loss attributable to ThermoEnergy Corporation		(6,327	)		(922	)		(11,814	)		(8,492	)
Deemed dividend on Series B Convertible Preferred Stock		(4,045	)		(6,900	)		(4,271	)		(6,900	)

Net loss attributable to ThermoEnergy Corporation common stockholders	$	(10,372	)	$	(7,822	)	$	(16,085	)	$	(15,392	)

Net loss per share attributable to ThermoEnergy Corporation common stockholders, basic and diluted	$	(0.18	)	$	(0.15	)	$	(0.28	)	$	(0.29	)

Weighted average shares used in computing loss per share, basic and diluted		56,867,098			53,679,473			56,506,905			53,679,473

See notes to consolidated financial statements.

THERMOENERGY CORPORATION

CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

	(Unaudited) Nine Months Ended September 30,
	2011			2010
Operating Activities:
Net loss	$	(11,871	)	$	(8,492	)
Adjustment to reconcile net loss to net cash used in operating activities:
Stock option expense		757			1,562
Equity in losses of joint venture		386			67
Warrant expense		1,799			—
Derivative liability (income) loss		(403	)		321
Loss on extinguishment of debt		2,042			614
Loss on write-off of property, plant and equipment		62			—
Non-cash interest added to debt		245			490
Depreciation		57			36
Provision for inventory reserves		20			9
Amortization of discount on convertible debt		2,219			1,444
Increase (decrease) in cash arising from changes in assets and liabilities:
Accounts receivable		816			(536	)
Costs in excess of billings		(329	)		—
Inventories		(89	)		—
Other current assets		(854	)		33
Accounts payable		1,098			(186	)
Billings in excess of costs		1,354			359
Other current liabilities		(1,023	)		(42	)
Other long-term liabilities		42			(37	)

Net cash used in operating activities		(3,672	)		(4,358	)

Investing Activities:
Investment in joint venture		(400	)		(59	)
Purchases of property and equipment		(127	)		(239	)

Net cash used in investing activities		(527	)		(298	)

Financing Activities:
Proceeds from issuance of short-term borrowings		4,510			4,625
Proceeds from issuance of Series B Convertible Preferred Stock and warrants, net of issuance costs of $375 in 2010					4,625
Payments on convertible debt		(2,803	)		—

Net cash provided by financing activities		1,707			9,250

Net change in cash		(2,492	)		4,594
Cash, beginning of period		4,299			1,109
Cash, end of period	$	1,807		$	5,703

Cash paid for interest	$	136		$	—
Supplemental schedule of non-cash financing activities:
Conversion of convertible debt and accrued interest to Series B Convertible Preferred Stock	$	10,139		$	1,900
Conversion of Series B Convertible Preferred Stock to common stock	$	284		$	—
Debt discount recognized on convertible debt	$	3,604		$	3,054
Accrued interest converted to debt	$	153		$	323
Exercise of warrants recorded as derivative liabilities	$	263		$	—
Receipt of treasury stock	$	—		$	18

See notes to consolidated financial statements.

THERMOENERGY CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2011

(Unaudited)

Note 1: Organization and summary of significant accounting policies

Nature of business

ThermoEnergy Corporation (the “Company”) was incorporated in January 1988 as a diversified technologies company engaged in the worldwide commercialization of advanced municipal and industrial wastewater treatment systems and carbon reducing power generation technologies.

The Company’s wastewater treatment systems are based on its proprietary Controlled Atmosphere Separation Technology (“CAST”) platform. The Company’s patented and proprietary platform technology is combined with off-the-shelf technologies to provide systems that are inexpensive, easy to operate and reliable. The Company’s wastewater treatment systems have global applications in aerospace, food and beverage processing, metal finishing, pulp & paper, petrochemical, refining, microchip and circuit board manufacturing, heavy manufacturing and municipal wastewater. The CAST platform technology is owned by its subsidiary, CASTion Corporation (“CASTion”).

The Company also owns a patented pressurized oxycombustion technology known as the Zero Emission Boiler System (“ZEBS™”), which converts fossil fuels (including coal, oil and natural gas) and biomass into electricity without producing air emissions while removing and capturing carbon dioxide in liquid form for sequestration or beneficial reuse. This technology is intended to be used to build new or to retrofit old fossil fuel power plants globally with no emissions while capturing carbon dioxide as a liquid for ready sequestration far more economically than any other competing technology. The ZEBS™ technology is held in the Company’s subsidiary, ThermoEnergy Power Systems, LLC (“TEPS”) and is being commercialized through a joint venture with Babcock Power Development, Inc. called Babcock-Thermo Clean Combustion LLC ("BTCC"). TEPS granted BTCC an exclusive worldwide license to commercialize the ZEBS™ technology.

Principles of consolidation and basis of presentation

The consolidated financial statements include the accounts of the Company and its subsidiaries. All significant intercompany accounts and transactions have been eliminated in consolidation. Certain prior year amounts have been reclassified to conform to current year classifications.

The accompanying unaudited financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) for interim financial information and with the instructions to Form 10-Q and Article 8-03 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by GAAP for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the nine-month period ended September 30, 2011 are not necessarily indicative of the results that may be expected for the year ended December 31, 2011.

The balance sheet at December 31, 2010 has been derived from the audited financial statements at that date but does not include all of the information and footnotes required by GAAP for complete financial statements.

For further information, refer to the financial statements and footnotes thereto included in the Annual Report on Form 10-K/A for the year ended December 31, 2010 of ThermoEnergy Corporation.

The 15% third party ownership interest in TEPS is recorded as a noncontrolling interest in the consolidated financial statements.

Revenue recognition

Revenues from fixed-price contracts are recognized on the percentage of completion method, measured by the percentage of costs incurred to total estimated costs. Contract costs include all direct material and labor costs and indirect costs related to contract performance, such as indirect labor, supplies, tools, repairs and depreciation. Selling, general and administrative costs are charged to expense as incurred. Provisions for estimated losses on uncompleted contracts are made in the period in which losses are determined. Changes in job performance, job conditions, and estimated profitability may result in revisions to costs and income and are recognized in the period in which revisions are determined.

THERMOENERGY CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2011

(Unaudited)

Cash

The Company places its cash in highly rated financial institutions, which are continually reviewed by senior management for financial stability. Effective December 31, 2010, extending through December 31, 2012, all “noninterest-bearing transaction accounts” are fully insured, regardless of the balance of the account. Generally the Company’s cash in interest-bearing accounts exceeds financial depository insurance limits. However, the Company has not experienced any losses in such accounts and believes that its cash are not exposed to significant credit risk.

Accounts receivable, net

Accounts receivable are recorded at their estimated net realizable value. Receivables related to the Company’s contracts have realization and liquidation periods of less than one year and are therefore classified as current. The Company’s method for estimating its allowance for doubtful accounts is based on judgmental factors, including known and inherent risks in the underlying balances, adverse situations that may affect the customer’s ability to pay and current economic conditions. Amounts considered uncollectible are written off based on the specific customer balance outstanding. The Company did not record any bad debt expense for the three months ended September 30, 2011 and 2010; the Company recorded bad debt expense of $0 and $1,000 for the nine-month periods ended September 30, 2011 and 2010, respectively. The allowance for doubtful accounts totaled $9,000 at September 30, 2011 and December 31, 2010.

Inventories

Inventories are stated at the lower of cost or market using the first-in, first-out method and consist primarily of raw materials and supplies.

The Company evaluates its inventory for excess quantities and obsolescence on an annual basis. In preparing its evaluation, the Company looks at the expected demand for its products for the next three to twelve months. Based on this evaluation, it establishes and maintains a reserve so that inventory is appropriately stated at the lower of cost or net realizable value. The Company recorded provisions for inventory reserves of $15,000 and $0 for the three months ended September 30, 2011 and 2010, respectively, and $20,000 and $9,000 for the nine-month periods ended September 30, 2011 and 2010, respectively. Inventory reserves totaled $103,000 at September 30, 2011 and $83,000 at December 31, 2010.

Property and equipment

Property and equipment are stated at cost and are depreciated over the estimated useful life of each asset. Depreciation is computed using the straight-line method. The Company evaluates long-lived assets based on estimated future undiscounted net cash flows or other fair value measures whenever significant events or changes in circumstances occur that indicate the carrying amount may not be recoverable. If that evaluation indicates that an impairment has occurred, a charge is recognized to the extent the carrying amount exceeds the undiscounted cash flows or fair values of the asset, whichever is more readily determinable.

The Company performed an evaluation of its property and equipment as of September 30, 2011 in conjunction with relocating its headquarters and recorded a write-off of $62,000. This impairment loss is included as a component of interest and other expense on its Consolidated Statement of Operations for the three and nine-month periods ended September 30, 2011.

Contingencies

The Company accrues for costs relating to litigation, including litigation defense costs, claims and other contingent matters, including liquidated damage liabilities, when such liabilities become probable and reasonably estimable. Such estimates may be based on advice from third parties or on management’s judgment, as appropriate. Revisions to accruals are reflected in earnings (loss) in the period in which different facts or information become known or circumstances change that affect the Company’s previous assumptions with respect to the likelihood or amount of loss. Amounts paid upon the ultimate resolution of such liabilities may be materially different from previous estimates.

THERMOENERGY CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2011

(Unaudited)

Stock options

The Company accounts for stock options in accordance with Accounting Standards Codification (“ASC”) Topics 505, “Equity”, and 718, “Compensation – Stock Compensation”. These topics require that the cost of all share-based payments to employees, including grants of employee stock options, be recognized in the consolidated financial statements based on their fair values on the measurement date, which is generally the date of grant. Such cost is recognized over the vesting period of the awards. The Company uses the Black-Scholes option pricing model to estimate the fair value of “plain vanilla” stock option awards.

Fair value of financial instruments and fair value measurements

The carrying amount of cash, accounts receivable, other current assets, accounts payable and other current liabilities in the consolidated financial statements approximate fair value because of the short-term nature of the instruments. The carrying amount of the Company’s convertible debt was $1,515,000 and $8,892,000 at September 30, 2011 and December 31, 2010, respectively, and approximates the fair value of these instruments. The Company’s warrant liabilities are recorded at fair value.

The Company's liabilities carried at fair value are categorized using inputs from the three levels of the fair value hierarchy, as follows:

Level 1:

Quoted prices in active markets for identical assets or liabilities.

Level 2:

Inputs other than Level 1 that are observable, either directly or indirectly, such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities.

Level 3:

Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the liabilities.

Liabilities measured at fair value on a recurring basis as of September 30, 2011 are as follows: (in thousands)

			Fair Value Measurements at Reporting Date Using
Description	Balance as of September 30, 2011		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Liabilities
Derivative liability	$	2,186	$	-	$	-	$	2,186

Total Liabilities	$	2,186	$	-	$	-	$	2,186

Liabilities measured at fair value on a recurring basis as of December 31, 2010 are as follows: (in thousands)

			Fair Value Measurements at Reporting Date Using
Description	Balance as of December 31, 2010		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Liabilities
Derivative liability	$	2,852	$	-	$	-	$	2,852
Total Liabilities	$	2,852	$	-	$	-	$	2,852

THERMOENERGY CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2011

(Unaudited)

The following table sets forth a reconciliation of changes in the fair value of derivatives classified as Level 3 (in thousands):

	Long-Term Warrant Liability
Balance at December 31, 2010	$	2,852
Exercise of warrants		(263	)
Derivative liability income		(403	)
Balance at September 30, 2011	$	2,186

Series B Convertible Preferred Stock

The Company accounts for its Series B Convertible Preferred Stock by first allocating the proceeds based on the relative fair value of the Series B Convertible Preferred Stock and the warrants issued to the investors, and then to any beneficial conversion features contained in the Preferred Stock. The Company determined the initial value of the Series B Convertible Preferred Stock and investor warrants using valuation models it considers to be appropriate. Because the Series B Convertible Preferred Stock has an indefinite life, it is classified within the stockholders’ deficiency section of the Company's consolidated balance sheets. The value of the warrants and beneficial conversion features are considered a “deemed dividend” and are added as a component of net loss attributable to common stockholders in the Company’s Consolidated Statements of Operations.

Net income (loss) per share

Basic net income (loss) per share (“EPS”) is computed by dividing the net income (loss) attributable to the common stockholders (the numerator) by the weighted average number of shares of common stock outstanding (the denominator) during the reporting periods. Fully diluted net income (loss) per share is computed by increasing the denominator by the weighted average number of additional shares that could have been outstanding from securities convertible into common stock, such as stock options and warrants (using the “treasury stock” method), and convertible preferred stock and debt (using the “if-converted” method), unless the effect on net income (loss) per share is antidilutive. Under the “if-converted” method, convertible instruments are assumed to have been converted as of the beginning of the period or when issued, if later. The effect of computing the Company’s diluted net income (loss) per share was antidilutive and, as such, basic and diluted net income (loss) per share are the same for the three and nine-month periods ended September 30, 2011 and 2010.

Effect of new accounting pronouncements

In January 2010, the FASB issued Accounting Standards Update (“ASU”) No. 2010-06, "Fair Value Measurements and Disclosures (Topic 820): Improving Disclosures about Fair Value Measurements" (“ASU 2010-06”). ASU 2010-06 amended certain provisions of ASC 820-10 by requiring additional disclosures for transfers in and out of Level 1 and Level 2 fair value measurements, as well as requiring fair value measurement disclosures for each class of assets and liabilities in addition to disclosures about the valuation techniques and inputs used to measure fair value for both recurring and nonrecurring fair value measurements that fall in either Level 2 or Level 3. The adoption did not have a material impact on the Company's financial statements or disclosures, as the Company did not have any financial instruments valued using Level 1 and Level 2 fair value measurements and did not have material classes of assets and liabilities that required additional disclosure. Certain provisions of ASU 2010-06 were effective for the Company for the fiscal year beginning January 1, 2011. These provisions require the Company to present separately information on all purchases, sales, issuances, and settlements of financial instruments valued using significant unobservable inputs (Level 3) in the reconciliation for fair value measurements. The Company has adopted the provisions of ASU 2010-06 in its 2011 financial statements.

In April 2010, the FASB issued ASU No. 2010-17, “Revenue Recognition - Milestone Method (Topic 605): Milestone Method of Revenue Recognition” (“ASU 2010-17”). ASU 2010-17 provides guidance on defining a milestone and determining when it may be appropriate to apply the milestone method of revenue recognition for certain research and development transactions. Under this new guidance, a company can recognize as revenue consideration that is contingent upon achievement of a milestone in the period in which it is achieved, only if the milestone meets all criteria to be considered substantive. This guidance will be effective on a prospective basis beginning January 1, 2011. The Company does not believe the adoption of ASU 2010-17 will have a material impact on its financial statements.

THERMOENERGY CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2011

(Unaudited)

In May 2011, the FASB issued ASU No. 2011-04, “Fair Value Measurement: Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S GAAP and IFRS” (“ASU 2011-04”). ASU 2011-04 defines fair value, clarifies a framework to measure fair value, and requires specific disclosures of fair value measurements. The guidance will be effective for interim and annual reporting periods beginning after January 1, 2012 and is required to be applied retrospectively. The Company does not believe the adoption of ASU 2011-04 will have a material impact on its financial statements.

In June 2011, the FASB issued ASU No. 2011-05, “Presentation of Comprehensive Income” (“ASU 2011-05”). ASU 2011-05 eliminates the current requirement to report other comprehensive income and its components in the statement of equity and instead requires the components of other comprehensive income to be presented either in a single continuous statement of comprehensive income or in two separate but consecutive statements. The guidance will be effective for interim and annual reporting periods beginning after January 1, 2012 and is required to be applied retrospectively. Other than presentation in the financial statements, the Company believes the adoption of ASU 2011-05 will have no effect on the Company’s financial position or results of operations.

Note 2: Management's consideration of going concern matters

The Company has incurred net losses since inception and will require additional capital to continue commercialization of the Company’s power and water technologies (the “Technologies”) and to fund the Company’s liabilities, which included approximately $1.8 million in accounts payable, $1.5 million of convertible debt, $687,000 of payroll tax liabilities (see Note 7), $3.2 million of billings in excess of costs, derivative liabilities of $2.2 million and approximately $1.65 million of other liabilities at September 30, 2011. In addition, the Company may be subject to tax liens if it cannot abide by the terms of the Offer in Compromise approved by the Internal Revenue Service to satisfactorily settle outstanding payroll tax liabilities (see Note 7). The consolidated financial statements have been prepared assuming the Company will continue as a going concern, realizing assets and liquidating liabilities in the ordinary course of business and do not reflect any adjustments that might result from the outcome of the aforementioned uncertainties. Management is considering several alternatives for mitigating these conditions.

Management is actively seeking to raise substantial working capital through additional equity or debt financing that will allow the Company to operate until it becomes cash flow positive from operations. Management is also actively pursuing commercial contracts to generate operating revenue. Management has determined that the financial success of the Company is partly dependent upon the Company’s ability to collaborate with financially sound third parties to pursue projects involving the Technologies.

Management has undertaken and successfully completed a program to reduce the Company’s outstanding debt as follows:

As more fully described in Note 4, the Company entered into Note Amendment and Forbearance Agreements in January 2011 with the holders of the CASTion Notes originally due May 31, 2010. As part of these agreements, the Company issued amended CASTion Notes that extended the maturity date until February 29, 2012.

Also, as more fully described in Note 4, the Company and certain investors entered into a Bridge Loan Agreement on March 10, 2010 pursuant to which the Company issued convertible notes (the “2010 Bridge Notes”) that provided $4.6 million of funding to the Company in 2010. Of this amount, $1.9 million was converted into the Company’s Series B Convertible Preferred Stock in July 2010. The Bridge Loan Agreement and the 2010 Bridge Notes were amended on June 30, 2010 and February 25, 2011. The amendment on February 25, 2011 extended the maturity date of the 2010 Bridge Notes to February 29, 2012.

As more fully described in Notes 4 and 5, the Company entered into a Bridge Loan and Warrant Amendment Agreement with certain investors on June 17, 2011 pursuant to which the Company received proceeds totaling approximately $2.9 million. The Bridge Loan and Warrant Amendment Agreement was amended on July 12, 2011 to provide for an additional $1.6 million of funding, bringing the total proceeds to approximately $4.5 million (the “2011 Bridge Loans”).

THERMOENERGY CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2011

(Unaudited)

On July 1, 2011, the Company used approximately $1.6 million of these proceeds to pay down the principal balance of the CASTion Notes as described above. Per the terms of the CASTion Notes, as amended, in the event the Company makes any payments of principal or accrued interest on or before July 5, 2011, an equal amount of such payment shall automatically convert into shares of the Company’s Series B Convertible Preferred Stock at the rate of $2.40 per share and Warrants for the purchase of the Company’s Common Stock equal to that number of shares of the Company’s Common Stock determined by dividing 200% of the amount of principal and interest converted by $0.30. Accordingly, on July 1, 2011, the Company issued 653,439 shares of its Series B Convertible Preferred Stock and Warrants for the purchase of 10,455,024 shares of its Common Stock. As a result, the amended CASTion Notes were considered to be repaid in full.

Consequently, per the terms of the amended 2010 Bridge Loan Agreement, as described above, the repayment of the CASTion Notes triggered the Company’s right to convert the entire outstanding balance of principal and interest on the 2010 Bridge Notes (approximately $4.5 million) into shares of Series B Convertible Preferred Stock. The Company effected this conversion on August 11, 2011.

Also on August 11, 2011, upon satisfaction of all of the conditions set forth in the 2011 Bridge Loan and Warrant Amendment Agreement, the holders of the 2011 Bridge Loans exercised all of the Warrants in accordance with the 2011 Bridge Loan and Warrant Amendment Agreement and surrendered all of the 2011 Bridge Loans in payment of the exercise price for the purchase under the Warrants of an aggregate of 3,469,387 shares of Series B Convertible Preferred Stock at a price of $1.30 per share.

Note 3: Babcock-Thermo Clean Combustion LLC

On February 25, 2009, the Company’s majority-owned subsidiary, TEPS, and Babcock Power Development, LLC (“BPD”), a subsidiary of Babcock Power, Inc., entered into a Limited Liability Company Agreement (the “LLC Agreement”) establishing Babcock-Thermo Carbon Capture LLC, a Delaware limited liability company now known as Babcock-Thermo Clean Combustion LLC (the “Joint Venture”) for the purpose of developing and commercializing its proprietary ZEBS technology.

TEPS has entered into a license agreement with the Joint Venture and BPD, pursuant to which it has granted to the Joint Venture an exclusive, irrevocable (except as otherwise provided therein), world-wide and royalty-free license to TEPS’ intellectual property related to or necessary to practice the ZEBS technology (the “ZEBS License”). In the LLC Agreement, BPD has agreed to develop, at its own expense, intellectual property in connection with three critical subsystems relating to the ZEBS technology: a combustor subsystem, a steam generating heating surface subsystem, and a condensing heat exchangers subsystem (collectively, the “Subsystems”) and BPD has entered into a license agreement with the Joint Venture and TEPS pursuant to which it has granted the Joint Venture an exclusive, irrevocable (except as otherwise provided therein), world-wide, fully paid up and royalty-free license to BPD’s know-how and other proprietary intellectual property related to or necessary to practice the Subsystems.

Pursuant to the LLC Agreement, TEPS and BPD each own a 50% membership interest in the Joint Venture. The LLC Agreement provides that each member may be required, from time to time, to make capital contributions to the Joint Venture to fund its operations. The Company and BPD each made capital contributions of $400,000 to the Joint Venture in the first nine months of 2011.

The Joint Venture is managed by a six-person Board of Managers, with three managers appointed by each member. The Board of Managers has adopted a set of milestones by which it will measure the progress of the Joint Venture. Pursuant to the LLC Agreement, either member may withdraw from the Joint Venture if any milestone is not met (unless the failure to meet such milestone is primarily attributable to a failure by such member to perform its obligations under the LLC Agreement or any related agreements). If a member exercises its right to withdraw, the license that such member has granted to the Joint Venture will automatically terminate.

The LLC Agreement obligates the Joint Venture and each member to indemnify and hold the other member and its affiliates harmless against damages and losses resulting from such member’s fraud, gross negligence or intentional misconduct with respect to the Joint Venture. The Company and Babcock Power, Inc. have entered into separate agreements to indemnify the joint venture and its members (other than the Company’s respective subsidiary-members) and their respective affiliates against damages and losses resulting from fraud, gross negligence or intentional misconduct of the respective subsidiary-members with respect to the Joint Venture.

THERMOENERGY CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2011

(Unaudited)

The LLC Agreement contains other conventional terms, including provisions relating to governance of the entity, allocation of profits and losses, and restrictions on transfer of a member’s interest.

The Company accounts for the Joint Venture using the equity method of accounting. Accordingly, the Company reduced the value of its investment in the Joint Venture by approximately $386,000 in the first nine months of 2011 to account for its share of net losses incurred by the Joint Venture. The value of the Company’s investment in the Joint Venture is approximately $34,000 as of September 30, 2011 and is classified as Other Assets on the Company’s Consolidated Balance Sheets.

Note 4: Convertible debt

Convertible debt consisted of the following at September 30, 2011 and December 31, 2010 (in thousands):

	September 30, 2011		December 31, 2010

Convertible Promissory Note, 5%, due March 7, 2013, less discount of $224 in 2011 and $345 in 2010	$	669	$	504
Convertible Promissory Note, 5%, due March 21, 2013, less discount of $93 in 2011 and $132 in 2010		846		762
Convertible Promissory Notes, 10%, due February 29, 2012		—		5,380
Convertible Bridge Notes, 10%, due February 29, 2012, less discount of $77 in 2011 and $496 in 2010		—		2,246

	$	1,515	$	8,892

Roenigk Loans

On March 21, 2007 the Company issued to Mr. Martin A. Roenigk, a member of the Company’s Board of Directors as of that date, a 5% Convertible Promissory Note due March 21, 2013 in the principal amount of $750,000. The principal amount and accrued interest on the Note is convertible into shares of Common Stock at a conversion price of $0.50 per share at any time at the election of the holder. Interest on the Note is payable semi-annually. The Company may, at its discretion, defer any scheduled interest payment until the maturity date of the Note upon payment of a $2,500 deferral fee. The Company added $45,000 of accrued interest to the principal balance of the Note during the nine months ended September 30, 2011. Total interest added to the principal balance of the Note was $189,000 as of September 30, 2011.

On March 7, 2008, Mr. Roenigk exercised his option to make an additional $750,000 investment in the Company under the terms of the Securities Purchase Agreement between the Company and Mr. Roenigk dated March 21, 2007. The Company issued to Mr. Roenigk a 5% Convertible Promissory Note due March 7, 2013 in the principal amount of $750,000. The principal amount and accrued interest on the Note is convertible into shares of Common Stock at a conversion price of $0.50 per share at any time at the election of the holder. Interest on the Note is payable semi-annually. The Company may, at its discretion, defer any scheduled interest payment until the maturity date of the Note upon payment of a $2,500 deferral fee. The Company added $43,000 of accrued interest to the principal balance of the Note during the nine months ended September 30, 2011. Total interest added to the principal balance of the Note was $142,000 as of September 30, 2011.

CASTion Acquisition Financing

On July 2, 2007, the Company issued Convertible Promissory Notes (the “CASTion Notes”) in the aggregate principal amount of $3,353,127 as part of the consideration for the acquisition of CASTion. The outstanding principal and accrued interest were convertible into shares of the Company’s Common Stock at a conversion price of $0.50 per share at any time at the holders’ discretion. The CASTion Notes contained conventional weighted-average anti-dilution provisions for the adjustment of the conversion price in the event the Company issued additional shares of Common Stock (or securities convertible into Common Stock) at a price less than the then-effective exercise price or conversion price. The Notes matured on May 31, 2010.

THERMOENERGY CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2011

(Unaudited)

On January 7, 2011 the Company entered into Note Amendment and Forbearance Agreements (the “Agreements”) with the holders of the CASTion Notes (the “CASTion Noteholders”). Pursuant to the Agreements, (i) the Company made payments totaling $1,144,336 against the outstanding balances of the CASTion Notes; (ii) the CASTion Noteholders converted an aggregate of $902,710 in principal and accrued interest on the CASTion Notes into shares of the Company’s Series B Convertible Preferred Stock; (iii) the Company issued to the CASTion Noteholders warrants for the purchase of an aggregate of 17,585,127 shares of its Common Stock at an exercise price of $0.40 per share and an aggregate of 6,018,065 shares of its Common Stock at an exercise price of $0.30 per share; (iv) the maturity date of the CASTion Notes was extended to February 29, 2012; (v) the Company made additional cash payments to the CASTion Noteholders totaling $37,914; and (vi) the CASTion Notes were amended and restated.

The amended and restated CASTion Notes bore interest at the rate of 10% per annum. Installment payments (based on a 10-year amortization schedule) were due on the last day of each month beginning January 31, 2011. The restated CASTion Notes were convertible, in whole or in part, at any time at the election of the CASTion Noteholders, into shares of the Company’s Series B Convertible Preferred Stock at the rate of $2.40 per share. The restated CASTion Notes provided that, in the event, on or before July 5, 2011, the Company made any payments of principal or accrued interest, then simultaneously with the making of such payment a portion of the remaining principal and accrued and unpaid interest on the restated CASTion Notes in an amount equal to the amount of such payment automatically converted into shares of the Company’s Series B Convertible Preferred Stock at the rate of $2.40 per share. The restated CASTion Notes also provided that, in the event that (i) the closing price of the Company’s Common Stock equaled or exceeded $0.72 per share for 20 consecutive trading days and (ii) the daily average trading volume of the Company’s Common Stock exceeded 30,000 shares for 20 consecutive trading days, then the entire principal amount, plus all accrued and unpaid interest thereon, would automatically convert into shares of the Company’s Series B Convertible Preferred Stock at the rate of $2.40 per share.

The Company accounted for the restated CASTion Notes as a debt modification, as the present value of cash flows of the restated CASTion Notes were in excess of those under the original terms. In addition, the Company estimated the fair value of the warrants issued using a Black-Scholes option pricing model and allocated $3.4 million of the balance of the restated CASTion Notes to the warrants on a relative fair value basis, which was recorded as a debt discount. The debt discount is amortized to interest expense over the stated term of the Restated Notes.

On July 1, 2011, the Company exercised its right to prepay a portion of the outstanding principal balance and accrued and unpaid interest on the restated CASTion Notes by making payments in the aggregate amount of $1,568,267. These payments represent slightly in excess of 50% of the balance of principal and accrued interest balance on the restated CASTion Notes. Accordingly, on July 1, 2011, the Company issued 653,439 shares of its Series B Convertible Preferred Stock and Warrants for the purchase of 10,455,024 shares of its Common Stock per the terms of the restated CASTion Notes. As a result, the restated CASTion Notes are repaid in full.

March 2010 Bridge Note Financing

On March 10, 2010, the Company entered into a Bridge Loan Agreement, effective March 1, 2010 with six of its principal investors (“the 2010 Investors”), all related parties, pursuant to which the Investors agreed to make bridge loans to the Company in the aggregate amount of $4.6 million. In connection therewith, the Company issued to the 2010 Investors 3% Secured Convertible Promissory Notes (the “2010 Bridge Notes”). The 2010 Bridge Notes bore interest at the rate of 3% per annum and were due and payable on February 28, 2011. The entire unpaid principal amount, together with all interest then accrued and unpaid under each 2010 Bridge Note, was convertible, at the election of the holder, into shares of the Company’s Common Stock at a conversion price of $0.24 per share.

THERMOENERGY CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2011

(Unaudited)

On February 25, 2011 the Company and the 2010 Investors entered into Note Extension and Amendment Agreements amending the terms of the 2010 Bridge Notes. As amended (the “Amended 2010 Bridge Notes”), bear interest at the rate of 10% per annum and mature on February 29, 2012. The Amended 2010 Bridge Notes are convertible into shares of the Company’s Series B Convertible Preferred Stock at the rate of $2.40 per share at any time at the election of the holders. In the event, prior to the maturity date of the Amended 2010 Bridge Notes, the Company pays in full the restated CASTion Notes as detailed above, then the Amended 2010 Bridge Notes shall convert, at the Company’s election, into shares of the Company’s Series B Convertible Preferred Stock at the rate of $2.40 per share. In the event that (i) the closing price of the Company’s Common Stock equals or exceeds $0.72 per share for 20 consecutive trading days and (ii) the daily average trading volume of the Company’s Common Stock exceeds 30,000 shares for 20 consecutive trading days, then the entire principal amount of the Amended 2010 Bridge Notes, plus all accrued and unpaid interest, shall automatically convert into shares of the Company’s Series B Convertible Preferred Stock at the rate of $2.40 per share. Upon conversion of all or any portion of the Amended 2010 Bridge Notes, the Company will issue five-year warrants for the purchase, at an exercise price of $0.30 per share, of that number of shares of the Company’s Common Stock determined by dividing (i) 200% of the amount of principal and interest so converted by (ii) $0.30 (the “Warrants”). The Amended 2010 Bridge Notes contain other conventional terms, including events of default upon the occurrence of which the Amended 2010 Bridge Notes become immediately due and payable.

The Company accounted for the Amended 2010 Bridge Notes as a debt modification, as the present value of cash flows of the Amended 2010 Bridge Notes were in excess of those under the original terms. In addition, the difference between the effective conversion price of the Amended 2010 Bridge Notes and the fair value of the Company’s Common Stock on the date of issuance resulted in a beneficial conversion feature of $117,000, the intrinsic value of the conversion feature on that date, which was recorded as a debt discount. The debt discount is amortized to interest expense over the stated term of the Amended 2010 Bridge Notes.

As stated above, on July 1, 2011 the Company repaid the entire principal balance of the restated CASTion Notes by making payments totaling $1,568,267 and converting the remaining balance into shares of Series B Convertible Preferred Stock. Per the terms of the amended 2010 Bridge Loan Agreement, as described above, the repayment of the CASTion Notes triggered the Company’s right to convert the entire outstanding balance of principal and interest on the 2010 Bridge Notes (approximately $4.5 million) into shares of Series B Convertible Preferred Stock and five-year warrants for the purchase, at an exercise price of $0.30 per share, of that number of shares of the Company’s Common Stock determined by dividing (i) 200% of the amount of principal and interest so converted by (ii) $0.30 (the “Warrants”). The Company effected this conversion on August 11, 2011, and as a result, the Amended 2010 Bridge Notes are repaid in full.

June 2011 Bridge Note Financing

On June 17, 2011 the Company entered into a Bridge Loan and Warrant Amendment Agreement (the “2011 Bridge Loan Agreement”) with six of its principal investors (“the 2011 Investors”), pursuant to which the Company issued Promissory Notes (the “2011 Bridge Notes”) in exchange for total proceeds of approximately $2.9 million. This Agreement was amended on July 12, 2011 to provide for an additional $1.6 million of funding to the Company and the issuance of additional 2011 Bridge Notes in such principal amount. The Company used approximately $1.6 million of the proceeds from the issuance of the 2011 Bridge Notes to pay down the principal balance of the restated CASTion Notes as described above.

The 2011 Bridge Notes are payable on demand at any time on or after February 29, 2012 (the “Maturity Date”). They do not bear interest until the Maturity Date and will bear interest at the rate of 10% per annum from and after the Maturity Date. The 2011 Bridge Notes may not be prepaid, in whole or in part, without the prior written consent of the 2011 Investors. The 2011 Investors have agreed to surrender the 2011 Bridge Notes in payment of the exercise price for warrants held by or issuable to them (the “Warrants”) if and when the conditions to their amendment and exercise have been satisfied. The 2011 Bridge Notes contain other conventional terms, including events of default upon the occurrence, and during the continuation, of which the 2011 Bridge Notes will bear interest at the rate of 10% per annum.

Pursuant to the 2011 Bridge Loan Agreement, the Company agreed, subject to the satisfaction of certain conditions, to amend the Warrants (i) to provide that they will be exercisable for the purchase of shares of our Series B Convertible Preferred Stock (the “Series B Stock”) instead of Common Stock (with the number of shares of the Series B Stock determined by dividing by ten (10) the number of shares of Common Stock for which the Warrants are currently exercisable) and (ii) to change the exercise prices of all Warrants (which currently range from $0.30 to $1.82 per share of Common Stock) to $1.30 per share of Series B Stock (the equivalent of $0.13 per Common-equivalent share). The Investors agreed, subject to the satisfaction of certain conditions, to exercise all of the Warrants. The principal amount of the 2011 Bridge Notes is equal to the aggregate exercise price of the Warrants (after they are amended as described above).

THERMOENERGY CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2011

(Unaudited)

Because the 2011 Bridge Notes do not bear interest, the Company calculated the present value of the 2011 Bridge Notes using an imputed interest rate of 10% and recorded imputed interest of $77,000 as a debt discount. The debt discount is amortized to interest expense over the expected term of the 2011 Bridge Notes.

On August 11, 2011, upon satisfaction of all of the conditions set forth in the 2011 Bridge and Warrant Agreement, the holders of the 2011 Bridge Notes exercised all of the Warrants in accordance with the 2011 Bridge and Warrant Agreement and surrendered all of the 2011 Bridge Notes in payment of the exercise price for the purchase under the Warrants of an aggregate of 3,469,387 shares of Series B Convertible Preferred Stock at a price of $1.30 per share. As a result, the 2011 Bridge Notes are repaid in full.

Note 5: Equity

On July 11, 2011 the Company received written consents from stockholders representing 71.3% in voting power of the Company’s capital stock authorizing an amendment of the Company’s Certificate of Incorporation for the following purposes:

to increase the total number of authorized shares of stock to 455,000,000 shares, of which 425,000,000 shares shall be Common Stock and 30,000,000 shares shall be Preferred Stock, with 208,334 shares of the Preferred Stock designated “Series A Convertible Preferred Stock”, 12,000,000 shares of the Preferred Stock designated “Series B Convertible Preferred Stock” and the remaining shares undesignated; and

to modify the definition of “Additional Stock” (as set forth in Section 6(g)(ii) of the Description of Series B Convertible Preferred Stock attached as Exhibit A to the Certificate of Designation, Preferences and Rights filed in the Office of the Secretary of State of the State of Delaware on November 18, 2009 (the “Series B Terms”)) to exclude any shares of Common Stock issued or deemed issued in a transaction or series of related transactions approved by the holders of a majority of the then-outstanding Series B Convertible Preferred Stock.

The Company filed a Certificate of Amendment to its Certificate of Incorporation to effect the amendment on August 11, 2011.

Common Stock

In March 2011, an investor of the Company converted 100,000 shares of Series B Convertible Preferred Stock into 1 million shares of the Company’s Common Stock. In May 2011, an investor of the Company converted 18,518 shares of Series B Convertible Preferred Stock into 185,180 shares of the Company’s Common Stock.

As stated in Note 8, on October 3, 2011, the Company issued 600,000 shares of Common Stock to Dawson James Securities, Inc. (“Dawson”) in partial consideration for financial advisory and other consulting services performed by Dawson pursuant to a Financial Advisory and Consulting Agreement dated as of September 15, 2011.

At September 30, 2011, approximately 264,000,000 shares of Common Stock were reserved for future issuance under convertible debt and warrant agreements, stock option arrangements and other commitments.

Stock Options

During the nine-month period ended September 30, 2011, the Board of Directors awarded employees and an advisor to the Board of Directors a total of 1.2 million stock options under the Company’s 2008 Incentive Stock Plan. The options are exercisable at $0.30 per share for a ten year period. The exercise price was equal to or greater than the market price on the respective grant dates.

THERMOENERGY CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2011

(Unaudited)

The following table presents option expense included in expenses in the Company’s Consolidated Statements of Operations for the nine-month periods ended September 30, 2011 and 2010:

	2011		2010

Cost of revenue	$	19	$	11
General and administrative		613		1,320
Engineering, research and development		51		141
Sales and marketing		74		90
Option expense before tax		757		1,562
Provision for income tax		—		—
Net option expense	$	757	$	1,562

The fair value of options granted during the nine-month periods ended September 30, 2011 and 2010 were estimated at the date of grant using a Black-Scholes option pricing model with the following assumptions:

	2011		2010

Risk-free interest rate	3.5	%	2.6% - 3.8%
Expected option life (years)	6.25		10.0
Expected volatility	91	%	80% - 97%
Expected dividend rate	0	%	0%

A summary of the Company’s stock option activity and related information for the nine-month periods ended September 30, 2011 and 2010 follows:

	2011					2010
	Number of Shares			Wtd. Avg. Exercise Price per Share		Number of Shares			Wtd. Avg. Exercise Price per Share
Outstanding, beginning of year		22,065,402		$	0.57		11,203,800		$	1.18
Granted		1,200,000		$	0.30		13,239,102		$	0.30
Canceled		(4,088,800	)	$	1.38		(2,791,250	)	$	1.67
Outstanding, end of period		19,176,602		$	0.47		21,651,652		$	0.58
Exercisable, end of period		9,864,590		$	0.62		7,217,479		$	1.13

The weighted average fair value of options granted was approximately $0.23 per share for the nine-month periods ended September 30, 2011 and 2010. The weighted average fair value of options vested was approximately $718,000 and $325,000 for the nine-month periods ended September 30, 2011 and 2010, respectively.

Exercise prices for options outstanding as of September 30, 2011 ranged from $0.30 to $1.75. The weighted average remaining contractual life of those options was approximately 7.5 years at September 30, 2011. The weighted average remaining contractual life of options vested and exercisable was approximately 6.5 years at September 30, 2011.

As of September 30, 2011, there was approximately $1.2 million of total unrecognized compensation cost related to non-vested share-based compensation arrangements granted under the Company’s stock option plans. That cost is expected to be recognized over a weighted-average period of 0.7 years. The Company recognizes stock-based compensation on the straight-line method.

THERMOENERGY CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2011

(Unaudited)

Warrants

At September 30, 2011, there were outstanding warrants for the purchase of 110,895,444 shares of the Company’s Common Stock at prices ranging from $0.01 per share to $1.50 per share (weighted average exercise price was $0.37 per share). The expiration date of these warrants are as follows:

Year	Number of Warrants

2012		19,720,910
2013		8,896,554
2014		5,845,601
2015		39,522,223
2016		35,567,656
After 2016		1,342,500
		110,895,444

Note 6: Segments

Operating segments are identified as components of an enterprise about which separate discrete financial information is available to the chief operating decision maker, or decision-making group, in assessing performance and allocating resources. The Company markets and develops advanced municipal and industrial wastewater treatment and carbon reducing clean energy technologies. The Company currently generates almost all of its revenues from the sale and application of its water treatment technologies. Revenues from its clean energy technologies have been limited to grants received from governmental and other agencies for continued development. In 2009, the Company established BTCC, a joint venture with Babcock Power Development, LLC, for the purpose of developing and commercializing the Company’s clean energy technology. Because revenues and costs related to the Company’s clean energy technologies is immaterial to the entire Company taken as a whole, the financial information presented in these financial statements represents all the material financial information related to the Company’s water treatment technologies.

The Company’s operations are currently conducted solely in the United States. The Company will continue to evaluate how its business is managed and, as necessary, adjust the segment reporting accordingly.

Note 7: Commitments and contingencies

On March 25, 2011, the Company was notified by the U.S. Internal Revenue Service that it had accepted the Company’s Offer in Compromise with respect to its tax liabilities relating to (i) employee tax withholding for all periods commencing with the quarter ended September 30, 2005 and continuing through September 30, 2009 and (ii) federal unemployment taxes (FUTA) for the years 2005 through 2008. Pursuant to the Offer in Compromise, the Company has agreed to satisfy its delinquent tax liabilities by paying a total of $2,134,636 (representing the aggregate amount of tax due, without interest or penalties). During the pendency of the IRS review of the Offer in Compromise and subsequent to its acceptance, the Company has made payments totaling $1,869,000; at September 30, 2011 a balance of $265,636 remained to be paid through December 2011. In connection with the Offer in Compromise, the Company has agreed that any net operating losses sustained for the years ending December 31, 2010 through December 31, 2012 will not be claimed as deductions under the provisions of Section 172 of the Internal Revenue Code except to the extent that such net operating losses exceed the amount of interest and penalties abated. The IRS acceptance of the Offer in Compromise is conditioned, among other things, on the Company filing and paying all required taxes for five tax years commencing on the date of the IRS acceptance.

Accrued payroll taxes, which include taxes, penalties and interest related to state taxing authorities, totaled approximately $687,000 as of September 30, 2011. The Company continues to work with the various state taxing authorities to settle its remaining payroll tax obligations.

THERMOENERGY CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2011

(Unaudited)

On April 21, 2010, Alexander G. Fassbender, the Company’s former Executive Vice President and Chief Technology Officer (“Fassbender”), filed a Complaint in the Fairfax County, Virginia Circuit Court alleging that his employment had been terminated in breach of his employment agreement and claiming damages in the aggregate amount of approximately $1 million, including unpaid salary, reimbursement of expenses, and other payments under his employment agreement. On April 7, 2011, the two parties entered into a settlement agreement through which, in exchange for mutual releases, the Company agreed to pay Fassbender a total of $400,000 in monthly installments of $16,667 per month over a two-year period. The Company issued a non-interest bearing note to Fassbender for these payments. This amount was recorded as a component of general and administrative expense on the Company’s Consolidated Statement of Operations in the fourth quarter of 2010. In addition, Fassbender agreed to tender all outstanding stock options to the Company in exchange for an equal number of warrants. The warrants are exercisable at an exercise price of $0.24 per share and have a five-year term.

In addition to the matters described above, the Company is involved from time to time in litigation incidental to the conduct of its business. Judgments could be rendered or settlements entered that could adversely affect the Company’s operating results or cash flows in a particular period. The Company routinely assesses all of its litigation and threatened litigation as to the probability of ultimately incurring a liability and records its best estimate of the ultimate loss in situations where it assesses the likelihood of loss as probable.

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

The following discussion should be read in conjunction with the financial statements and notes thereto appearing elsewhere in this report.

Overview

We are a diversified technologies company engaged in the worldwide commercialization of advanced municipal and industrial wastewater treatment systems and carbon reducing power generation technologies.

Our wastewater treatment systems not only meet local, state and federal environmental regulations, but typically provide a rapid rate of return on investment by recovering and reusing expensive feedstocks, reducing contaminated wastewater discharge and recovering and reusing wastewater used in process operations.

We currently generate revenues from the sale and development of wastewater treatment systems. We enter into contracts with our customers to provide a wastewater treatment solution that meets the customer’s present and future needs. Our revenues are tied to the size and scale of the wastewater treatment system required by the customer, as well as the progress made on each customer contract.

Historically we marketed and sold our products in North America. In 2011, we began marketing and selling our products in Asia and Europe. These marketing and sales activities are performed by our direct sales force and authorized independent sales representatives.

We are also the owner of a patented pressurized oxycombustion technology known as the Zero Emissions Boiler System (“ZEBS™”), which converts fossil fuels (including coal, oil and natural gas) and biomass into electricity without producing air emissions, and at the same time removing and capturing carbon dioxide in liquid form for sequestration or beneficial reuse. This technology can be used to build new or retrofit old fossil fuel power plants globally with no emissions while capturing carbon dioxide as a liquid for ready sequestration far more economically than any other competing technology. We, through our majority-owned subsidiary, ThermoEnergy Power Systems, LLC (“TEPS”), entered into a joint venture with Babcock Power Development, Inc. called Babcock-Thermo Carbon Capture LLC, now known as Babcock-Thermo Clean Combustion LLC ("BTCC") in 2009 to obtain the resources necessary to facilitate the development and commercialization of this technology.

We have made significant progress over the past year in resolving our past legal and financial issues; strengthening our balance sheet; hiring key management personnel; and building our business for future growth, and we are excited about our prospects. However, we have incurred net losses and negative cash flows from operations since inception. We incurred net losses of $11.9 million for the nine-month period ended September 30, 2011 and $9.9 million for the year ended December 31, 2010. Cash outflows from operations totaled $3.7 million for the nine-month period ended September 30, 2011 and $5.6 million and for the year ended December 31, 2010. As a result, we will require additional capital to continue to fund our operations.

Results of Operations

Comparison of Quarters Ended September 30, 2011 and 2010

Revenues totaled $1,193,000 for the third quarter of 2011 compared to $641,000 for the third quarter of 2010. In the third quarter of 2011, we were in the later stages of engineering and design work on our $27.1 million contract with the New York City Department of Environmental Protection (“NYCDEP”), and we commenced fabrication and procurement efforts for the second phase on the NYCDEP contract. We expect to generate significant revenues from the NYCDEP contract in the fourth quarter of 2011 and throughout 2012. We also completed production on one industrial contract in the third quarter of 2011. Revenues for the third quarter of 2011 were mainly derived from work on the NYCDEP contract.

Gross profit for the third quarter of 2011 was $120,000 (10% of revenues) compared to gross profit of $29,000 (5% of revenues) for the third quarter of 2010. Gross profit in 2011 relates mainly to work performed on the NYCDEP contract and new business in 2011, partially offset by $102,000 of costs for maintaining our production group to prepare for the manufacturing phase of our NYCDEP contract and other new business. Gross profit in 2010 was the result of our efforts on the NYCDEP contract during the quarter.

General and administrative expenses decreased by $501,000 or 36% in the third quarter of 2011 compared to 2010, primarily due to a $400,000 decrease in non-cash stock option expenses as certain options granted to our Chief Executive Officer and Chief Financial Officer vested over time, a $100,000 decrease in payroll-related expenses, mainly related to payment of milestone bonuses related to our NYCDEP contract in 2010 that did not repeat in 2011, and a $60,000 decrease in consulting expenses. The decrease was partially offset by a $34,000 increase in insurance expenses due to increased business activity and a $24,000 increase in legal expenses.

Engineering, research and development expenses increased by $10,000 or 8% in the quarter ended September 30, 2011 compared to 2010. The increase is related to reduced efforts on our NYCDEP contract in 2011 compared to 2010.

Sales and marketing expenses increased by $262,000 or 88% in the third quarter of 2011 compared to 2010. This increase is mainly due to $161,000 of additional expense in 2011 for increased sales headcount and focused efforts to increase our sales pipeline and $93,000 related to the commencement of international business development activities.

We repriced certain warrants held by the investors of our Bridge Loan and Warrant Amendment Agreement during the third quarter of 2011. The repricing of these warrants resulted in an expense of approximately $1.8 million in the third quarter of 2011.

In the third quarter of 2011, we repaid a portion of the principal balance on our restated CASTion Notes, and we converted the remaining balance of our restated CASTion Notes and the balance of our 2010 Bridge Notes and 2011 Bridge Notes into shares of our Series B Preferred Convertible Stock. As a result, we recognized a $2.0 million loss on the extinguishment of debt in the third quarter of 2011.

Changes in the fair value of our derivative warrant liabilities resulted in the recognition of derivative mark-to-market expense of $653,000 in the third quarter of 2011 and mark-to-market income of approximately $2.6 million in the third quarter of 2010. Expense in the third quarter of 2011 relates to the increase in the likelihood that future corporate transactions would trigger anti-dilution provisions on these warrants. Income in 2010 primarily relates to the decrease in our stock price at September 30, 2010 compared to June 30, 2010.

Interest and other expense decreased by $887,000 during the third quarter of 2011 compared to 2010 due to reduced debt levels as a result of converting our 2010 Bridge Notes and restated CASTion Notes into equity in the third quarter of 2011.

We recognized losses related to our BTCC joint venture totaling $117,000 in the third quarter of 2011 compared to losses of $3,000 in the third quarter of 2010. The increase in losses were the direct result of BTCC investing in a dedicated full-time Chief Executive Officer in the beginning of 2011 and increasing its business development activity to market the ZEBS technology.

Comparison of Nine-Month Periods Ended September 30, 2011 and 2010

Revenues totaled $3,575,000 for the first nine months of 2011 compared to $2,054,000 for the first nine months of 2010, an increase of $1,521,000 or 74%. We were in the later stages of engineering and design work on our $27.1 million contract with the NYCDEP during 2011, commenced fabrication and procurement efforts for the second phase on the NYCDEP contract, substantially completed production on one industrial contract and started installation work on an industrial contract for which production was completed in 2010. We completed production on two large industrial contracts and commenced work on the engineering and design phase of our NYCDEP contract in the first nine months of 2010, which comprised most of our revenues.

Gross profit for the first nine months of 2011 was $254,000 (7.1% of revenues) compared to gross profit of $131,000 (6.4% of revenues) for the first nine months of 2010. Gross profit in 2011 relates mainly to work performed on the NYCDEP contract and new business in 2011, partially offset by $225,000 of costs for maintaining our production group to prepare for the manufacturing phase of our NYCDEP contract and other new business. Gross profit in 2010 was primarily the result of our completion of industrial projects during 2010.

General and administrative expenses decreased by $259,000 or 7% in the nine-month period ended September 30, 2011 compared to 2010, due primarily to a $707,000 decrease in non-cash stock option expenses as certain options granted to our Chief Executive Officer and Chief Financial Officer vested over time, partially offset by a $254,000 increase in legal expenses related to settling an employee lawsuit in April 2011 and filing a Registration Statement in 2011 and a $104,000 increase in accounting expenses related to financial statement audit work and compliance work related to the Registration Statement.

Engineering, research and development expenses decreased by $300,000 or 54% in the nine-month period ended September 30, 2011 compared to 2010. The decrease was related to redirecting work performed by our engineering team throughout 2011 related to our NYCDEP contract that were charged to Cost of Revenues. Our engineering team only commenced work on our NYCDEP contract in the third quarter of 2010, which resulted in fewer expenses being charged to Cost of Revenues.

Sales and marketing expenses increased by $799,000 or 89% in the nine-month period ended September 30, 2011 compared to 2010. This increase is due to increased sales headcount and consulting expenses to focus our efforts to increase our sales pipeline and beginning international business development activities during 2011.

Changes in the fair value of our derivative warrant liabilities resulted in the recognition of derivative mark-to-market income of $403,000 and mark-to-market loss of $321,000 in the nine-month periods ended September 30, 2011 and 2010, respectively. Income in 2011 relates primarily to a decrease in our stock price from December 31, 2010 to September 30, 2011 and the passage of time, partially offset by the increase in the likelihood that future corporate transactions would trigger anti-dilution provisions on these warrants. The charge in 2010 primarily relates to increasing the expected volatility rate assumption used as of September 30, 2010.

Interest and other expense increased during the first nine months of 2011 compared to 2010 by $440,000 due to amortization of debt discounts recognized upon amending our Convertible Notes and Bridge Notes in the first quarter of 2011 and the increase in the interest rate on the amended Bridge Notes from 3% to 10% in the first quarter of 2011, partially offset by reduced debt levels as a result of converting our 2010 Bridge Notes and restated CASTion Notes into equity in the third quarter of 2011.

We recognized losses related to our BTCC joint venture totaling $386,000 in the first nine months of 2011 compared to losses of $67,000 in the first nine months of 2010. The increase in losses were the direct result of BTCC investing in a dedicated full-time Chief Executive Officer in the beginning of 2011 and increasing its business development activity to market the ZEBS technology.

Liquidity and Capital Resources

We have made significant progress over the past 18 months in resolving our past legal and financial issues, strengthening our balance sheet, streamlining our capital structure, hiring key management personnel and building our business for future growth. We have:

Improved our business prospects by expanding our product solutions with the introduction of MobileCAST, TurboCAST and Thermo ARPTM and signing a strategic alliance with Contego Systems to recover and recycle airport deicing fluid;

Attracted and retained several key executives and started a Board of Advisors;

Raised over $9 million in funding in 2010 and $4.5 million in funding thus far in 2011;

Paid down $2.8 million of debt and converted $9.8 million of debt and $300,000 of accrued interest into our Series B Convertible Preferred Stock during 2011;

Achieved relisting of our Common Stock on the OTC bulletin board;

Settled IRS payroll tax issues, resulting in a $2.3 million gain in the fourth quarter of 2010, and reached settlements with former CASTion shareholders and a former employee who had threatened litigation; and

Signed several contracts for new business in our industry.

However, we have historically lacked the financial and other resources necessary to market the Technologies or to build demonstration projects without the financial backing of government or investment partners. We have funded our operations primarily from the sale of convertible debt, short-term borrowings, preferred stock and common stock, generally from stockholders and other parties who are sophisticated investors in clean technology. We are currently in discussions with current and potential new investors for equity or debt financing to fund our operations until we can operate on a cash flow positive basis.

Cash used in operations amounted to $3,672,000 and $4,358,000 for the nine-month periods ended September 30, 2011 and 2010, respectively. Cash used in operations is primarily a result of our continued net losses in 2011 and 2010. Cash used in investing activities included investments in BTCC totaling $400,000 and purchases of property and equipment of $127,000 during 2011.

At September 30, 2011, we do not have sufficient working capital to satisfy our anticipated operating expenses for the next 12 months. As of September 30, 2011, we had a cash balance of approximately $1.8 million and current liabilities of approximately $7.2 million, which consisted primarily of accounts payable of approximately $1.8 million, billings in excess of costs of approximately $3.2 million, accrued payroll taxes of approximately $687,000 and other current liabilities of approximately $1.4 million.

On January 7, 2011 we entered into Note Amendment and Forbearance Agreements with the holders (the “Noteholders”) of our Convertible Promissory Notes (the “Old Notes”). Pursuant to the Agreements, (i) we made an aggregate of $1,144,336 in payments against the outstanding balances of the Old Notes; (ii) the Noteholders converted an aggregate of $902,710 in principal and accrued interest under the Old Notes into shares of our Series B Convertible Preferred Stock; (iii) we issued to the Noteholders warrants for the purchase of an aggregate of 17,585,127 shares of our Common Stock at an exercise price of $0.40 per share and an aggregate of 6,018,065 shares of our Common Stock at an exercise price of $0.30 per share; (iv) we amended and restated the Old Notes to read in the form of Amended and Restated Promissory Notes due February 29, 2012 (the “Restated Notes” and, with the Old Notes, the “Notes”); (v) we made additional cash payments to the Noteholders in the aggregate amount of $37,914; and (vi) the Noteholders agreed, subject to certain conditions set forth in the Note Amendment and Forbearance Agreements, to forbear until February 29, 2012, from exercising their rights and remedies under the Restated Notes.

On February 25, 2011, we entered into a Note Extension and Amendment Agreement with the holders of our Convertible Bridge Notes (the “Bridge Noteholders”) due February 28, 2011 through which the maturity date of these Notes (the “Amended Notes”) was extended to to February 29, 2012.

The Amended Notes were convertible, in whole or in part, at any time at the election of the Bridge Noteholders, into shares of our Series B Convertible Preferred Stock at the rate of $2.40 per share. In the event, prior to the maturity date of the Amended Notes, we paid the Amended Notes in full, then at our election the entire outstanding principal of, and accrued and unpaid interest on, the Amended Notes would convert into shares of our Series B Convertible Preferred Stock at the rate of $2.40 per share. In the event that (i) the closing price of our Common Stock for 20 consecutive trading days equaled or exceeded $0.72 per share and (ii) the daily average trading volume of our Common Stock exceeded 30,000 shares for 20 consecutive trading days, then upon notice from us to the Bridge Noteholders, given at any time thereafter, the entire principal amount of the Amended Notes then outstanding, plus all accrued and unpaid interest thereon, would automatically convert into shares of our Series B Convertible Preferred Stock at the rate of $2.40 per share. We agreed that, upon conversion of all or any portion of the Amended Notes, we would issue to the converting Bridge Noteholder a five-year warrant for the purchase, at an exercise price of $0.30 per share, of that number of shares of our Common Stock determined by dividing (i) 200% of the amount of principal and interest so converted by (ii) $0.30 (the “Warrants”). The Amended Notes contained other conventional terms, including events of default upon the occurrence of which the Amended Notes became immediately due and payable.

On June 17, 2011 we entered into a Bridge Loan and Warrant Amendment Agreement (the “Agreement”) with six current investors who held warrants for the purchase in the aggregate of 22,379,232 shares of our Common Stock (collectively, the “Warrants”). Pursuant to the Agreement, we received proceeds totaling approximately $2.9 million in exchange for Promissory Notes (the “2011 Bridge Notes”). The 2011 Bridge Notes were payable on demand at any time on or after February 29, 2012 (the “Maturity Date”). They did not bear interest until the Maturity Date and bore interest at the rate of 10% per annum from and after the Maturity Date. The 2011 Bridge Notes could not be prepaid, in whole or in part, without the prior written consent of the Investors. The Investors agreed to surrender the 2011 Bridge Notes in payment of the exercise price for the Warrants if and when the conditions to their amendment and exercise were satisfied. The 2011 Bridge Notes contained other conventional terms, including events of default upon the occurrence, and during the continuation, of which the 2011 Bridge Notes would bear interest at the rate of 10% per annum. The Agreement was amended on July 12, 2011 to provide for an additional $1.6 million of funding to us.

Pursuant to the Agreement, we agreed, subject to the satisfaction of certain conditions, to amend the Warrants (i) to provide that they would be exercisable for the purchase of shares of our Series B Convertible Preferred Stock (the “Series B Stock”) instead of Common Stock (with the number of shares of the Series B Stock determined by dividing by ten (10) the number of shares of Common Stock for which the Warrants are currently exercisable) and (ii) to change the exercise prices of all Warrants (which ranged from $0.30 to $1.82 per share of Common Stock) to $1.30 per share of Series B Stock (the equivalent of $0.13 per Common-equivalent share). The Investors agreed, subject to the satisfaction of certain conditions, to exercise all of the Warrants. The principal amount of the Notes was equal to the aggregate exercise price of the Warrants (after they were amended as described above).

On July 1, 2011 we paid approximately $1.6 million in the aggregate to the holders of the Restated Notes using the proceeds received from the June 17, 2011 financing as described above. Pursuant to the terms of the Restated Notes, as amended, in the event we made any payments of principal or accrued interest on or before July 5, 2011, an equal amount of such payment would automatically convert into shares of our Series B Convertible Preferred Stock at the rate of $2.40 per share and Warrants for the purchase of our Common Stock equal to that number of shares of our Common Stock determined by dividing 200% of the amount of principal and interest converted by $0.30. Accordingly, on July 1, 2011, we issued to the Noteholders 653,439 shares of our Series B Convertible Preferred Stock and Warrants for the purchase of 10,455,024 shares of our Common Stock. As a result, the Restated Notes were repaid in full.

Consequently, pursuant to the terms of the amended 2010 Bridge Loan Agreement, as described above, the repayment of the Restated Notes triggered our right to convert the entire outstanding balance of principal and interest on the 2010 Bridge Notes (approximately $4.5 million) into shares of our Series B Convertible Preferred Stock. We effected this conversion on August 11, 2011.

Also on August 11, 2011, upon satisfaction of all of the conditions set forth in the 2011 Bridge and Warrant Agreement, the holders of the 2011 Bridge Notes exercised all of the Warrants in accordance with the 2011 Bridge and Warrant Agreement and surrendered all of the 2011 Bridge Notes in payment of the exercise price for the purchase under the Warrants of an aggregate of 3,469,387 shares of our Series B Convertible Preferred Stock at a price of $1.30 per share.

Although our financial condition has improved, there can be no assurance that we will be able to obtain the funding necessary to continue our operations and development activities. We continue to engage current and potential new investors in discussions for equity or debt financing to fund our operations until we can operate on a cash flow positive basis.

ITEM 3. Quantitative and Qualitative Disclosures About Market Risk

Not applicable.

ITEM 4. Controls and Procedures

The Company, under the direction of its Chief Executive Officer and Chief Financial Officer, has established disclosure controls and procedures that are designed to ensure that information required to be disclosed by the Company in the reports that it files or submits under the Exchange Act, is recorded, processed, summarized, and reported within the time periods specified in the Commission’s rules and forms. The disclosure controls and procedures are also intended to ensure that such information is accumulated and communicated to the Company’s management, consisting of the Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosures.

The Company’s Chief Executive Officer and Chief Financial Officer carried out an evaluation of the effectiveness of disclosure controls and procedures as defined in Rules 13a-15(e) and 15d-15(e) of the Exchange Act as of the end of the period covered by this report. Based on this evaluation, the Company’s Chief Executive Officer and Chief Financial Officer have concluded that the Company’s disclosure controls and procedures were not effective as of September 30, 2011 due to (i) our failure to allocate adequate resources to ensure that necessary internal controls were implemented and followed and (ii) a lack of segregation of duties in our significant accounting functions.

The Company did not make any changes to its internal controls over financial reporting during the quarter ended September 30, 2011.

PART II — OTHER INFORMATION

ITEM 1. Legal Proceedings

None.

ITEM 1A. Risk Factors

Not applicable.

ITEM 2. Unregistered Sales of Equity Securities and Use of Proceeds

(a) On July 1, 2011, we issued to the holders of the Restated CASTion Notes, upon the automatic conversion, in accordance with the terms of the Restated Notes, of portions of the principal of, and accrued and unpaid interest under, such Restated Notes, the following shares of our Series B Convertible Preferred Stock and Warrants:

Note Holder	Payment		Conversion Amount		Series B Shares	Warrants

Spencer Trask Specialty Group LLC	$	929,876.35	$	929,872.80	387,447 shares	6,199,152 shares

Massachusetts Technology Development Corporation	$	400,311.36	$	400,308.00	166,795 shares	2,668,720 shares

BCLF Ventures I, LLC	$	218,272.95	$	218,272.80	90,947 shares	1,455,152 shares

Essex Regional Retirement Board	$	6,602.43	$	6,600.00	2,750 shares	44,000 shares

BancBoston Ventures Inc.	$	13,203.94	$	13,200.00	5,500 shares	88,000 shares

The automatic conversions on July 1, 2011 were triggered by our voluntary pre-payment of the Restated Note. The Warrants entitle the holders thereof to purchase, at a purchase price of $0.30 per share at any time on or before the fifth anniversaries of their issuance.

(b) On August 11, 2011, we issued to one individual and five entities (the “Noteholders”) an aggregate of 1,185,707 shares of our Series B Convertible Preferred Stock (“Series B Stock”) upon conversion, in accordance with their terms, of an aggregate of $2,932.107.65 in principal of, and accrued interest on, our Amended and Restated Secured Convertible Promissory Notes due February 29, 2012 (the “Convertible Notes”) held by the Noteholders. The Convertible Notes were converted into shares of Series B Stock at the rate of $2.40 per share. The Convertible Notes were converted, at our election, pursuant to a provision of the Note Extension and Amendment Agreement, dated February 25, 2011, between us and the Noteholders (the “Note Agreement”) permitting such conversion upon our retirement of Amended and Restated Promissory Notes held by (i) BancBoston Ventures, Inc., (ii) BCLF Ventures I, LLC, (iii) Essex Regional Retirement Board, (iv) Massachusetts Technology Development Corporation and (v) Spencer Trask Specialty Group, LLC and issued in partial payment for our acquisition of a controlling interest in our subsidiary, CASTion Corporation (the “CASTion Notes”). Pursuant to the Note Agreement, upon the conversion of each Convertible Note we issued to the holder thereof a Common Stock Purchase Warrant (each, a “Warrant”) for the purchase of that number of shares of our Common Stock determined by dividing 200% of the amount of principal and interest of such Convertible Note by $0.30. Set forth below are the number of shares of Series B Stock and the number of shares of Common Stock issuable upon exercise of the Warrants issued to each Noteholder, together with the amount of principal and accrued interest of each Noteholder’s Convertible Note:

Noteholders	Series B Shares	Warrants	Principal & Interest of Convertible Notes
The Quercus Trust	440,088 shares	7,041,423 shares	$	1,056,213.49
Robert S. Trump	411,583 shares	6,585,342 shares	$	987,801.29
Focus Fund L.P.	11,635 shares	186,165 shares	$	27,924.77
Empire Capital Partners, LP	119,467 shares	1,911,485 shares	$	286,722.70
Empire Capital Partners, Ltd	119,467 shares	1,911,485 shares	$	286,722.70
Empire Capital Partners Enhanced Master Fund, Ltd	119,467 shares	1,911,485 shares	$	286,722.70

The Warrants may be exercised, at any time on or before August 11, 2016, at an exercise price of $0.30 per share.

(c) Also on August 11, 2011, pursuant to the Bridge Loan and Warrant Amendment Agreement, dated June 17, 2011 between us and the Warrantholders identified below (as amended on July 12, 2011, the “Bridge Loan Agreement”) three individuals and five entities (the “Warrantholders”) exercised outstanding warrants for the purchase of an aggregate of 3,469,387 shares of Series B Stock at an exercise price, in cash, of $1.30 per share (or $4,510,202.92 in the aggregate) as follows:

Warrantholders	Series B Shares	Exercise Price
Robert S. Trump	1,829,127 shares	$	2,377,865.10
Focus Fund L.P.	300,000 shares	$	390,000.00
Hughes Capital	15,385 shares	$	20,000.00
Scott A. Fine	50,000 shares	$	65,000.00
Peter J. Richards	50,000 shares	$	65,000.00
Empire Capital Partners, LP	410,940 shares	$	534,222.39
Empire Capital Partners, Ltd	410,060 shares	$	533,078.19
Empire Capital Partners Enhanced Master Fund, Ltd	403,875 shares	$	525,037.24

Pursuant to the Bridge Loan Agreement the Warrantholders advanced to us the cash exercise price for the warrants in exchange for bridge notes (the “Bridge Notes”) pending satisfaction of the conditions to the amendment and exercise of such warrants. Upon exercise of such warrants and the issuance of the shares of our Series B Stock upon such exercise, the Bridge Notes were cancelled.

All of the issuances described above were made without registration in reliance on the exemption provided by Section 4(2) of the Securities Act of 1933 in that such issuances did not involve any public offering.

(d) On October 3, 2011, we issued 600,000 shares of our Common Stock to Dawson James Securities, Inc. (“Dawson”) in partial consideration for financial advisory and other consulting services performed by Dawson pursuant to a Financial Advisory and Consulting Agreement dated as of September 15, 2011 between us and Dawson.

ITEM 3. Defaults Upon Senior Securities

None.

ITEM 4. (Removed and Reserved)

ITEM 5. Other Information

None.

ITEM 6. Exhibits

The following exhibits are filed as part of this report:

Exhibit No.		Description

3(i)		Certificate of Amendment to the Certificate of Designation, Preferences and Rights of ThermoEnergy Corporation, as filed in the Office of the Secretary of State of the State of Delaware on August 11, 2011 — Incorporated by reference to Exhibit 3(i) to Current Report on Form 8-K filed August 11, 2011.

3(ii)		Certificate of Amendment to the Certificate of Incorporation of ThermoEnergy Corporation, as filed in the Office of the Secretary of State of the State of Delaware on August 11, 2011 — Incorporated by reference to Exhibit 3(i) to Current Report on Form 8-K filed August 11, 2011.

31.1		Sarbanes Oxley Act Section 302 Certificate of Principal Executive Officer — Filed herewith

31.2		Sarbanes Oxley Act Section 302 Certificate of Principal Financial Officer — Filed herewith

32.1		Sarbanes Oxley Act Section 906 Certificate of Principal Executive Officer — Filed herewith

32.2		Sarbanes Oxley Act Section 906 Certificate of Principal Financial Officer — Filed herewith

101.INS *		XBRL Instance Document

101.SCH *		XBRL Taxonomy Extension Schema Document

101.CAL *		XBRL Taxonomy Extension Calculation Linkbase Document

101.DEF *		XBRL Taxonomy Extension Definition Linkbase Document

1.01 LAB *		XBRL Extension Labels Linkbase Document

101.PRE *		XBRL Taxonomy Extension Presentation Linkbase Document

* In accordance with SEC rules, this interactive data file is deemed “furnished” and not “filed” for purposes of Sections 11 or 12 of the Securities Act of 1933 and Section 18 of the Securities and Exchange Act of 1934, and otherwise is not subject to liability under those sections or acts.

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.

Date: November 14, 2011	THERMOENERGY CORPORATION

	/s/ Cary G. Bullock
	Cary G. Bullock
	President and Chief Executive Officer

	/s/ Teodor Klowan, Jr.
	Teodor Klowan, Jr. CPA
	Executive Vice President and Chief Financial Officer