UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

____________

FORM 10-Q

____________

Commission file number: 000-25663

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

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes þ No o

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

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

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

TABLE OF CONTENTS

PART I – FINANCIAL INFORMATION

ITEM 1.

FINANCIAL STATEMENTS.

ECOSPHERE TECHNOLOGIES, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

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

1

ECOSPHERE TECHNOLOGIES, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)

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

2

ECOSPHERE TECHNOLOGIES, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

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

3

ECOSPHERE TECHNOLOGIES, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

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

4

ECOSPHERE TECHNOLOGIES, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2014

(UNAUDITED)

1.

DESCRIPTION OF THE BUSINESS AND BASIS OF PRESENTATION

Description of the Business

Ecosphere Technologies, Inc. (“Ecosphere,” “ETI” or the “Company”), is a U.S. technology licensing and innovative manufacturing company that develops environmental solutions for global markets. We help industry increase production, reduce costs and protect the environment through a portfolio of 29 patented and patent-pending technologies: technologies like Ozonix® and the Ecos PowerCube®, which are licensable across a wide range of industries and applications throughout the world via ICAP Patent Brokerage (“ICAP”), the world’s largest intellectual property brokerage firm.

The Company is a leader in emerging Advanced Oxidation Processes (“AOP”) and has an extensive portfolio of intellectual property that includes eleven (11) approved United States patents, with seven (7) issued for Ozonix® and numerous patents pending for its Ozonix® and other technologies. Ozonix® is a revolutionary AOP that offers customers a chemical-free alternative to high-volume water treatment, disinfection and recycling for a wide variety of industries and applications, including but not limited to agriculture, energy, food and beverage, industrial, marine, mining and municipal wastewater treatment.

Ecosphere’s patented Ozonix® technology has been commercially proven in the oil and gas hydraulic fracturing industry and is currently being used by Fidelity National Environmental Solutions (“FNES”), formerly Ecosphere Energy Services (“EES”), and its sub-licensing partners around the United States and Canada. FNES has an exclusive field-of-use license for Ecosphere's patented Ozonix® technology for global energy applications including, but not limited to, onshore and offshore oil and natural gas exploration and production, power generation, refineries and coal. 

In addition to its current operations, FNES has two sub-licensing partners, which include Hydrozonix, LLC in the United States and Hydrosphere Energy Solutions, LLC in the territory of Alberta and North East British Columbia, Canada. Since 2009, FNES and its sub-licensing partners have enabled oil and gas customers to treat, recycle and reuse over 4.5 billion gallons of water for more than 1,200 oil and natural gas wells around the United States and Canada in all major shale plays including but not limited to Fayetteville, Haynesville, Woodford, Eagle Ford, Bakken, Marcellus and Permian Basin; protecting $5 billion worth of well assets and generating over $70 million in equipment sales, service and technology licensing revenue.

Ecosphere and FNES have received numerous awards and accolades for its patented and proven Ozonix® water treatment solutions for the energy sector, including but not limited to:

·

2014 Popular Science Magazine – Best New Product of 2014 – Green category’s for the Ecos PowerCube®;

·

2013 Oil and Gas Awards - Water Management Company of the Year Award, Midcontinent Region;

·

2013 Bloomberg New Energy Finance Awards - New Energy Pioneer;

·

2013 IHS CERAWeek - Energy Innovation Pioneer Award;

·

2013 American Technology Awards - "Clean Tech/Green Tech" Winner;

·

2013 World Technology Awards - Corporate "Environment" Category Winner;

·

2013 Governor’s Innovators in Business Awards by Enterprise Florida – Rising Star;

·

2012 Frost & Sullivan North American Product Leadership Award in Disinfection Equipment for Shale Oil and Gas Wastewater Treatment; and

·

2010, 2011, 2012 Artemis "Top 50 Water Technologies" Winner.

Outside of the energy industry, Ecosphere has recently signed an exclusive technology licensing and equipment purchase agreement with Brasil Clean Energy (“BCE”), a Brazilian environmental services company, to deploy its patented Ozonix® water treatment technology across the Food and Beverage industry in Brazil. In September 2014, the Company completed manufacturing, testing and delivery of BCE’s first piece of equipment, an Ozonix® EF10M mobile water treatment system capable of treating approximately 420 gallons-per-minute in a 10x12 footprint.

5

ECOSPHERE TECHNOLOGIES, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2014

(UNAUDITED)

In addition to Ozonix®, Ecosphere has recently received a patent from the United States Patent Office for the world’s largest, mobile solar-powered generator. The Ecos PowerCube® is a portable, self-contained micro-utility that uses the power of the sun to provide electricity in the most remote, off-grid locations. Designed to meet the growing demand for off-grid energy, with a unique, patented array of stacked solar panels, the Ecos PowerCube® maximizes the total amount of solar power generation possible in 10', 20' and 40' ISO shipping container footprints - providing users with approximately 400% more solar power in a given footprint. With solar power generation capabilities up to 15 kW, the Ecos PowerCube® can be transported by land, air, or sea and is ideally suited to support off-grid agricultural, military, emergency/disaster relief, humanitarian and wireless communication efforts for remote applications around the world.

In November 2014, Ecosphere’s patented Ecos PowerCube® technology was recognized as a winner in the Green category of the 2014 Best of What’s New Awards from Popular Science. Each year, Popular Science reviews thousands of new innovative products and chooses the top 100 winners across 12 categories for inclusion in the annual Best of What’s New issue – the best-read issue of the year. To win, a product or technology must represent a significant step forward in its category.  Ecosphere’s patented Ecos PowerCube® solar panel array technology will be featured in this December’s special issue, on newsstands as of the date this Report is filed.

In 2013, Ecosphere retained Navigant Consulting, Inc. (NYSE:NCI), a leading company in the field of intellectual property valuation, to perform an analysis to value the Company’s patented Ozonix® and Ecos PowerCube® technology portfolios.  The valuation was delivered in November 2013, which includes all of the potential industries and applications where Ozonix® can be used and licensed, including the global energy field-of-use, of which the shareholders of Ecosphere Technologies currently own 30.6% of through its interest in FNES. The valuation also includes an extensive review of all of the potential industries and applications where the Ecos Powercube® can be used and licensed throughout the world. While this valuation is subject to a number of assumptions, the Company believes that it helps to illustrate the Company’s hidden value and opportunity that is not recognized on our Balance Sheet or by the investment community. During 2013, Ecosphere received $10 million in gross proceeds from FNF for the sale of the Company’s 20% interest in FNES. Ecosphere’s management team estimates that this sale represents approximately 2% of the estimated value of the Company’s global Ozonix® intellectual property portfolio, not including the Ecos PowerCube®. Based upon a recent Navigant valuation, management believes that the Ecos PowerCube®’s value is about 15% of the combined valuation of its technologies.  This does not give effect to its latest product, the Ecos GrowCube®.

Accordingly, in June 2014, the Company engaged ICAP Patent Brokerage to monetize its patented Ozonix® and Ecos PowerCube® technology portfolios and to serve as its exclusive licensing agent. ICAP PB is now the Company’s exclusive broker, tasked with successfully licensing both technologies across a wide variety of industries and applications on a global basis. ICAP Patent Brokerage’s veteran brokers have more than 35 years of experience in monetizing and leveraging intellectual property assets, drawing on an extensive knowledge of the marketplace across multiple sectors throughout the United States, Asia, and Europe. ICAP brings credibility, stability and liquidity to the IP marketplace and is quickly becoming the intellectual property brokerage of choice for IP assets in both the primary and secondary markets.  With the growing pressure on global water resources and the need for clean, renewable energy, we expect Ecosphere’s patented technology portfolio to continue to expand. The Chief Executive Officer of ICAP is a director of and consultant to the Company.

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

Basis of Presentation

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

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ECOSPHERE TECHNOLOGIES, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2014

(UNAUDITED)

Going Concern

As of October 31, 2014, Ecosphere had cash on hand of approximately $0.1 million. Due to the nature of its technology licensing business model, Ecosphere presently does not have any regularly recurring revenue. These factors raise substantial doubt about the Company’s ability to continue as a going concern. To support its operations, the Company has a number of plans to monetize its intellectual property, which are described below.

In August 2014, the Company received a purchase order from FNES for a second Ozonix® EF10M and a deposit of approximately $0.2 million that is for an existing sub-licensing customer, Hydrosphere Energy Solutions, whose licensed territory consists of Alberta and North East British Columbia, Canada. The Company completed and delivered the Ozonix® EF10M unit during the fourth quarter of 2014 for FNES.

In July 2014, The Company signed an exclusive technology licensing and equipment purchase agreement with Brasil Clean Energy (“BCE”), a Brazilian environmental services company, to deploy its patented Ozonix® water treatment technology for the Food and Beverage industry in Brazil. Under the terms of the agreement in order to maintain exclusivity, BCE is required to purchase a minimum of $5 million worth of Ozonix® equipment over the next two years, plus a royalty payment based on usage or revenue, with a minimum amount earned per machine. BCE ordered its first Ozonix® EF10M in July 2014 and the manufacturing and customer acceptance of this Unit was complete at September 30, 2014.

Management believes that its current plans will provide sufficient liquidity for the next 12 months. Ecosphere plans to continue monetizing its intellectual property, and has identified the following liquidity sources that it expects to realize over the next three years:

·

Ecosphere is actively marketing exclusive and non-exclusive licensing opportunities for sale to strategic, well positioned partners that wish to bring our patented Ozonix® and Ecos PowerCube® technologies to specific industries in their respective countries and regions of the world. Management expects this will result in similar realization of the value that has been realized by the development and sale of the global energy rights for its Ozonix® technology to FNES. Ecosphere owns 100% of the global rights to its patented Ozonix® technology for all non-energy related applications, including but not limited to agriculture, food and beverage, industrial, marine and municipal wastewater treatment, and any other industry in which water is treated with conventional liquid chemicals.  Ecosphere also owns 100% of the global right to its patented Ecos PowerCube® technology for all industries and applications worldwide.

·

Ecosphere’s business model revolves upon the licensing of its intellectual property to strategic customers and partners around the world that are well-positioned and capitalized to bring Ecosphere’s patented technologies to their respective industries and countries. Additionally, Ecosphere has its own in-house design, engineering and manufacturing facilities to support customers and licensees that choose to not manufacture Ecosphere’s patented technologies themselves. In addition to the various licensing opportunities that are available for its patented Ozonix® and Ecos PowerCube® technologies globally, the Company’s 30.6% interest in FNES is also available for sale to strategic buyers.

·

Ecosphere is launching during the week of November 10^th its Ecos GrowCube®, a state-of-the-art turnkey fully automated greenhouse that will use hydroponic growing techniques to maximize crop production using Ecosphere’s Ozonix® patents and thereby eliminating the use of toxic chemicals and pesticides without soil or fossil fuels.  A new Ecosphere subsidiary is seeking to raise up to $2 million in order to commence commercializing this new venture

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

In addition to needing capital to support its operations, Ecosphere has $2,007,500 in convertible notes payable due over the next 12 months. This consists of $50,000 that became due in September 2014, $712,500 due in February 2015, $245,000 due in March 2015 and $1,000,000 due in September 2015. See Note 6.

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ECOSPHERE TECHNOLOGIES, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2014

(UNAUDITED)

2.

SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Principles of Consolidation

The accompanying unaudited condensed consolidated financial statements include the accounts of Ecosphere, it’s wholly and majority owned subsidiaries and through May 23, 2013, Ecosphere Energy Services, LLC (“EES”), now Fidelity National Environmental Solutions LLC (“FNES”). On May 24, 2013, the Company sold a 12% interest in FNES and transferred an additional 1.5% interest to a board member of FNES, reducing the Company’s ownership in FNES from 52.6% to 39.1%. Since May 24, 2013, the Company accounts for its investment in FNES under the equity method. On July 31, 2013, the Company sold an additional 8% interest in FNES and transferred an additional 0.5% interest to a board member of FNES, reducing the Company’s ownership in FNES from 39.1% to 30.6% (See Note 3). The Company continues to account for its investment in FNES under the equity method. All intercompany account balances and transactions have been eliminated.

Noncontrolling Interest

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

In October 2013, the Company’s subsidiary, Ecosphere Mining, LLC, granted to its directors an aggregate of 5% ownership in Ecosphere Mining, LLC. Accordingly the Company is presenting noncontrolling interests as a component of equity on its consolidated balance sheets and reported noncontrolling interest net income or loss under the heading “Net (income) loss applicable to noncontrolling interest in consolidated subsidiary” in the unaudited condensed consolidated statements of operations.

Use of Estimates

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

Cash Equivalents

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

Restricted Cash

Restricted cash as of September 30, 2014, represents a $50,050 compensating balance held pursuant to certain of the Company's short-term financing arrangements.

Accounts Receivable and Allowance for Doubtful Accounts

Accounts receivable are stated at their estimated net realizable value. The Company reviews its accounts to estimate losses resulting from the inability of its customers to make required payments. Any required allowance is based on specific analysis of past due accounts and also considers historical trends of write-offs. Past due status is based on how recently payments have been received from customers. The Company’s collection experience has been favorable reflecting a limited number of customers. No allowance was deemed necessary at September 30, 2014 and December 31, 2013.

8

ECOSPHERE TECHNOLOGIES, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2014

(UNAUDITED)

Inventory

Inventory is primarily comprised of raw materials to manufacture water treatment equipment, finished goods representing one Ecos PowerCube® completed for future sale and demonstration purposes where no binding sales contract exists and work-in-process representing water treatment equipment being manufactured and assembled for future sale. Inventory on hand at each respective balance sheet date is stated at the lower of cost or market with cost determined using a weighted average methodology. See Note 4.

Property, Equipment and Capitalized Leases

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

Debt Issuance Cost

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

Patents

Patents are stated at cost and are being amortized on a straight-line basis over the estimated future periods to be benefited. All patents at September 30, 2014 and December 31, 2013 have either been acquired from a related company or assigned to the Company by the Company's founder. Patents are recorded at the historical cost basis.

Impairment of Long-Lived Assets

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

Investment in Unconsolidated Investee

The Company accounts for investments in which the Company owns more than 20% of the investee, using the equity method in accordance with ASC Topic 323, Investments—Equity Method and Joint Ventures. Under the equity method, an investor initially records an investment in the stock of an investee at cost, and adjusts the carrying amount of the investment to recognize the investor's share of the earnings or losses of the investee after the date of acquisition. The amount of the adjustment is included in the determination of net income by the investor, and such amount reflects adjustments similar to those made in preparing consolidated statements including adjustments to eliminate intercompany gains and losses, and to amortize, if appropriate, any difference between investor cost and underlying equity in net assets of the investee at the date of investment. The investment of an investor is also adjusted to reflect the investor's share of changes in the investee's capital. Dividends received from an investee reduce the carrying amount of the investment. A series of operating losses of an investee or other factors may indicate that a decrease in value of the investment has occurred which is other than temporary and which should be recognized even though the decrease in value is in excess of what would otherwise be recognized by application of the equity method.

Derivative Instruments

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

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ECOSPHERE TECHNOLOGIES, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2014

(UNAUDITED)

Fair Value of Financial Instruments and Fair Value Measurements

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

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

Level 1:

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

Level 2:

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

Level 3:

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

Revenue Recognition

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

Equipment and Component Sales

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

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

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

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

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ECOSPHERE TECHNOLOGIES, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2014

(UNAUDITED)

Field Services (See Note 3)

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

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

After Market Part Sales

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

Royalties

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

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

Equity-based Compensation

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

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

Income Taxes

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

Accounting for Uncertainty in Income Taxes

The Company applies the provisions of ASC Topic 740-10-25, Income Taxes – Overall – Recognition (“ASC Topic 740-10-25”) with respect to the accounting for uncertainty of income tax positions. ASC Topic 740-10-25 clarifies the accounting for uncertainty in income taxes recognized in a company’s financial statements and prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. ASC Topic 740-10-25 also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure and transition. As of September 30, 2014, tax years since 2011 remain open for IRS audit. The Company has received no notice of audit from the Internal Revenue Service for any of the open tax years.

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ECOSPHERE TECHNOLOGIES, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2014

(UNAUDITED)

Net Loss Per Share

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

For the three and nine months ended September 30, 2014, no potential common shares were included in the calculation of diluted loss per share because they were anti-dilutive.

Basic and diluted net income per share for the three and nine months ended September 30, 2013, were calculated as follows:

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

Anti-Dilutive Potential Common Stock

New Accounting Standards

In August 2014, the Financial Accounting Standards Board (the “FASB”) issued Accounting Standards Update 2014-15, “Presentation of Financial Statements - Going Concern (Subtopic 205-40); Disclosure of Uncertainties about an Entity’s Ability to Continue as a Going Concern”. This update requires management of the Company to evaluate whether there is substantial doubt about the Company’s ability to continue as a going concern. This update is effective for the annual period ending after December 15, 2016, and for annual and interim periods thereafter. Early adoption is permitted. The Company does not expect this standard to have an impact on the Company’s consolidated financial statements upon adoption.

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ECOSPHERE TECHNOLOGIES, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2014

(UNAUDITED)

3.

INVESTMENT IN UNCONSOLIDATED INVESTEE

As a result of its sale of a 12% interest in FNES on May 24, 2013, the Company deconsolidated FNES and accounts for its investment using the equity method of accounting. The Company sold an additional 8% interest in FNES in July 2013, reducing its ownership interest in FNES to 30.6% as of December 31, 2013 and September 30, 2014. Condensed unaudited summary financial information for FNES as of September 30, 2014 and for the nine months ended September 30, 2014 is as follows:

13

ECOSPHERE TECHNOLOGIES, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2014

(UNAUDITED)

4.

INVENTORY

Inventory consists of the following at September 30, 2014 and December 31, 2013:

5.

PROPERTY AND EQUIPMENT

Property and equipment consists of the following at September 30, 2014, and December 31, 2013:

The Company had additions to furniture and fixtures and office equipment relating to the build out of the mining office in Park City, UT. Depreciation expense amounted to approximately $0.1 million and $0.2 million for the three and nine months ended September 30, 2014.

14

ECOSPHERE TECHNOLOGIES, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2014

(UNAUDITED)

6.

NOTES PAYABLE AND OTHER DEBT

Long-term debt consists of the following at September 30, 2014, and December 31, 2013:

Convertible Notes Payable

15

ECOSPHERE TECHNOLOGIES, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2014

(UNAUDITED)

16

ECOSPHERE TECHNOLOGIES, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2014

(UNAUDITED)

A summary of convertible notes payable and the related discounts as of September 30, 2014, and December 31, 2013 is as follows:

Note Payable

On January 1, 2012, the Company reclassified a non-interest bearing unsecured note payable to a former director totaling $272,399 of which $119,174 and $153,224 were outstanding at September 30, 2014, and December 31, 2013, respectively, from related party debt due to lack of on-going affiliation with the lender. The note is non-interest bearing and payable in quarterly payments of $17,025. Accordingly, $102,150 is included as a current liability in the accompanying unaudited condensed consolidated financial statements.

17

ECOSPHERE TECHNOLOGIES, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2014

(UNAUDITED)

Financing Obligations

Capital Lease Obligation

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

Future minimum lease payments under this capital lease obligation as of September 30, 2014, by fiscal year, are as follows:

Third Party Debt

Aggregate annual maturities of third party debt are as follows as of September 30, 2014:

18

ECOSPHERE TECHNOLOGIES, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2014

(UNAUDITED)

7.

DERIVATIVE FINANCIAL INSTRUMENTS

The Company applies the provisions of ASC Topic 815-40, Contracts in Entity’s Own Equity (“ASC Topic 815-40”), under which convertible instruments and warrants, which contain terms that protect holders from declines in the stock price (reset provisions), may not be exempt from derivative accounting treatment. As a result, warrants are recorded as a liability and are revalued at fair value at each reporting date. Further, under derivative accounting, the warrants are recorded at their fair value. If the fair value of the warrants exceeds the face value of the related debt, the excess is recorded as change in fair value in operations on the issuance date. During the nine month period ended September 30, 2014, upon the expiration of the warrants, the fair value decreased to zero resulting in a gain from change in fair value of derivative instruments of $1,764. The Company has no warrants with repricing options outstanding at September 30, 2014.

The following is a roll forward for the nine months ended September 30, 2014 of the fair value liability of price adjustable warrant derivative instruments:

8.

REDEEMABLE CONVERTIBLE CUMULATIVE PREFERRED STOCK

Series A

At September 30, 2014, and December 31, 2013, there were 6 shares of Series A Redeemable Convertible Cumulative 15% Preferred Stock outstanding. The shares are redeemable at the option of the Company at $27,500 per share plus accrued dividends or redeemable at the option of the holder upon a change of control event at $25,000 per share plus accrued dividends. A Change of Control (“CoC”) event means a transfer of greater than fifty percent of the shares of common stock of the Company. The shares are convertible each into 25,200 common shares. Accrued dividends totaled $1,070,369 and $1,053,494 on September 30, 2014, and December 31, 2013, respectively. There was no Series A Preferred Shares activity during the nine months ended September 30, 2014. Annual dividends accrue at a rate of $3,750 per share.

Series B

At September 30, 2014, and December 31, 2013, there were 241 shares of Series B Redeemable Convertible Cumulative 10% Preferred Stock outstanding. The shares are redeemable at the option of the Company at $3,000 per share plus accrued dividends or redeemable at the option of the holder upon a Change of Control event at $2,500 per share plus accrued dividends. The shares are convertible each into 876 common shares. Accrued dividends totaled $1,959,722 and $1,914,533 on September 30, 2014, and December 31, 2013, respectively. There was no Series B Preferred Shares activity during the nine months ended September 30, 2014.  Annual dividends accrue at a rate of $250 per share.

9.

COMMON STOCK

Shares issued and issuable during the nine months ended September 30, 2014 are summarized below.

———————

(a)

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

19

ECOSPHERE TECHNOLOGIES, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2014

(UNAUDITED)

10.

STOCK OPTIONS AND WARRANTS

Issuance of Warrants with Convertible Debt

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

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

In August 2014, the holders of the February 2013 convertible notes (See Note 6), agreed to waive their right to the early partial redemption and the Company paid the holders $24,263 plus $3,500 in lawyer’s fees. In addition to the payment, the Company reduced the conversion price under the Notes and the exercise price under the 1,250,000 Warrants noted above to $0.115 per share.

In September 2014, the Company issued 17,391,304 five-year warrants exercisable at $0.115 per share in connection with the issuance of a convertible notes in the aggregate principal amount of $1,000,000 (see Note 6). In addition, the Company agreed to reduce the exercise price of 562,500 previously issued warrants to $0.115 and extend the term of the warrants to five-years from the date of the convertible note agreement. The fair value of the extended warrants totaled $28,043 and is to be amortized over the one year debt term.

Option Exercise

Cashless Exercise

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

The fair value of each option and warrant is estimated on the date of grant using the BSM option-pricing model. The Company used the following assumptions for options and warrants issued or valued during the three months ended September 30, 2014:

Stock-based compensation expense related to options for the nine months ended September 30, 2014 was $397,878. At September 30, 2014, total unrecognized compensation cost related to unvested options granted under the Company’s option plans totaled $90,130. This unrecognized compensation cost is expected to be recognized over the next 15 months.

Extension of Options and Warrants in Exchange for Cash

The Company agreed to extend the term of options that expired in June 2014 and December 2014 for an additional two years, in exchange for cash of $50,000. The fair value of the extended options was determined using the BSM method and the following assumptions: volatility ranging from 56.36% to 58.28%, an expected term between 2.11 and 2.59 years, a risk-free discount rate of 0.37% and no dividends, totaling $155,437. The excess of the fair value of the extended options was recorded as additional interest expense of $105,374.

The Company agreed to extend the term of options that expired in June 2014 for an additional two years in exchange for cash of $10,000. The fair value of the extended options was determined using the BSM method and the following assumptions: volatility of 54.82%, an expected term of 2.07 years, a risk-free discount rate of 0.41% and no dividends, totaling $49,300. The excess of the fair value of the extended options was recorded as additional interest expense of $9,687.

20

ECOSPHERE TECHNOLOGIES, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2014

(UNAUDITED)

11.

RELATED PARTY TRANSACTIONS

Related Party Purchase of FNES Note Receivable

In June 2014, Ecosphere sold the remaining 25% portion of a FNES note payable for the Ozonix® EF80 Unit sold in November 2013 in exchange for $0.3 million in cash. The buyer of the note is an employee of the Company. As a result of the sale of accounts receivable the Company recognized a loss of approximately $0.1 million.

Related Party Private Licensing Engagement Agreement

In June 2014, the Company entered into a one year Private Licensing Engagement Agreement (the “Agreement”) with ICAP Patent Brokerage LLC (“ICAP”) in efforts to monetize the Company’s patented Ozonix® and Ecos PowerCube® technology portfolios. The Agreement may be terminated by either party with 60 days’ notice. In the event that the Company enters into an Intellectual Property Licensing Agreement, ICAP is entitled to receive a commission equal to 10% of the monies paid to the Company and its affiliates in connection with such transaction. The Chief Executive Officer of ICAP Patent Brokerage is also one of the Company’s board members and consultants.

Related Party Consulting Agreements

In January 2013, the Company entered into a three year consulting agreement at the rate of $250,000 per year that may be terminated with 30 days’ notice with one of the Company’s board members and who is also the Chief Executive Officer of ICAP Patent Brokerage. For the nine months ended September 30, 2014, the Company has incurred $187,500 pursuant to the consulting agreement.

Related Party Cashless Option Exercise

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

Related Party Equipment Sales

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

Related Party Service Fee

The Company has been receiving a service fee for its continued accounting, executive, administrative and other miscellaneous services to FNES. In April 2014, the monthly service fee was reduced from $56,360 to $44,310. The Company continues to provide the services described above and will continue to do so in a transitional phase. Once this transitional phase is complete and FNES has taken over all functions listed above, FNES will no longer pay a service fee to the Company. All costs relating to the services fee are offset against various expense accounts on the statement of operations. The Company had an accounts receivable balance at September 30, 2014 of $44,310 relating to September 2014 services performed for FNES.

Related Party Accounts Receivable

At December 31, 2013, the Company had an accounts receivable balance of approximately $3.5 million due from FNES. The $3.5 million accounts receivable balance primarily consisted of the $3.5 million remaining balance FNES owed on two Ozonix® EF80 units purchased in July and November 2013. In March 2014, Ecosphere sold the FNES note payable for the Unit sold in July 2013 in exchange for $1 million in cash. The buyer of the note is an FNES member and director. The Company also sold 50% of the FNES note payable for the Unit sold in November 2013 in exchange for $0.6 million in cash during the three months ended March 31, 2014. During the three months ended June 30, 2014, the Company sold an additional 50% of the FNES note payable for the Unit sold in November 2013 in exchange for $0.6 million. As of September 30, 2014, the Company had no accounts receivable balance in connection with the notes payable for the Ozonix® EF80 units sold to FNES in July and November 2013.

21

ECOSPHERE TECHNOLOGIES, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2014

(UNAUDITED)

As a result of the sale of accounts receivable the Company recognized a loss of $985,085 for the nine months ended September 30, 2014. At September 30, 2014, the Company had an accounts receivable balance of $54,787 due from FNES. The accounts receivable balance consisted of a $44,310 service fee and $10,477 in miscellaneous charges.

12.

COMMITMENTS AND CONTINGENCIES

Leases

The Company makes monthly rent payments of $11,789 under a month-to-month agreement for the Company’s Stuart, Florida corporate offices and manufacturing location. The Company has been under a month-to-month agreement for the two buildings adjacent to the Stuart facility that holds the Company’s machining equipment. The lease agreements expired in April and May 2012 and the Company continues to make monthly rent payments of $4,955.

In September 2013, the Company entered into a five year lease agreement for an office located in Park City, UT to begin developing the mining application. The commencement date for this operating lease is January 1, 2014 with the lease expiring on the day immediately prior to the fifth anniversary of the commencement date, December 31, 2019. The Company has an obligation of $195,561 as of September 30, 2014, relating to this five-year lease agreement.

Legal

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

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

In December 2012, the Company reached a settlement with KIA, who filed a lawsuit against the Company in 2007, amounting to $100,000 to be paid with an initial $25,000 payment and 36 monthly installments for the remainder of the settlement amount. Should the Company default on any of its required payments, the settlement amount will increase to $150,000. The Company had originally accrued $197,500 in liabilities related to this settlement. As a result of the settlement, the Company reduced legal expense by $47,500 (as the original expense was charged to this account) leaving an accrued balance of $125,000 at December 31, 2012, which was comprised of the $150,000 obligation less the initial $25,000 payment. As of September 30, 2014, the Company had an accrued balance of $83,333 which is comprised of the $150,000 obligation less $66,667 in payments. Upon final payment in accordance with the settlement, the Company will record a $50,000 gain.

In March 2011, a former vendor obtained a judgment against the Company for a number of disputed billings. As of September 30, 2014 the Company has accrued $70,000 which is anticipated to be the amount of payment due to the vendor plus attorney’s fees.

Other Commitments

The Company has a Royalty Agreement with its president and founder where he is entitled to receive royalties equal to 4% of Ecosphere’s revenues generated from the patents and inventions which were created by him (the “Inventions”) less any base salary paid to him. In addition to the royalties paid on revenues, the royalties will also be paid on any consideration Ecosphere receives or its shareholders receive from a merger or sale of our assets outside of the ordinary course of business relating to the Inventions plus consideration received by our shareholders from exchange offer or tender offer, as well as proceeds received by Ecosphere from outstanding debt conversions (for all new debt issued beginning January 1, 2013) and sales of Ecosphere’s equity securities. Royalty payments will be paid for the life of all Inventions regardless of whether Mr. McGuire remains an employee of Ecosphere. Under the Royalty Agreement, Ecosphere granted Mr. McGuire a security interest (subordinated to all creditors and shareholders) in all of the Inventions and all revenues generated from the Inventions to secure payments owed to him under the Royalty Agreement. Provided that Ecosphere is not in default of the Royalty Agreement, Mr. McGuire will assign his rights to any technology invented by him during the term of his Employment Agreement. His amended Royalty Agreement provides that the Company will be in default for non-payment only if it has the liquidity to pay Mr. McGuire or if it defrauds him regarding its ability to pay him.

22

ECOSPHERE TECHNOLOGIES, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2014

(UNAUDITED)

In June 2014, the Company entered into a one year Private Licensing Engagement Agreement (the “Agreement”) with ICAP Patent Brokerage in efforts to monetize the Company’s patented Ozonix® and Ecos PowerCube® technology portfolios. The Agreement may be terminated by either party with 60 days’ notice. In the event that the Company enters into an Intellectual Property Licensing Agreement, ICAP is entitled to receive a commission equal to 10% of the monies paid to the Company and its affiliates in connection with such transaction. The Chief Executive Officer of ICAP Patent Brokerage is also one of the Company’s board members and consultants.

13.