United States Securities & Exchange Commission EDGAR Filing

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-K /A

No. 1


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

		For the fiscal year ended December 31, 2008

		OR

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

For the transition period from ____________ to ____________

Commission file number: 000-25663

ECOSPHERE TECHNOLOGIES, INC.

(Exact name of registrant as specified in its charter)


Delaware		20-3502861
(State or other jurisdiction of		(I.R.S. Employer
incorporation or organization)		Identification No.)

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

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

Securities registered pursuant to Section 12(b) of the Act:


Title of each class		Name of each exchange on which registered
None

Securities registered pursuant to Section 12(g) of the Act: Common Stock

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.

Yes o

No þ

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Exchange Act.

Yes o

No þ

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 o

No o

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. o

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

Large accelerated filer o

Accelerated filer o

Non-accelerated filer o (Do not check if a smaller reporting company)

Smaller reporting company þ

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

As of June 30, 2008 the aggregate market value of the registrant’s common stock held by non-affiliates of the registrant was $28,637,000 based on the closing sale price as reported on the Over-the-Counter Bulletin Board.

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


Class		Outstanding at March 16, 2009
Common Stock, $0.01 par value per share		85,311,795 shares

DOCUMENTS INCORPORATED BY REFERENCE

PART I

This report on Form 10-K/A No. 1 amends the Form 10-K filed on March 25, 2009. It is being filed to add a consent of the independent registered public accounting firm, which was inadvertently not filed.

Item 8.

Financial Statements and Supplementary Data.

See pages F-1 through F-39.

PART IV

Item 15.

Exhibits, Financial Statement Schedules.

(a) Documents filed as part of the report.

(1) All Financial Statements

(2) Financial Statements Schedule

(3) Exhibits


Exhibit Number		Description
3.1		Certificate of Incorporation (1)
3.2		Certificate of Amendment to the Certificate of Incorporation
3.3		Certificate of Correction to the Certificate of Incorporation
3.4		Bylaws (1)
3.5		Amendment to Bylaws (2)
4.1		Form of Common Stock Certificate (3)
4.2		Form of Senior Convertible Debenture (4)
4.3		Form of Warrant Issued to Debenture Holders (5)
4.4		Warrant (Heller Capital) (5)
4.5		Form of Secured Convertible Note – December Offering (See Exhibit A of Exhibit 10.10 below)
4.6		Form of Secured Convertible Note – May Offering (See Exhibit A of Exhibit 10.11 below)
4.7		Form of Secured Convertible Note – August Offering (See Exhibit A of Exhibit 10.12 below)
4.8		Form of Secured Convertible Note – Bledsoe – May 2008 (See Exhibit A of Exhibit 10.13 below)
4.9		Form of Secured Convertible Note – Bledsoe – November 2008 (See Exhibit A of Exhibit 10.15 below)
10.1		Securities Purchase Agreement (4)(6)
10.2		2006 Equity Incentive Plan (7)
10.3		Amendment to the 2006 Equity Incentive Plan (2)
10.4		Agreement with Vice-Admiral George R. Sterner (8)(9)
10.5		Form of 2006 Management Compensation Adjustment Plan (10)
10.6		Form of Amendment to 2006 Management Compensation Adjustment Plan (3)
10.7		Form of Stock Option Agreement (3)
10.8		Form of Restricted Stock Agreement (7)
10.9		Form of Stock Option Agreement in Warrant/Option Exchange Offer (5)
10.10		Secured Line of Credit Agreement dated December 28, 2007 (5)(6)
10.11		Secured Line of Credit Agreement dated May 12, 2008 (2)(6)
10.12		Secured Line of Credit Agreement dated August 28, 2008 (2)(6)
10.13		Credit Agreement with Bledsoe Capital Group, LLC dated May 12, 2008 (2)(6)
10.14		Exclusive Option with Bledsoe Capital Group, LLC dated June, 5, 2008 (2)
10.15		Credit Agreement with Bledsoe Capital Group, LLC dated November 12, 2008 (6)
10.16		Summary of Employment Arrangement with Patrick Haskell (2)
10.17		Summary of Employment Arrangement with Dennis McGuire (2)
10.18		Summary of Employment Arrangement with Adrian Goldfarb
10.19		Summary of Employment Arrangement with Michael R. Donn, Sr.(2)
10.20		Consulting Agreement with WSR Consulting, Inc.(5)
10.21		Letter Agreement Amending WSR Consulting Agreement
10.22		Gordon Goodman Settlement Agreement (2)


Exhibit Number		Description
10.23		Summary of Robert Barrata Note Extension Agreement (2)
10.24		Charles Vinick Consulting Agreement
21.1		Subsidiaries
23.1		Consent of Salberg & Company, P.A.
31.1		Certification of Chief Executive Officer (Section 302)
31.2		Certification of Chief Financial Officer (Section 302)
32.1		Certification of Chief Executive Officer (Section 906)
32.2		Certification of Chief Financial Officer (Section 906)

———————

(1)

Contained in Form 10-QSB filed on December 11, 2006.

(2)

Contained in the Form 10-Q filed on November 14, 2008.

(3)

Contained in Form SB-2 filed on January 18, 2007.

(4)

Contained in Form 8-K filed on December 20, 2006.

(5)

Contained in the Form 10-KSB filed on April 15, 2008.

(6)

This Agreement contains representations and warranties the parties made to each other. The statements made in those representations and warranties are qualified by information in confidential disclosure schedules that were in connection with signing the Agreement. While we do not believe that the disclosure schedules contain information that the securities laws require to be publicly disclosed, the disclosure schedules do contain information that modifies, qualifies and creates exceptions to the representations and warranties set forth in the Agreement. Accordingly, you should not rely on the representations and warranties as characterizations of the actual state of facts, since they are modified by the underlying disclosure schedules. Moreover, information concerning the subject matter of the representations and warranties may have changed since the date of the Agreement, which subsequent information may or may not be fully reflected in any subsequent public disc losures.

(7)

Contained in Form 10-QSB filed on December 11, 2006.

(8)

Contained in Form 10-KSB filed on April 4, 2006.

(9)

Portions subject to a Request for Confidential Treatment.

(10)

Contained in Form 10-KSB filed on August 10, 2006.

SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) 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: May 29, 2009


	Ecosphere Technologies, Inc.


	By:	/s/ PATRICK HASKELL
		Patrick Haskell
		Chief Executive Officer (Principal Executive Officer)

INDEX TO FINANCIAL STATEMENTS



		Page

Report of Independent Registered Public Accounting Firm		F-2

Consolidated Balance Sheets		F-3

Consolidated Statements of Operations		F-4

Consolidated Statements of Changes in Stockholders’ Deficit		F-5

Consolidated Statements of Cash Flows		F-6

Notes to Consolidated Financial Statements		F-8

F- 1

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and Stockholders' of

Ecosphere Technologies, Inc.

We have audited the accompanying consolidated balance sheets of Ecosphere Technologies, Inc. and Subsidiaries as of December 31, 2008 and 2007, and the related consolidated statements of operations, changes in stockholders' equity and cash flows for the years ended December 31, 2008 and 2007. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall consolidated financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Ecosphere Technologies, Inc. and Subsidiaries at December 31, 2008 and 2007, and the consolidated results of its operations and its cash flows for the years ended December 31, 2008 and 2007, in conformity with accounting principles generally accepted in the United States of America.

The accompanying consolidated financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note 2 to the consolidated financial statements, the Company has a net loss applicable to common stock of $11,831,906, and net cash used in operations of $4,379,171 for the year ended December 31, 2008, and a working capital deficit, a stockholders' deficit and an accumulated deficit of $9,229,775, $10,753,301 and $64,993,779, respectively, at December 31, 2008. In addition, the Company has redeemable convertible cumulative preferred stock that is eligible for redemption at a redemption amount of $3,933,545 including accrued dividends as of December 31, 2008 and is in default on certain promissory notes at December 31, 2008. These matters raise substantial doubt about its ability to continue as a going concern. Management’s Plan in regards to these matters is also described in Note 2. The consolidated financial sta tements do not include any adjustments that might result from the outcome of this uncertainty.

/s/ Salberg & Company, P.A.

SALBERG & COMPANY, P.A.

Boca Raton, Florida

February 27, 2009

F- 2

ECOSPHERE TECHNOLOGIES, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS


	December 31,
	2008			2007
Current Assets
Cash and equivalents	$	461,514		$	329,848
Accounts receivable		123,728			3,800
Inventories		32,426			162,601
Prepaid expenses and other current assets		72,101			117,685
Total current assets		689,769			613,934
Property and equipment, net		1,875,891			548,118
Construction in progress		319,975			—
Patents, net		41,165			23,290
Debt issue costs, net		276,055			—
Deposits		55,998			—
Investment		—			250,000
Total assets	$	3,258,853		$	1,435,342
Liabilities, Redeemable Convertible Cumulative Preferred Stock and Stockholders’ Deficit
Current Liabilities
Accounts payable	$	1,009,467		$	956,815
Accounts payable - related parties		5,485			32,994
Accrued liabilities		1,457,497			1,182,798
Capital lease obligations		38,249			34,238
Due to affiliate		2,000			2,000
Deferred revenue - related party		—			156,000
Insurance premium finance contracts		42,270			—
Notes payable – related parties (net of discount) – current portion		1,370,141			476,000
Notes payable – third parties (net of discount) – current portion		5,994,435			1,842,555
Total current liabilities		9,919,544			4,683,400
Capital lease obligations – less current portion		13,721			51,970
Deferred rent		4,126			—
Notes payable - related parties - less current portion		115,818			—
Notes payable to third parties (net of discount) – less current portion		25,400			285,983
Total Liabilities		10,078,609			5,021,353
Redeemable convertible cumulative preferred stock series A 11 shares authorized; 7 and 9 shares issued and outstanding, respectively, $25,000 per share redemption amount plus dividends in arrears ($1,111,306 at December 31, 2008)		1,111,306			1,129,431
Redeemable convertible cumulative preferred stock series B 484 shares authorized; 424 and 429 shares issued and outstanding, respectively, $2,500 per share redemption amount plus dividends in arrears ($2,822,239 at December 31, 2008)		2,822,239			2,728,364
Commitments and Contingencies (Note 13)
Stockholders’ Deficit
Common stock, $0.01 par value; 300,000,000 shares authorized; 83,791,919 and 63,927,180 shares issued and outstanding at Decembere 31, 2008 and 2007, respectively		837,914			639,266
Common stock issuable, $0.01 par value, 286,000 and 297,763 issuable at December 31, 2008 and 2007, respectively		2,860			2,978
Additional paid-in capital		53,399,704			45,214,073
Accumulated deficit		(64,993,779	)		(53,300,123	)
Total stockholders’ deficit		(10,753,301	)		(7,443,806	)
Total liabilities, redeemable convertible cumulative preferred stock,and stockholders’ deficit	$	3,258,853		$	1,435,342

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

F- 3

ECOSPHERE TECHNOLOGIES, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS


		For The Year Ended
		December 31,
		2008			2007
Revenues from operations		$	247,202		$	750,007

Cost of revenues			163,169			888,302

Gross profit (loss)			84,033			(138,295	)

Operating gains and other operating income:
Gain from sale of intellectual property and related assets, net			––			5,259,370

Operating expenses
	Selling, general and administrative		6,082,656			5,849,673
	Impairment of assets		6,601			15,000
	Impairment of investment		––			5,000
Total operating expenses			6,089,257			5,869,673

Loss from operations			(6,005,224	)		(748,598	)

Other income (expense):
	Other income (loss)		(12,599	)		11,664
	Loss on conversion		(256,271	)		(74,189	)
	Loss on extinguishment of debt		—			(2,757,534	)
	Interest expense		(5,419,562	)		(2,992,663	)
Total other income (expense)			(5,688,432	)		(5,812,722	)

Net loss			(11,693,656	)		(6,561,320	)

Preferred stock dividends			(138,250	)		(141,802	)

Net loss applicable to common stock		$	(11,831,906	)	$	(6,703,122	)

Net loss per common share applicable to common stock (basic and diluted)		$	(0.16	)	$	(0.11	)

Weighted average number of common shares outstanding (basic and diluted)			73,158,831			60,596,054

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

F- 4

ECOSPHERE TECHNOLOGIES, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' DEFICIT

For the Years Ended December 31, 2007 and 2006


	Common Stock (Shares)		Common Stock Par Value			Common Stock Issuable (Shares)		Common Stock Issuable Par Value			Additional Paid In Capital		Accumulated Deficit
																Total


Balance at December 31, 2006	56,487,639		$	564,877		—		$	—		$	38,762,072	$	(46,738,803	)	$	(7,411,854	)
Shares issued for services	1,430,999			14,310		—			—			444,157		—			458,467
Redeemable preferred stock conversions	29,225			292		—			—			87,208		—			87,500
Shares Issued for interest	1,736,048			17,360		—			—			454,088		—			471,448
Conversions of notes to common stock	1,139,706			11,397		—			—			503,309		—			514,706
Employee, director and advisor shares for service	300,952			3,010		—			—			308,067		—			311,077
Stock options granted and vested to employees, directors and advisors	—			—		—			—			104,134		—			104,134
Beneficial conversion features of debt offerings	—			—		—			—			1,325,807		—			1,325,807
Warrants issued in connection with debt offerings and modifications	—			—		—			—			1,685,565		—			1,685,565
Shares issued in connection with debt offerings, renewals	801,881			8,019		297,763			2,978			222,969		—			233,966
Shares issued as finders fees for leasing arrangement	2,000,000			20,000		—			—			660,000		—			680,000
Options issued to management for commissions related to the sale of the UES technology and assets	—			—		—			—			773,500		—			773,500
Exercise of warrants	10,080			101		—			—			(101)		—			—
Other	(9,350	)		(100	)	—			—			25,100		—			25,000
Redeemable preferred stock dividends	—			—		—			—			(141,802)		—			(141,802)
Net loss, 2007	—			—		—			—			—		(6,561,320	)		(6,561,320	)
Balance at December 31, 2007	63,927,180			639,266		297,763			2,978			45,214,073		(53,300,123	)		(7,443,806	)
Shares issued for services	559,524			5,595		250,000			2,500			375,905		—			384,000
Shares issued in connection with debt offerings, renewals	881,622			8,817		(297,763	)		(2,978	)		113,266		—			119,105
Conversions of notes and debentures to common stock	12,599,112			125,991		—			—			1,754,055		—			1,880,046
Shares issued for interest	431,848			4,319		—			—			113,906		—			118,225
Conversion of Series A Preferred Stock to common stock	12,000			120		36,000			360			49,520		—			50,000
Conversion of Series B Preferred Stock to common stock	4,170			41		—			—			12,459		—			12,500
Vesting of Restricted Stock	1,093,050			10,931		—			—			210,932		—			221,863
Exercise of warrants for cash	1,285,000			12,850		—			—			176,450		—			189,300
Cashless exercise of warrants	2,998,413			29,984		—			—			(29,984)		—			—
Warrants and options granted for services	—			—		—			—			541,886		—			541,886
Beneficial conversion features of debt offerings	—			—		—			—			1,374,636		—			1,374,636
Warrants issued in connection with debt offerings	—			—		—			—			2,253,062		—			2,253,062
Stock options granted and vested to employees, directors and advisors	—			—		—			—			1,377,788		—			1,377,788
Redeemable preferred stock dividends	—			—		—			—			(138,250)		—			(138,250	)
Net loss, 2008	—			—		—			—			—		(11,693,656	)		(11,693,656	)
Balance at December 31, 2008	83,791,919		$	837,914		286,000		$	2,860		$	53,399,704	$	(64,993,779	)	$	(10,753,301	)

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

F- 5

ECOSPHERE TECHNOLOGIES, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS


		For the Year Ended December 31,
		2008			2007
OPERATING ACTIVITIES:
	Net loss	$	(11,693,656	)	$	(6,561,320	)
	Adjustments to reconcile net loss to net cash (used in) provided by operating activities					.
	Depreciation and amortization		259,642			310,583
	Amortization of debt issue costs		515,363			232,156
	Accretion of imputed interest		––			190,000
	Accretion of discount on notes payable		4,294,206			1,514,772
	Provision for asset impairment		––			20,000
	Loss on conversion of accrued interest and accounts payable to stock		208,500			74,189
	Loss on extinguishment of debt		––			2,757,534
	Non-cash expense to renew / extend loans		12,500			48,437
	Warrants and stock options issued for services		17,969			877,634
	Impairment of inventory		6,601			––
	Common stock issued for interest / services		33,170			766,744
	Non-cash expense from option / warrant exhange / repricing		15,679			184,835
	Non-cash portion of gain from sale of intellectual property and related assets, net		––			(250,000	)
	Non-cash stock based compensation		1,583,972			––
Changes in operating assets and liabilities
	Decrease (increase) in accounts receivable		(119,928	)		17,123
	(Increase) decrease in inventories		(32,426	)		1,392,747
	Decrease (increase) in prepaid expenses and other current assets		122,975			(65,805	)
	(Increase) in debt issue costs and other non-current assets		(180,001	)		––
	Increase accounts payable		67,652			779,696
	Increase (decrease) in accounts payable - related party		(1,389	)		2,000
	Increase in deferred rent		4,126			––
	Increase in deferred revenue		––			156,000
	Increase in accrued expenses		505,874			786,809
	Net cash (used in) provided by operating activities		(4,379,171	)		3,234,134
INVESTING ACTIVITIES:
	Proceeds from sale of investment		250,000			––
	Construction in process purchases		(319,975	)		––
	Purchase of property and equipment		(1,585,315	)		(500,250	)
	Net cash (used in) provided by investing activities		(1,655,290	)		(500,250	)
FINANCING ACTIVITIES:
	Proceeds from issuance of notes payable and warrants		5,627,500			355,000
	Proceeds from issuance of notes payable and warrants to related parties		1,080,000			620,000
	Proceeds from issuance of notes payable to related parties		41,656			––
	Proceeds from exercise of warrants for cash		189,300			––
	Repayments of notes payable		(390,646	)		(4,923,987	)
	Repayments of notes payable to related parties		(347,445	)		(424,000	)
	Principal payments on capital leases		(34,238	)		(20,807	)
	Net cash provided by (used in) financing activities		6,166,127			(4,393,794	)
	Net increase (decrease) in cash		131,666			(1,659,910	)
Cash and cash equivalents, beginning of year			329,848			1,989,758
Cash and cash equivalents, end of year		$	461,514		$	329,848

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

F- 6

ECOSPHERE TECHNOLOGIES, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)


	For the Year Ended December 31,
	2008		2007
Supplemental Cash Flow Information:
Cash paid for interest	$	229,750	$	310,997
Cash paid for income taxes	$	—	$	—

Non-cash investing and financing activities:
Accrued preferred stock dividends	$	138,250	$	141,802
Beneficial conversion features of convertible notes and debentures	$	1,374,636	$	1,325,807
Warrants issued in connection with financing	$	2,253,062	$	1,413,294
Common stock issued for services	$	88,000	$	—
Common stock issued for debt issue costs	$	288,000	$	—
Common stock issued to repay debt	$	—	$	525,000
Conversion of convertible notes and debentures payable to common stock	$	1,880,046	$	—
Common stock issued as payment of accrued interest	$	118,225	$	318,412
Series A Redeemable Convertible Cumulative Preferred Stock converted to common stock	$	50,000	$	—
Series B Redeemable Convertible Cumulative Preferred Stock converted to common stock	$	12,500	$	87,500
Purchase of equipment financed with capital lease and common stock	$	—	$	1,890,000
Conversion of accrued interest to notes payable	$	145,383	$	—

F- 7

ECOSPHERE TECHNOLOGIES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

FOR THE YEARS ENDED DECEMBER 31, 2008 AND 2007

NATURE OF OPERATIONS, BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

NATURE OF OPERATIONS AND BASIS OF PRESENTATION

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

The accompanying consolidated financial statements include the accounts of Ecosphere Technologies, Inc. (“Ecosphere” or the “Company”), its 90%-owned subsidiary, Ecosphere Systems, Inc. (“ESI”), and its wholly-owned subsidiaries Ecosphere Envirobotic Solutions, Inc. (“UES”), Ecosphere Energy Solutions, Inc. (“EES”) and Ecosphere Renewable Energy Corp, (“EREC”). ESI was formed during the first quarter of 2005 and markets the Company’s mobile water filtration technologies for disaster relief, homeland security and military applications. UES was formed in October 2005 to pursue the sale of UHP robotic coating removal equipment and technology and to perform contract services in the maritime coating removal industry that demonstrated the capabilities of the underlying technology. EES was organized in November 2006. It develops and markets water filtration system s to the oil and gas exploration industry using the Company’s patent pending Ozonix^TM Process. In November 2008, the Company changed the name of EES to Ecosphere Energy Services, Inc. EREC was formed in July 2008 to market the Company’s LifeLink and Ecos Power Cube technologies.

In connection with the sale of certain intellectual property and assets of UES in October 2007, the Company obtained a 5% interest in Chariot Robotics, Inc. This interest was recorded as an investment at December 31, 2007 in the amount of $250,000. In January 2008, the Company sold its 5% interest in Chariot Robotics, Inc. for $250,000.

PRINCIPALS OF CONSOLIDATION

The consolidated financial statements include the accounts of Ecosphere Technologies, Inc. and its subsidiaries. All significant inter-company balances and transactions have been eliminated in the consolidation.

CASH AND CASH EQUIVALENTS

For the purposes of the statements of cash flows, the Company considers all highly liquid investments with an original maturity of three months or less when purchased to be cash equivalents. The Company’s cash equivalents consist of a money market account.

For purposes of the statement of cash flows for sales of intellectual property and related assets and liabilities, which is treated as an operating activity with net proceeds recognized as operating gains (see revenue recognition policy below) such intellectual property and related assets and liabilities are considered to be transferred to inventory prior to the sale.

ACCOUNTS RECEIVABLE

Accounts receivable are customer obligations due under normal trade terms. The Company generally requires deposits or letters of credit from customers who purchase its water filtration systems. Senior management reviews accounts receivable on a monthly basis to determine if any receivables will potentially be uncollectible. The Company includes any accounts receivable balances that are determined to be uncollectible, along with a general reserve, in its overall allowance for doubtful accounts. After all attempts to collect a receivable have failed, the receivable is written off against the allowance.

F- 8

ECOSPHERE TECHNOLOGIES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

FOR THE YEARS ENDED DECEMBER 31, 2008 AND 2007

INVENTORIES

Inventories are stated at the lower of cost or market, with cost determined using a first-in, first-out method. At December 31, 2007, inventory of $162,601 consisted of the cost to date for building the prototype Ozonix^TM unit which was being tested in the field and was pending acceptance by the Ecosphere Energy Services, LLC, a Joint Venture between EES and two joint venture partners. During 2008, the value of the prototype was written down to zero. At December 31, 2008, inventory of $32,426 consists of the cost of a trailer which will be incorporated into a future recycling unit.

PROPERTY AND EQUIPMENT AND DEPRECIATION

Property and equipment is recorded at cost. For equipment manufactured for use by the Company, cost includes direct component parts and supplies plus direct labor. Depreciation is computed using the straight-line method based on the estimated useful lives of the related assets of 5 to 7 years. Leasehold improvements are amortized over the lesser of the lease term or the useful life of the improvements. Expenditures for maintenance and repairs are expensed as incurred.

PATENTS

Patents are stated at cost (inclusive of perfection costs) and are being amortized on a straight-line basis over the estimated future periods to be benefited (16.5 years). All patents at December 31, 2008 and 2007 have either been acquired from a related Company or assigned to the Company by a shareholder of the Company. Patents are recorded at the historical cost basis. The Company recognized amortization expense of $2,100 and $6,828 for the years ended December 31, 2008 and 2007, respectively. In addition, in connection with the Company’s sale of intellectual property and assets to UES in 2007, the Company reduced the carrying value of patents by $39,000, net of accumulated amortization of $39,000, to reflect the patents transferred in the UES sale.

DEBT ISSUE COSTS

In connection with the debenture financings, the Company incurred debt acquisition costs in the form of commissions paid to various third parties. The Company capitalizes these costs and amortizes them over the life of the debenture, using the effective interest method of amortization. In connection with a restructuring of the associated debt in October 2007, which was treated as a debt extinguishment in accordance with Emerging Issues Task Force (EITF) abstracts 96-19 and 05-7, we wrote off the remaining debt acquisition costs. In 2008, the Company incurred additional debt acquisition costs of $791,417 related to the various financings during the year, $180,000 of which were paid in cash with the remainder paid in common stock and warrants. Amortization expense in 2008 and accumulated amortization at December 31, 2008 amounted to $515,363. (Notes 9 and 11)

IMPAIRMENT OF LONG-LIVED ASSETS

The Company accounts for long-lived assets in accordance with the provisions of Statement of Financial Accounting Standards ("SFAS") No. 144, "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. During the year ended December 31, 2008, the Company wrote off the cost of the original Ozonix™ unit, $162,601, which was built for testing in the Barnett Shale of Texas, when it was determined the value of the unit was impaired. In connection with the write-off, the Company also reduced deferred revenue related to the unit in the amount of $156,000, resulting in a loss on impairment of $6,601.

REVENUE RECOGNITION

In accordance with Staff Accounting Bulletin 104, Revenue from sales of equipment 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. Revenue from water-filtration contracts is earned based upon the

F- 9

ECOSPHERE TECHNOLOGIES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

FOR THE YEARS ENDED DECEMBER 31, 2008 AND 2007

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. Revenue from the sale of intellectual property and related assets is recognized as a net gain from the sale of intellectual property and related assets, an operating item, when payment has been received and ownership of the patents and related assets has been transferred to the buyer and is recorded net of any carrying value and selling costs. Equipment or inventory sold in connection with the sale of intellectual property is recognized as a wash sale with no resulting gain or loss.

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

RESEARCH AND DEVELOPMENT

In accordance with Statement of Financial Accounting Standards No. 2, “Accounting for Research and Development Costs” expenditures for research and development of the Company's products are expensed when incurred, and are included in operating expenses. The Company recognized research and development costs of $1,090 and $174,388 for the years ended December 31, 2008 and 2007, respectively.

ADVERTISING

The Company conducts advertising for the promotion of its products and services. In accordance with SOP 93-7, advertising costs are charged to operations when incurred; such amounts aggregated $4,224 in 2008 and $445 in 2007.

INVESTMENT IN JOINT VENTURE

The Company accounts for joint ventures under the equity method of accounting pursuant to Accounting Principles Board (APB) Opinion 18 “The Equity Method of Accounting for Investments in Common Stock (as amended)” which records the Company’s proportionate share of the joint venture net income or loss as an increase or decrease to the investment in the joint venture, respectively, and recognizing that proportionate share of net income or loss in operations. The Company’s proportionate losses of the joint ventures are recorded only to the extent of the Company’s investment plus previously recognized profits.

ACCOUNTING FOR DERIVATIVES

The Company evaluates its convertible debt, options, warrants or other contracts to determine if those contracts or embedded components of those contracts qualify as derivatives to be separately accounted for under Statement of Financial Accounting Standards 133 “Accounting for Derivative Instruments and Hedging Activities” and related interpretations including EITF 00-19 “Accounting for Derivative Financial Instruments Indexed to, and Potentially Settled in, a Company's Own Stock.”

The result of this accounting treatment is that the fair value of the embedded derivative is marked-to-market each balance sheet date and recorded as a liability. In the event that the fair value is recorded as a liability, the change in fair value is recorded in the statement of operations as other income or expense. Upon conversion or exercise of a derivative instrument, the instrument is marked to fair value at the conversion date and then that fair value is reclassified to equity. Equity instruments that are initially classified as equity that become subject to reclassification under SFAS 133 are reclassified to liability at the fair value of the instrument on the reclassification date. The Company did not have any derivative instruments at December 31, 2008 or 2007.

STOCK-BASED COMPENSATION

On January 1, 2006, the Company adopted Statement of Financial Accounting Standards No. 123 (Revised) (“Statement 123(R)”) which became effective for all accounting periods beginning after December 15, 2005. As such, we recognize an expense for the fair value of our unvested outstanding stock options as of December 31, 2005, which will be expensed as the stock options vest. Statement 123(R) required the Company to select one of three transition methods; prospective, retroactive or modified prospective. The Company has elected to use the modified prospective transition method. Under the modified prospective method, compensation cost, for all grants after the effective date, is recognized for the fair value of all share based award grants as those grants vest. Additionally the portion of outstanding awards for which the requisite service period has not been rendered is recognized as compensation expense based upon the grant date fair value of those awards as calculated under the original provisions of SFAS 123 “Accounting for Stock Based Compensation.”

F- 10

ECOSPHERE TECHNOLOGIES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

FOR THE YEARS ENDED DECEMBER 31, 2008 AND 2007

INCOME TAXES

The Company accounts for income taxes pursuant to the provisions of SFAS No. 109, "Accounting for Income Taxes," which requires, among other things, an asset and liability approach to calculating deferred income taxes. The asset and liability approach requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of temporary differences between the carrying amounts and the tax bases of assets and liabilities. 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.

Beginning January 1, 2007, the Company adopted the provisions of the FASB’s Financial Interpretation Number 48 (FIN. 48), Accounting for Uncertain Income Tax Positions. When tax returns are filed, it is highly certain that some positions taken would be sustained upon examination by the taxing authorities, while others are subject to uncertainty about the merits of the position taken or the amount of the position that would be ultimately sustained. In accordance with the guidance of FIN 48, the benefit of a tax position is recognized in the financial statements in the period during which, based on all available evidence, management believes it is more likely than not that the position will be sustained upon examination, including the resolution of appeals or litigation processes, if any. Tax positions taken are not offset or aggregated with other positions. Tax positions that meet the more-likely-than-not recognition threshold are measured as the largest amount of tax benefit that is more than 50 percent likely of being realized upon settlement with the applicable taxing authority. The portion of the benefits associated with tax positions taken that exceeds the amount measured as described above should be reflected as a liability for unrecognized tax benefits in the accompanying balance sheet along with any associated interest and penalties that would be payable to the taxing authorities upon examination. The Company believes its tax positions are all highly certain of being upheld upon examination. As such, the Company has not recorded a liability for unrecognized tax benefits. As of December 31, 2008, tax years 2005, 2006 and 2007 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.

Effective January 1, 2007, the Company adopted FASB Staff Position FIN 48-1, Definition of Settlement in FASB Interpretation No. 48, (“FSP FIN 48-1”), which was issued on May 2, 2007. FSP FIN 48-1 amends FIN 48 to provide guidance on how an entity should determine whether a tax position is effectively settled for the purpose of recognizing previously unrecognized tax benefits. The term “effectively settled” replaces the term “ultimately settled” when used to describe recognition, and the terms “settlement” or “settled” replace the terms “ultimate settlement” or “ultimately settled” when used to describe measurement of a tax position under FIN 48. FSP FIN 48-1 clarifies that a tax position can be effectively settled upon the completion of an examination by a taxing authority without being legally extinguished. For tax positions considered effectively se ttled, an entity would recognize the full amount of tax benefit, even if the tax position is not considered more likely than not to be sustained based solely on the basis of its technical merits and the statute of limitations remains open. The adoption of FSP FIN 48-1 did not have an impact on the accompanying consolidated financial statements.

NET LOSS PER SHARE

Basic net loss per share is computed on the basis of the weighted average number of common shares outstanding during each year. Diluted net loss per share is computed on the basis of the weighted average number of common shares and dilutive securities outstanding. Dilutive securities having an anti-dilutive effect on diluted loss per share are excluded from the calculation.

FAIR VALUE OF FINANCIAL INSTRUMENTS

The carrying amounts of the Company's financial assets, including cash, accounts receivable and of certain financial liabilities (accounts payable, accounts payable - related parties and accrued expenses), approximate fair value because of their short maturities. Based upon the Company's estimate of its current incremental borrowing rate for loans with similar terms and average maturities, the carrying amounts of notes payable to related parties and notes payable approximate fair value.

Based upon the conversion terms of the Company's Series A and B Redeemable Convertible Cumulative Preferred Stock (Preferred Stock) and the estimated current fair value of the Company's common stock into which the Preferred Stock is convertible, the fair value of the Preferred Stock aggregates approximately $162,000 and $115,000 as of December 31, 2008 and 2007.

F- 11

ECOSPHERE TECHNOLOGIES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

FOR THE YEARS ENDED DECEMBER 31, 2008 AND 2007

Based upon the conversion terms of the Company's convertible debentures and the estimated current fair value of the Company's common stock into which the debentures is convertible, the fair value of the debentures aggregate approximately $2,380,500 and $1,297,500, respectively, as of December 31, 2008 and 2007.

Additionally, all convertible notes and convertible notes with original issue discounts have aggregate fair values of approximately $5,031,789 and $1,594,000, respectively, as of December 31, 2008, based upon the conversion terms of the notes and the estimated fair value of the Company’s common stock into which they are convertible.

USE OF ESTIMATES

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and 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 inventories, estimates of depreciable lives and valuation of property and equipment, estimates of the amortization period of intangible assets, valuation of discounts on debt, valuation of beneficial conversion features in convertible debt, valuation of equity based instruments issued for other than cash and the valuation allowance on deferred tax assets.

RECLASSIFICATIONS

Certain amounts included in the 2007 consolidated financial statements have been reclassified to conform to the 2008 presentation. These reclassifications had no effect on total assets, liabilities, stockholders’ deficit or gross profit (loss), loss from operations or net loss.

NEW ACCOUNTING PRONOUNCEMENTS

In September 2006, the Financial Accounting Standards Board, or FASB, issued SFAS No. 157, “Fair Value Measurements” (SFAS No. 157). SFAS No. 157 establishes a common definition for fair value to be applied to US GAAP guidance requiring use of fair value, establishes a framework for measuring fair value, and expands disclosure about such fair value measurements. SFAS No. 157 is effective for fiscal years beginning after November 15, 2007. The adoption did not have a significant impact on our consolidated financial position and results of operations.

On February 15, 2007, the FASB, issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities.” Under SFAS No. 159, we may elect to report financial instruments and certain other items at fair value on a contract-by-contract basis with changes in value reported in earnings. This election is irrevocable. SFAS No. 159 provides an opportunity to mitigate volatility in reported earnings caused by measuring hedged assets and liabilities that were previously required to use a different accounting method than the related hedging contracts when the complex hedge accounting provisions of SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities”, are not met. SFAS No. 159 is effective for years beginning after November 15, 2007. Since adoption, the Company has not elected fair value option for any financial instruments, however, any future selection o f fair value option, for a selected financial instrument, may have a material effect on the Company’s financial condition and results of operations.

In December 2007, the FASB issued SFAS No. 160, Noncontrolling Interests in Consolidated Financial Statements, an amendment of ARB 51 , which changes the accounting and reporting for minority interests. Minority interests will be recharacterized as non-controlling interests and will be reported as a component of equity separate from the parent’s equity, and purchases or sales of equity interests that do not result in a change in control will be accounted for as equity transactions. In addition, net income attributable to the noncontrolling interest will be included in consolidated net income on the face of the income statement and, upon a loss of control, the interest sold, as well as any interest retained, will be recorded at fair value with any gain or loss recognized in earnings. SFAS No. 160 is effective for us beginning January 1, 2009 and will apply prospectively, except for the presentation and disclosure requi rements, which will apply retrospectively. We do not expect this standard to have a material effect on our consolidated financial statements.

F- 12

ECOSPHERE TECHNOLOGIES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

FOR THE YEARS ENDED DECEMBER 31, 2008 AND 2007

In December 2007, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards (“SFAS”) No. 141 (revised 2007), Business Combinations , which replaces SFAS No 141. The statement retains the purchase method of accounting for acquisitions, but requires a number of changes, including changes in the way assets and liabilities are recognized in the purchase accounting. It also changes the recognition of assets acquired and liabilities assumed arising from contingencies, requires the capitalization of in-process research and development at fair value, and requires the expensing of acquisition-related costs as incurred. SFAS No. 141R is effective for us beginning January 1, 2009. We do not expect it to have a material effect on our consolidated financial statements.

In June 2008, the FASB issued FASB Staff Position (FSP) Emerging Issues Task Force (EITF) 03-6-1, “Determining Whether Instruments Granted in Share-Based Payment Transactions are Participating Securities.” This FSP addresses whether instruments granted in share-based payment transactions are participating securities prior to vesting and, therefore, need to be included in the earnings allocation in computing earnings per share under the two-class method as described in SFAS No. 128, “Earnings per Share.” The Company will adopt the FSP, which affects the calculation of earnings per share, in the first quarter of 2009. The provisions of the FSP are to be applied retrospectively. The Company expects that it will not have a material effect on the consolidated financial statements.

FSP No. 132(R)-1, “Employers’ Disclosures about Postretirement Benefit Plan Assets,” was issued on December 30, 2008. This statement, effective for fiscal years ending after December 15, 2009, clarifies an employer’s disclosures about plan assets of a defined benefit pension or other postretirement plan. This statement prescribes expanded disclosures regarding investment allocation decisions, categories of plan assets, inputs, and valuation techniques used to measure fair value, the effect of Level 3 inputs on changes in plan assets and significant concentrations of risk. The Company will adopt the FSP at the end of 2009 and expects it will not have a material effect on the consolidated financial statements.

GOING CONCERN

The accompanying consolidated financial statements were prepared assuming that the Company will continue as a going concern. This basis of accounting contemplates the realization of assets and the satisfaction of liabilities in the normal course of operations. During the year ended December 31, 2008, the Company incurred net losses applicable to common stock of approximately $11.8 million. At December 31, 2008, the Company had a working capital deficiency of approximately $9.2 million, a stockholders’ deficit of approximately $10.8 million, had an accumulated deficit of approximately $65 million and had outstanding convertible preferred stock that is redeemable under limited circumstances for approximately $3.9 million (including accrued dividends) as of December 31, 2008. The Company has not attained a level of revenues sufficient to support recurring expenses, and the Company does not presently have t he resources to settle previously incurred obligations. These factors, among others, raise substantial doubt about the Company’s ability to continue as a going concern.

The Company’s continued existence is dependent upon its ability to resolve its liquidity problems. Management devotes a substantial amount of time to speaking with potential investors but has not reached any agreement upon terms. Pending our ability to do so, our Chief Financial Officer has arranged to borrow up to $150,000 from domestic and overseas investors. Additionally, we have regularly been communicating with Bledsoe Capital Group, LLC with respect to the possible exercise of their option on modified terms. Because of the continuing decline in the economy in the United States and overseas, we have been hampered in our ability to raise the necessary working capital. As a result of limited liquidity, only critical vendor payments are being made to conserve cash resources. Working capital limitations may impinge on day-to-day operations. The continued support and forbearance of its creditors and preferred shareholde rs will be required, although this is not assured.

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

F- 13

ECOSPHERE TECHNOLOGIES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

FOR THE YEARS ENDED DECEMBER 31, 2008 AND 2007

ACCOUNTS RECEIVABLE

As of December 31, 2008, accounts receivable in the amount of $123,728 relates to amounts due from a customer for processing frac flowback water in November and December 2008. Accounts receivable as of December 31, 2007 amounted to $3,800. As of December 31, 2008, the Company has not recorded an allowance for doubtful accounts as all amounts due are considered fully collectible.

PREPAID EXPENSES AND OTHER CURRENT ASSETS

Prepaid expenses and other current assets are summarized as follows:


	December 31, 2008		December 31, 2007
Vendor deposits	$	14,351	$	14,342
Prepaid consulting fees		—		450
Prepaid interest expense		—		71,556
Prepaid insurance		55,750		—
Other		2,000		31,337
Total prepaid expenses and other current assets	$	72,101	$	117,685

PROPERTY AND EQUIPMENT

Property and equipment consists of the following:


	Est. Useful Lives	December 31, 2008			December 31, 2007
Plant and machinery	5 years	$	1,526,330		$	23,944
Water filtration equipment	5 years		865,375			865,487
Furniture and fixtures	7 years		286,694			277,250
Automobile and trucks	5 years		56,047			41,233
Leasehold improvements	5 years		234,718			214,116
Office equipment	5 years		436,859			398,679

			3,406,023			1,820,709
Less total accumulated depreciation			(1,530,132	)		(1,272,591	)

Property and equipment, net		$	1,875,891		$	548,118

The Company entered into two capital leases during the year ended December 31, 2007, expiring at various dates through March 2010. The leased assets and the related liabilities were transferred on the sale of assets and intellectual property. Amortization of the assets held under capital leases, prior to the UES sale, is included in the costs of revenue component of depreciation expense and was approximately $137,485 for the year ended December 31, 2007. The remaining capital lease relates to a copier. During the year ended December 31, 2008, depreciation expense related to this asset amounted to $21,404.

In connection with the UES sale of intellectual property and associated equipment and inventory, the Company sold all of the assets held for sale at September 30, 2007, with a net book value of approximately $2,198,000. The sale of the equipment and inventory was recorded as a wash sale with no corresponding gain or loss being recognized. Depreciation expense of $153,522 primarily relating to the sold equipment is included in cost of revenues in 2007. Total depreciation expense for 2007, including the $153,522 included in cost of revenues in 2007 was $303,755. Depreciation expense for 2008 was $257,542.

The Company placed two Ozonix filtration units into service during the year ended December 31, 2008 at an aggregate capitalized cost of approximately $1,467,000. These units are being depreciated using the straight line method over five years. These units plus the Water Filtration Truck and another non-Ozonix water filtration unit collateralize certain secured notes payable of the Company. As of December 31, 2008, the aggregate carrying value of these assets was approximately $1,676,000.

F- 14

ECOSPHERE TECHNOLOGIES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

FOR THE YEARS ENDED DECEMBER 31, 2008 AND 2007

ACCRUED EXPENSES

The major components of accrued expenses are summarized as follows:


	December 31, 2008		December 31, 2007
Accrued payroll and related benefits	$	441,342	$	468,808
Accrued interest		476,753		372,282
Other accrued expenses		539,402		341,708
Total accrued expenses	$	1,457,497	$	1,182,798

NOTES PAYABLE

(a.)

Related Parties

Notes payable to related parties consist of the following:


	December 31, 2008		December 31, 2007
Unsecured notes payable to Director, interest at prime plus 2% (9.25% at December 31, 2007). Effective January 1, 2007, the Company and Director modified the note whereby the Company agreed to pay Director $40,000 per quarter beginning on March 31, 2007, until all amounts currently owed to Director (this $240,000 note, plus accrued interest and commissions earned, totaling $341,412) are paid in full. Per the agreement, payments will first be applied to accrued interest, then accrued commissions and then the principal balance of the note. After no payments were made under the January 1, 2007 terms, the Company and the Director entered into a new agreement in June 2008 whereby the Company made a payment of $31,080 to the Director and signed a new note agreement for the balance of all amounts due under the prior agreement plus accrued interest, $374,423. The new agreement calls for quarterly principal and interest payments of $50,000 and a fixed interest rate of 7%. As of December 31, 2008, the Company has made one payment of $50,000 under the new terms. The note is in default as of December 31, 2008.	$	335,714	$	240,000

Secured 12 % one year notes convertible at $0.15 per share of common stock payable to the Company’s Chief Executive Officer with principal amounts of $650,000. The holder received 1,300,000 three year warrants exercisable at $0.15 per share. The Company recorded a note discount related to the warrants and the beneficial conversion of $318,307 which is being amortized over the life of the notes. As of December 31, 2008 the unamortized amount of this these discounts is $48,419. The notes are due in varying amounts from March 2009 to May 2009. As of December 31, 2008, the Company owes accrued interest of $57,317 on these notes. $325,000 of these notes were reclassified to related party in 2008.		601,581		—

Secured one year original issue discount note convertible at $0.36 per share of common stock payable to the Company’s Chief Executive Officer with a principal amount of $111,111. The holder funded $100,000 to the Company. As such the Company recognized an original issue discount of $11,111 which is being amortized over the term of the note. In addition, the Company recorded a note discount related to the beneficial conversion feature of $24,691 which is being amortized over the life of the note. As of December 31, 2008 the unamortized amount of these discounts is $23,443. The note is due in August 2009.		87,668		—

F- 15

ECOSPHERE TECHNOLOGIES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

FOR THE YEARS ENDED DECEMBER 31, 2008 AND 2007


	December 31, 2008		December 31, 2007
Secured 12 % one year note convertible at $0.15 per share of common stock payable to a Director with a principal amount of $50,000. The holder received 100,000 three year warrants exercisable at $0.15 per share. The Company recorded a note discount related to the warrants and the beneficial conversion of $33,299 which has been fully amortized as of December 31, 2008, since the note was exchanged in 2008. The note is due in March 2009. As of December 31, 2008, the Company owes accrued interest of $4,800 on these notes. This note replaced a note dated January 2008 and was reclassified to related party in 2008.		50,000		—

Secured one year original issue discount note convertible at $0.36 per share of common stock payable to a Director with a principal amount of $200,000. The holder funded $180,000 to the Company. As such the Company recognized an original issue discount of $20,000 which is being amortized over the term of the note. In addition, the Company recorded a note discount related to the beneficial conversion feature of $166,667 which is being amortized over the life of the note. As of December 31, 2008 the unamortized amount of these discounts is $129,378. The note is due in September 2009.		70,622		—

Secured 12 % one year notes convertible at $0.15 per share of common stock payable to the Company’s Senior Vice President of Business Development with principal amounts of $300,000. The holder received 600,000 three year warrants exercisable at $0.15 per share. The Company recorded a note discount related to the warrants and the beneficial conversion of $221,882 which is being amortized over the life of the debt. As of December 31, 2008 balance of unamortized discount was $82,294. The notes are due in varying amounts from March 2009 to May 2009. As of December 31, 2008, the Company owes accrued interest of $22,882 on these notes.		217,706		—

Secured one year original issue discount note convertible at $0.36 per share of common stock payable to the Company’s Senior Vice President of Business Development with a principal amount of $111,111. The holder funded $100,000 to the Company. As such the Company recognized an original issue discount of $11,111 which is being amortized over the term of the note. In addition, the Company recorded a note discount related to the beneficial conversion feature of $24,691 which is being amortized over the life of the note. As of December 31, 2008 the unamortized amount of this discount is $23,443. The note is due in September 2009.		87,668		—

Secured 12 % one year note convertible at $0.15 per share of common stock payable to an Employee with a principal amount of $35,000. The holder received 70,000 three year warrants exercisable at $0.15 per share. The Company recorded a note discount related to the warrants and the beneficial conversion of $15,592 which has been fully amortized as of December 31, 2008, since the note was exchanged in 2008. The note is due in March 2009. As of December 31, 2008, the Company owes accrued interest of $3,381 on this note. This note replaced a note dated December 2007 and was reclassified to related party in 2008.		35,000		—

F- 16

ECOSPHERE TECHNOLOGIES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

FOR THE YEARS ENDED DECEMBER 31, 2008 AND 2007


	December 31, 2008		December 31, 2007
Unsecured demand notes payable to principal shareholders, interest at 10%.		—		210,000

Unsecured note payable to a company owned by Ecosphere’s principal shareholders, interest at prime plus 2% (9.25% at December 31, 2007), due upon demand. The note plus accrued interest of $18,750 was repaid in December 2008.		—		26,000


Total		1,485,959		476,000
Less: current portion		1,370,141		476,000
Related party notes payable – net of current portion	$	115,818	$	—

All amounts due to related parties are due in 2009 and 2010.

(b.)

Other

Notes payable consist of the following:


	December 31, 2008		December 31, 2007
Unsecured, convertible, three year, 9% debentures (December 2006 Convertible Debenture Financing), with a principal amount of $5,595,238 at December 31, 2006, issued at an original discount, with warrants. During 2007, the debentures were replaced by new debentures that are convertible into common stock at $0.15 per share and the original warrants were replaced by warrants exercisable at $0.15 per share, as a result of the closing of the UES asset sale on October 9, 2007. In addition, principal in the amount of $4,000,000 was repaid and principal in the amount of $14,706 was converted into 97,410 shares of common stock, resulting in a principal balance of $1,580,532 at December 31, 2007. The debt modification and repayment has been treated as a debt extinguishment under EITF 96-19 and accordingly, all pre-extinguishment discounts were written-off, resulting in a loss on extinguishment of debt in 2007 in the amount of $2,648,534, and the new discounts have been recorded. The Company recorded a discount in the amount of $1,045,260 related to the warrants and a discount of $535,273 related to the beneficial conversion feature. At December 31, 2008 and 2007, unamortized discounts totaled $503,655 and $1,398,164, respectively. During the year ended December 31, 2008, the holders converted $428,657 of principal into 2,857,713 shares of common stock. As of December 31, 2008, the Company owes accrued interest of $51,834 on these debentures.	$	648,221	$	182,369

Unsecured notes payable, interest at prime plus 2% (5.25% at December 31, 2008), due as follows: $1,297,870 on July 13, 2008. The principal amount of these notes as of December 31, 2008 and 2007 was $504,652 and $772,870, respectively. On February 13, 2007 the maturity date was extended to July 13, 2007 in exchange for a principal payment of $50,000, payment of accrued interest of $38,684 and payment of an extension fee and expenses totaling $51,500 which has been expensed as of September 30, 2007. On July 13, 2007, the Company entered into a second extension agreement with the lender in which, it paid the lender $525,000 in principal, accrued interest from February 22, 2007, a $50,000 extension fee (one-half in cash and one-half in common stock) and $3,500 of the lender’s attorney fees. In July 2008, the maturity date was extende d until October 2008 with the payment of $100,000 of principal, $15,510 of accrued interest and $25,000 of extension fees (50% in cash and 50% in stock) and expenses of $2,500. In October 2008, the due date was further extended until January 2009 by the payment of $168,218 of principal and $14,275 of accrued interest. The remaining principal balance is currently due. As of December 31, 2008, the Company owes accrued interest of $6,444 on this note.		504,652		772,870

F- 17

ECOSPHERE TECHNOLOGIES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

FOR THE YEARS ENDED DECEMBER 31, 2008 AND 2007


	December 31, 2008		December 31, 2007
Unsecured convertible notes payable, net of unamortized discount of $745,095 at December 31, 2007, interest at 10% due at various dates between October 10, 2008 and November 19, 2008. The Notes are convertible into shares of common stock at the rate of $0.15 per share resulting in the recognition and recording of a debt discount related to the beneficial conversion feature in the amount of $716,673. The note holders were previously holders of unsecured debt of the Company which was in default. The prior principal balances due, plus accrued interest were converted into new notes with an aggregate principal balance of $943,392 at December 31, 2007. In addition, the company agreed to issue one share of common stock for every $1 of new convertible debt, and agreed to prepay the interest on the note. No interest has been prepaid as of December 31, 2007. The relative fair value of the common stock was $185,529 which was recorded as a debt discount. In 2008, additional notes in default, with principal and accrued interest in the aggregate amount of $557,817 were converted into unsecured convertible notes. As result, the Company issued an additional 557,817 shares of common stock to the note holders. The relative fair value of the stock $108,475, plus the beneficial conversion feature of the notes, $401,905 was recorded as a debt discount. During the year ended December 31, 2008, all of these unsecured convertible notes with an aggregate principal balance of $1,451,389 were converted into 9,741,399 shares of common stock and all discounts were amortized to interest expense.		—		198,297

Unsecured bridge finance notes payable, convertible into common stock at the rate of $1.00 per share of common stock, contains two detachable warrants for every dollar of principal to acquire shares of common stock at an exercise price of $1.00 and $1.25 per share, interest at 5%, due on demand. $25,000 of the notes payable was converted into 25,000 shares of common stock in 2007 and $10,000 was converted into a new 10% convertible note in 2007. Subsequent to December 31, 2007, a note holder agreed to convert $100,000 of bridge finance notes payable into a $103,068 note payable due in October 2008, bearing interest of 10% and convertible into common stock at the rate of $0.15 per share. In addition, the Company issued 103,068 shares of common stock to the holder and agreed to prepay all interest due under the note.		—			150,000

Unsecured convertible notes in the principal amount of $355,000, convertible into common stock at the rate of $0.15 per share. In addition, holders received two warrants for each $1 of principal, net of unamortized discount of $161,880 at December 31, 2007. The warrants expire in 2012 and have an exercise price of $0.15 and $0.20. A beneficial conversion feature, related to the conversion feature of the notes, was recorded in the amount of $73,861. In March 2008, the notes were exchanged for secured convertible line of credit agreements bearing interest of 12%, changing the $0.20 warrant exercise price to $0.15 and securing the agreements with the Company’s Water Filtration Truck demonstration unit. In 2008, $325,000 of these notes were reclassified to related party debt. As of December 31, 2008, the Company owes accrued interest of $3,381 on this note.		30,000			193,120

Secured 12% convertible notes in the principal amount of $1,350,000, convertible into common stock at the rate of $0.15 per share. In addition, holders received two warrants for each $1 of principal. The warrants expire in 2012 and have an exercise price of $0.15 per share. A debt discount of $1,283,203 was recorded related to the relative fair value of the warrants and the beneficial conversion feature of the notes. Unamortized discount as of December 31, 2008 was $293,919. These notes are secured with Company’s Water Filtration Truck demonstration unit and are due in varying amounts from March 2009 to June 2009. As of December 31, 2008 accrued interest under these notes amounted to $194,060.		1,056,081			—

F- 18

ECOSPHERE TECHNOLOGIES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

FOR THE YEARS ENDED DECEMBER 31, 2008 AND 2007


	December 31, 2008		December 31, 2007
Secured $1 million, one year line of credit agreement bearing interest of 10% and secured by the initial pilot project Ozonix unit. The Company issued warrants to purchase 1,000,000 shares of the Company’s common stock at an exercise price of $0.15 per share expiring in five years. The Company recorded a debt discount for the relative fair market value of the warrants, $182,567 and is amortizing the discount over the term of the notes. As of December 31, 2008, the balance of unamortized discount was $54,168. Principal and interest are due under this agreement on May 21, 2009. Accrued interest as of December 31, 2008 amounted to $61,507.		945,832		—

Secured $2 million, notes payable bearing interest of 15% and secured by the Newfield and Williams project Ozonix units. Amounts under this agreement are due in November and December 2009. The Company issued warrants to purchase 666,667 shares of the Company’s common stock at an exercise price of $0.38 per share expiring in five years. The Company recorded a debt discount for the relative fair market value of the warrants, $190,076 and is amortizing the discount over the term of the notes. As of December 31, 2008, the balance of unamortized discount was $166,316. Accrued interest as of December 31, 2008 amounted to $25,274.		1,833,684		—

Secured one year original issue discount notes convertible at $0.36 per share of common stock payable to various holders of Business Development with a principal amount of $1,428,889. The holders funded $1,286,000 to the Company. As such the Company recognized an original issue discount of $142,889 which is being amortized over the term of the note. In addition, the Company recorded a note discount related to the beneficial conversion feature of $737,856 which is being amortized over the life of the notes. As of December 31, 2008 the unamortized amount of these discounts is $629,993. The notes are due in various amounts from September through December 2009.		798,896		—

Unsecured convertible notes payable, convertible into common stock at a fixed rate equal to the closing price of the Company’s common stock the day before the investment was made which was $0.56. Interest at 12%, due 12 months from the respective issues dates through August 2007. As of December 31, 2008, the due date of the note has been extended until December 2009. As of December 31, 2008, the Company owes accrued interest of $3,025 on this note.		100,000		275,000

Unsecured bridge finance note payable of $50,000, convertible into common stock at the rate of $1.00 per share of common stock, contains two detachable warrants for every dollar of principal to acquire shares of common stock at an exercise price of $1.00 and $1.25 per share, interest at 18%.		—		50,000

Unsecured notes payable of $50,000 and $150,000 at December 31, 2008 and 2007, respectively, issued with one restricted common share for each dollar invested; interest at 8%, due 12 months from the respective issue dates through November 2007. At December 31, 2008 and 2007, $50,000 and $150,000, respectively, of the notes payable was in default with a resultant interest rate of 18%. As of December 31, 2008, the Company owes accrued interest of $9,238 on this note.		50,000		150,000

Unsecured notes payable to a group of shareholders with original principal of $156,882, originally requiring 58 monthly payments of $15,067 at an interest rate of 26%, payable through September 2010. These notes were reclassified as notes payable to an unrelated party during the year ended December 31, 2007. During 2008 two note holders converted the balance of principal and accrued interest into new unsecured convertible notes bearing interest of 10%. As of December 31, 2008, only one note holder remains.		52,469		156,882
Total		6,019,835		2,128,538

Less current portion		5,994,435		1,842,555

Long-term debt	$	25,400	$	285,983

F- 19

ECOSPHERE TECHNOLOGIES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

FOR THE YEARS ENDED DECEMBER 31, 2008 AND 2007


		Principal		Unamortized Discount			Debt, Net of Discount
Unrelated parties
	Convertible & non-convertible notes payable	$	7,667,885	$	(1,648,050	)	$	6,019,835
	Less current portion		7,642,485		(1,648,050	)		5,994,435
	Convertible & non-convertible notes payable, net of current portion	$	25,400	$	—		$	25,400

Related parties
	Convertible & non-convertible notes payable	$	1,792,937	$	(306,978	)	$	1,485,959
	Less current portion		1,677,119		(306,978	)		1,370,141
	Convertible & non-convertible notes payable, net of current portion	$	115,818	$	—		$	115,818

As of December 31, 2008, the Company was in default on certain of the above mentioned notes payable totaling $385,714 for failure to make payments as agreed.

As of December 31, 2008 the weighted average interest rate on the Company’s short term debt was 11.5%.

Future cash payment obligations for notes payable are as follows:


Year ending December 31,
2009	$	9,319,603
2010		141,218
2011 and later		—
Total	$	9,460,821

REDEEMABLE CONVERTIBLE CUMULATIVE PREFERRED STOCK

Series A

As of December 31, 2008 and 2007, respectively, there were seven and nine 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, and the shares became redeemable at the option of the holder in September 2002 at $25,000 per share plus accrued dividends. The shares are convertible each into 24,000 common shares. Accrued dividends totaled $936,306 and $904,431 on December 31, 2008 and 2007, respectively. During the year ended December 31, 2008, two holders each converted one share of Series A preferred stock into common stock.

Series B

As of December 31, 2008 and 2007, there were 424 and 429 shares of Series B Redeemable Convertible Cumulative 10% Preferred Stock outstanding, respectively. The shares are redeemable at the option of the Company at $3,000 per share plus accrued dividends, and the shares became redeemable at the option of the holder in September 2002 at $2,500 per share plus accrued dividends. The shares are convertible each into 835 common shares. Accrued dividends totaled $1,762,239 and $1,655,864 on December 31, 2008 and 2007, respectively. During the year ended December 31, 2008, five holders converted a total of 5 shares of Series B preferred stock into shares of common stock.

In February 2009, the Board approved a correction to the Preferred Stock designations to adjust the conversion rate of Series A and B for any stock splits or other recapitalizations. The Board also ratified the past actions whereby management issued common stock upon conversion of Series A Preferred shares at a 24,000 to 1 ratio.

F- 20

ECOSPHERE TECHNOLOGIES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

FOR THE YEARS ENDED DECEMBER 31, 2008 AND 2007

COMMON STOCK

The Company is authorized to issue up to 300,000,000 shares of its $0.01 par value common stock as of December 31, 2008.

Shares issued

Issuances of the Company’s common stock during the years ended December 31, 2008 and 2007, respectively, included the following:

Shares Issued for Cash

2008

1,285,000 shares of common stock were issued for $189,300 cash through the exercise of warrants with strike prices between $0.10 and $0.28 per share.

Shares Issued for Services and Finders fees

2008

Of a total of 450,000 shares issuable to our CEO as a finder’s fee for arranging $1,750,000 of financing, with a fair market value of $288,000 based on the quoted market price of the stock on the date of grant, $0.64. 250,000 shares of common stock were issued. The Company recognized a loss on conversion of $200,500 representing the difference between the finder’s fee of $87,500 and the fair value of the total shares of common stock to be issued. 250,000 shares remain issuable as of December 31, 2008.

359,524 shares of common stock with a fair market value of $96,000 based on the quoted market prices of the stock on the dates of grant of between $0.23 and $0.42 per share, were issued to various parties for services valued at $88,000. As such, the Company recognized a loss on conversion of $8,000.

2007

2,000,000 shares of common stock were issued as partial finder’s fee compensation related to the leasing of equipment with a value of $680,000 based on a quoted trading price of $0.34 per share.

333,333 shares of common stock were issued as an inducement to services providers with a value of $118,750 based on a quoted trading price ranging from $0.35 to $0.36 per share.

1,041,666 shares were issued in payment of legal fees related to the UES sale at a quoted trading price of $0.31 per share or $322,917.

56,000 shares were issued for services rendered and previously recorded as accounts payable of $14,000. The shares were valued based on a quoted trading price of $0.30 per share or $16,800, resulting in a loss on conversion of $2,800 which is included in the loss on conversion in the accompanying consolidated statement of operations.

Shares Issued as Compensation

2008

100,000 shares of common stock granted in 2007 were issued, upon vesting in 2008, as compensation to an employee. The expense was recognized over the requisite service period. The Company recognized compensation expense of $31,000 in 2008 related to these shares based on the quoted trading price of $0.31 per share, on the date of grant, February 12, 2007.

833,333 shares of common stock were issued as compensation to Directors for their service in 2007 and were vested immediately. The Company recognized compensation expense of $150,000 related to these shares based on the quoted trading price of $0.18 on the date of grant, April 30, 2008.

F- 21

ECOSPHERE TECHNOLOGIES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

FOR THE YEARS ENDED DECEMBER 31, 2008 AND 2007

143,716 shares of common stock were issued to Directors in connection with their vesting on August 10, 2008 and 2007. The Company recognized compensation expense of $116,410 in 2008 related to these shares based on the quoted trading price of $0.81 on the date of grant, August 10, 2006.

16,000 shares of common stock vested and were issued to an Advisory Board Member in connection with the vesting on August 23, 2008. The Company recognized compensation expense of $4,000 in 2008 related to these shares based on the quoted trading price of $0.25 on the date of grant, August 23, 2007. As of December 31. 2008, 36,000 shares remain unvested related to this grant.

2007

200,000 shares of common stock were issued as compensation to an employee with a value of $62,000 based on a quoted trading price of $0.31 per share, 50% of the shares vested upon issuance and 50% will cliff vest one year from issuance. As of December 31, 2007, 100,000 shares were considered as issued and outstanding in the accompanying financial statements. Compensation expense is recognized pro rata over the vesting period.

200,952 shares of common stock were issued in connection with the appointment of one new advisory board member and one new director. Shares were issued based upon the prescribed fees for such appointments, $12,000 and $40,000, respectively, at the quoted trading price of $0.35 and $0.24 respectively, on the date of appointment by the board of directors.

Shares Issued in Conversion of Preferred Stock

2008

48,000 common shares were issuable upon conversion of 2 shares of Series A Preferred Stock and 4,175 shares of common stock were issued upon conversion of 5 shares of Series B Preferred Stock. As of December 31, 2008, 36,000 shares remained issuable. The total value of the preferred shares converted was $62,500.

2007

29,225 shares of common stock were issued upon conversion of 35 shares of Series B Convertible Preferred Stock with a value of $87,500, which was reclassified from redeemable Series B convertible cumulative preferred stock to permanent equity at the conversion date.

Shares Issued in Payment of Interest

2008

376,999 shares of common stock with a value of $145,559 based on quoted trading prices of between $0.17 and $0.71 per share, were issued as payment for interest of $103,892 to the holders of the December 2006 debentures, resulting in an aggregate loss on conversion of $41,667 which is included in loss on conversion in the accompanying consolidated statement of operations.

54,849 shares of common stock, with a value of $14,333, based on a quoted trading price of $0.26 per share were issued as payment for interest, resulting in an aggregate loss on conversion of $6,106 which is included in loss on conversion in the accompanying consolidated statement of operations.

2007

1,736,048 shares of common stock were issued as quarterly interest payments of $400,059, to the holders of the December 2006 debentures based on a quoted trade price of $0.36 per share for 415,681 shares, $0.19 per share for 708,419 shares and $0.25 per share for 612,148 shares aggregating a total value of $471,448, resulting in a loss on conversion of $71,389 which is included in loss on conversion in the accompanying consolidated statement of operations.

F- 22

ECOSPHERE TECHNOLOGIES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

FOR THE YEARS ENDED DECEMBER 31, 2008 AND 2007

Shares Issued in Conversion of Debt and other liabilities

2008

9,741,399 shares of common stock were issued to lenders upon conversion of 10% convertible notes in the amount of $1,451,389 at a conversion rate of $0.15 per share.

2,857,713 shares of common stock were issued upon conversion of December 2006 convertible debentures in the amount of $428,657 at a conversion rate of $0.15 per share.

2007

1,041,666 shares of common stock were issued upon conversion of convertible debt in the amount of $500,000.

98,040 shares of common stock were issued to convert $14,706 of convertible note principal at a conversion rate of $0.15 per share. The shares were valued for accounting purposes at the quoted trading price on the conversion date, ranging from $0.21 to $0.23 per share, resulting in a non-material loss on conversion.

Shares Issued in Conversion of Debt to New Debt or Extension of Maturity Dates

2008

583,859 shares of common stock were issued as inducement for the conversion or extension of notes in default. The shares were issued with fair market values of between $0.20 and $0.47 per share based upon the quoted trading price at the conversion or extension dates. The value of the shares $119,105 was recorded as a discount on notes of $106,605 which was amortized to interest expense when all the notes converted to common stock in 2008 and a direct charge to interest expense of $12,500. In addition, 297,763 previously issuable shares were issued in 2008.

2007

801,881 shares of common stock were issued and 297,763 shares of common stock are issuable as inducement for the conversion or extension of notes in default. The shares were issued with fair market values of between $0.23 and $0.31 per share based upon the quoted trading price at the conversion or extension dates. The value of the shares $233,966 was recorded as interest expense and discount on notes of $48,437 and $185,529, respectively. Of the above mentioned 1,099,644 issued and issuable shares, 156,250 shares valued at $48,437 were for a maturity date extension fee and such amount was recorded as interest expense, and 943,393 shares were issued in connection with converting debt in default into 10% convertible notes. The value of the 943,393 shares, $185,529 has been recorded as a discount on the notes and will be recognized as interest expense over the term of the debt.

Shares Issued in Cashless Warrant Exercise

2008

6,000 shares of common stock were issued for 6,000 warrants, at no cost per warrant. These warrants were issued prior to the December 2006 issuance of the Company’s senior convertible debentures; and the exercise price was lowered to zero with no accounting effect.

2,992,413 shares of common stock were issued for 4,209,833 warrants upon the holders invoking the noncash exercise clause of the warrant agreements.

2007

10,080 shares of common stock were issued for 10,080 warrants at no cost per warrant. These warrants were issued prior to the December 2006 issuance of the Company’s senior convertible debentures; and the exercise price was lowered to zero with no accounting effect.

F- 23

ECOSPHERE TECHNOLOGIES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

FOR THE YEARS ENDED DECEMBER 31, 2008 AND 2007

The Company recognized share-based compensation expense related to stock grants, issued per the terms of the 2006 Equity Incentive Plan, as amended, of $221,863 for the year ended December 31, 2008. The following table summarizes non-vested restricted stock and the related activity as of December 31, 2008:


	Shares			Weighted Average Grant-Date Fair-Value
Non-vested at January 1, 2008		441,960		$	0.44
Granted		1,589,667		$	0.27
Vested		(1,278,958	)	$	0.25
Forfeited		(10,163	)	$	0.82

Non-vested at December 31, 2008		742,506		$	0.40

Total unrecognized share-based compensation expense from unvested restricted stock as of December 31, 2008 was $257,749 which is expected to be recognized over a weighted average period of approximately .54 year. No restricted stock grants were issued prior to May 2006, the initiation of the plan.

10.

NET LOSS PER SHARE

Basic net loss per common share applicable to common stockholders is computed on the basis of the weighted average number of common shares outstanding during each period presented. Diluted net loss per common share applicable to common stockholders is computed on the basis of the weighted average number of common shares and dilutive securities outstanding. Dilutive securities having an anti-dilutive effect on diluted net loss per common share are excluded from the calculation.

The Company’s outstanding options and warrants to acquire common stock and shares of common stock which may be issued upon conversion of outstanding redeemable convertible cumulative preferred stock and convertible debt (all aggregating 112,516,134 and 84,488,325 shares of common stock at December 31, 2008 and 2007, respectively) are not included in the computation of net loss per common share because the effects of inclusion would be anti-dilutive. These shares may dilute future earnings per share.

11.

STOCK OPTIONS AND WARRANTS

The fair value of each option is estimated on the date of grant using the Black-Scholes option-pricing model. This model incorporates certain assumptions for inputs including a risk-free market interest rate, expected dividend yield of the underlying common stock, expected option life and expected volatility in the market value of the underlying common stock. We used the following assumptions for options issued in the following periods:


	For the Year Ended December 31,
	2008		2007
Expected volatility		92.5 - 148.3%		116 - 144%
Expected lives		2.5 - 5 yrs		4 - 10 yrs.
Risk-free interest rate		1.22 - 3.35%		3.54 - 4.64%
Expected dividend yield		None		None

The Black-Scholes option-pricing model was developed for use in estimating the fair value of traded options, which have no vesting restrictions and are fully transferable. In addition, option valuation models require the input of highly subjective assumptions including the expected stock price volatility. Because the Company’s stock options and warrants have characteristics different from those of its traded stock, and because changes in the subjective input assumptions can materially affect the fair value estimate, in management’s opinion, the existing models do not necessarily provide a reliable single measure of the fair value of such stock options. The risk free interest rate is based upon quoted market yields for United States Treasury debt securities. The expected dividend yield is based upon the Company’s history of having never issued a dividend and management’s current expectation of future action surrounding dividends. Expected volatility in 2008 is based on historical volatility for the expected term as it is a reasonable estimate of expected future volatility. Implied volatility was not considered as the Company does not have any traded options or warrants. The expected terms of the options and warrants are estimated using either the option term, for non-employee options and warrants, or the simplified method for employee and director grants.

F- 24

ECOSPHERE TECHNOLOGIES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

FOR THE YEARS ENDED DECEMBER 31, 2008 AND 2007

Stock-based compensation expense for the years ended December 31, 2008 and 2007 was $1,599,650 and $299,216, respectively. As of December 31, 2008 and 2007, there was $3,354,073 and $194,521, respectively, of total unrecognized compensation cost related to unvested options granted under the Company’s option plans. This unrecognized compensation cost is expected to be recognized over the next two years.

EMPLOYEE FIXED STOCK OPTION PLANS:

On August 15, 1999, the Company adopted an Outside Directors Stock Option Plan, which provides for the granting of 2,000,000 stock options to members of the Board who are not full or part time employees of the Company. Under the plan, each eligible director will be granted an option to purchase up to 200,000 shares on the date the person is elected to the Board and will be granted an option to purchase 50,000 shares upon reelection to the Board at each annual shareholders meeting. The stock options are not exercisable until six months after the grant date and are exercisable over a five-year period. As of December 31, 2008 and 2007, no options are outstanding under this plan.

On August 18, 2000, the Company adopted a Long Term Incentive Program, which provides for the granting of 4,000,000 stock options and stock appreciation rights (SARs) to key employees. Options granted may be either "incentive stock options," pursuant to provisions of the Internal Revenue Code, non-qualified options, or restricted stock awards. The stock options are exercisable for a period no longer than ten years after the date they are granted. Pursuant to the terms of the Plan, no new awards may be granted under the Plan after September 1, 2002. As of December 31, 2008 and 2007, respectively, options to purchase 40,000 and 99,999 shares of common stock at $0.28 and $3.00 per share were outstanding under the plan.

On November 17, 2003, the Company adopted the 2003 Equity Incentive Program, which provides for the granting of 4,000,000 stock options and stock appreciation rights (SARs) to key employees. Options granted may be either "incentive stock options," pursuant to provisions of the Internal Revenue Code, non-qualified options, or restricted stock awards. Exercise prices of stock options are generally not less than the fair market value of common stock on the grant date. Options vest at a rate of at least 20% per year over five years from the date the option is granted. Stock options are exercisable for a period no longer than ten years after the Date they are granted. The Plan shall terminate November 17, 2013. As of December 31, 2008 and 2007, options to purchase 135,500 shares of common stock at $1.10 per share are outstanding under this Plan.

On November 17, 2003, the Company adopted the 2003 Stock Option Plan for Outside Directors (Directors) and Advisory Board Members (Director Advisors), which provided for the granting of 2,000,000, and increased on August 2, 2005 to 4,500,000, stock options to members of these Boards who are not full or part time employees of the Company. As of December 31, 2008 and 2007, respectively, options to purchase 1,803,000 and 3,300,000 shares of common stock at exercise prices ranging from $0.28 to $1.43 and $0.53 to $1.43 per share are outstanding under this Plan. The Plan shall continue in existence for a term of ten years unless terminated by the Company.

In May 2006, the Board approved the 2006 Equity Incentive Plan, and as part of that approval, closed the 2003 Equity Incentive Plan and 2003 Stock Option Plan for Outside Directors (Directors) and Advisory Board Members (Director Advisors) from any additional grants.

2006 Equity Incentive Plan

Approved in May 2006, this plan provided for the Company to issue up to 10,000,000 stock options, stock appreciation rights, restricted stock or restricted stock units to our directors, employees and consultants.

F- 25

ECOSPHERE TECHNOLOGIES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

FOR THE YEARS ENDED DECEMBER 31, 2008 AND 2007

Under the 2006 Equity Incentive Plan, all of our directors who are not employees or 10% shareholders and all director advisors shall automatically receive a grant of restricted stock with the number of shares based upon market price at the time of grant. In September 2008, our Board approved changes to these automatic grants which now include stock options. The changes were approved by a vote of the Company’s shareholders in November 2008. The number of shares of restricted stock or options and the exercise price of options will be based on fair market value at the time of grant.


	PROPOSED				FORMER
Qualifying Event	Options(1)		Restricted Stock(1)(2)(3)		Restricted Stock(3)
Initial appointment as Chairman of the Board	$	75,000	$	75,000	$	150,000
Initial election or appointment of non-employee director	$	40,000	$	40,000	$	40,000
Initial appointment as an Advisory Board member	$	15,000	$	10,000	$	12,000
Annual grant to Chairman of the Board	$	40,000	$	40,000	$	75,000
Annual grant to non-employee director	$	25,000	$	25,000	$	15,000
Annual grant to Advisory Board Member	$	10,000	$	5,000	$	3,000
Initial appointment and annual grant of and to a non-employee director as Lead Director(4) or Chairman of a member of the following: Audit Committee, Compensation Committee and other committees at the discretion of the Compensation Committee	$	15,000	$	15,000	$	10,000
InInitial appointment of and annual grant to a non-employee director to the following: Audit Committee, Compensation Committee and other committees at the discretion of the Compensation Committee	$	10,000	$	10,000	$	5,000

———————

(1)

In the event that the Company does not have authorized capital, these persons will receive grants of cash settled SARs .

(2)

The director or director advisor may elect options instead of restricted stock in order to defer income taxes.

(3)

The director or director advisor may at their option receive restricted stock units in lieu of restricted stock.

(4)

The Board may, when the Chairman is an employee, appoint a director to act as Lead Director who will have all of the authority customarily associated with such a position. Our board has appointed a Lead Director.

The Company also changed the vesting of these automatic grants. Previously, all awards vested in three equal installments one, two and three years following the date of each grant, subject to continued service as a director Advisory Board Member on the applicable vesting date. Now, the initial grants to a Chairman of the Board, Board member and Advisory Board member shall vest in annual installments over three years and all other grants shall vest annually, all subject to the person’s continued service in the same capacity on the applicable vesting date. The Company also have added a provision generally prohibiting sales of common stock by our directors for six months after resignation.

Because the Company did not hold an Annual Meeting of Shareholders in 2007 and therefore there were no new appointments or re-appointments and the Company did not grant or have any automatic grants of restricted stock to Board, Board Committee or Advisory Board members, except for persons who joined us in 2007. In April 2008, the Company amended our 2006 Plan to eliminate tying the annual grants to an annual shareholders meeting and provided that the grants for 2007 occurred on April 30, 2008. This amendment has been superseded by the August amendment.

Limitation on Awards

The exercise price of options or SARs granted under the 2006 Plan shall not be less than the fair market value of the underlying common stock at the time of grant. In the case of ISOs, the exercise price may not be less than 110% of the fair market value in the case of 10% shareholders. Options and SARs granted under the 2006 Plan shall expire no later than five years after the date of grant. The option price may be paid in United States dollars by check or wire transfer or, at the discretion of the Board or Compensation Committee, by delivery of shares of our

F- 26

ECOSPHERE TECHNOLOGIES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

FOR THE YEARS ENDED DECEMBER 31, 2008 AND 2007

common stock having fair market value equal as of the date of exercise to the cash exercise price, or a combination thereof.

A maximum of 10,000,000 shares are available for grant under the 2006 Equity Incentive Plan. The identification of individuals entitled to receive awards, the terms of the awards, and the number of shares subject to individual awards, are determined by our Board of Directors or the Compensation Committee, in their sole discretion. The aggregate number of shares with respect to which options or stock awards may be granted under the Equity Incentive Plan and the purchase price per share, if applicable, shall be adjusted for any increase or decrease in the number of issued shares resulting from a stock dividend, stock split, reverse stock split, recapitalization or similar event. As of December 31, 2008 and 2007, respectively, options to purchase 4,983,046 and 3,894,626 shares of common stock at exercise prices ranging from $0.21 to $0.83 per share are outstanding under this Plan.

Expired options relate to options that have terminated because the expiration date has passed or have expired because the employee’s employment has been terminated, and the relevant expiration period has passed. Forfeited options in 2008 relate to options retired in connection with the Option / Warrant exchange program.

Employee Fixed Plan Options


	For the Year December 31, 2008				For the Year December 31, 2007
	Shares		Weighted Average Exercise Price		Shares		Weighted Average Exercise Price
Outstanding at beginning of year	7,565,625		$	0.93	8,268,830		$	0.99

Granted	2,400,920		$	0.39	650,000		$	0.39

Exercised	—		$	––	––		$	––

Forfeited	(3,224,749	)	$	1.05	(882,374	)	$	0.68

Expired	––		$	––	(470,831	)	$	0.47

Outstanding at end of year	6,741,796		$	0.69	7,565,625		$	0.93

Exercisable at end of year	5,913,669		$	0.72	6,415,625		$	0.95

Outstanding
Weighted average remaining contractual term				4.77				5.45
Aggregate intrinsic value			$	70,620			$	––
Weighted average grant date fair value			$	0.20			$	0.20

Exercisable
Weighted average remaining contractual term				4.22				5.83
Aggregate intrinsic value			$	70,620			$	––

During May 2007, the Company granted 400,000 options to an employee valued at $0.34 per share or $135,000. The options have an exercise price of $0.50 and vest over 24 months. The Company recognized expense of $45,067 in 2007. The employee resigned on August 3, 2007 and his options were therefore forfeited three months later on November 3, 2007 at which time the $45,067 prior expense was reversed. The remaining 482,374 options forfeited during the year were related to adjustments of the number of options vesting under the options granted to senior management in May 2006, as a result of semi-annual performance reviews.

In December 2007, the Company granted 250,000 options to employees. The options have an exercise price of $0.18 per share, the fair market value on the date of grant, vest immediately and expire in ten years. The Company recognized expense of $43,318 in 2007 related to the options.

F- 27

ECOSPHERE TECHNOLOGIES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

FOR THE YEARS ENDED DECEMBER 31, 2008 AND 2007

In September 2008 in conjunction with the appointment of three new directors, the Board of Directors issued 854,168 options and cash settled SARS, exercisable at $0.48 per share, the fair value on the date of the grant, and vesting over a three year period, subject to continued service on the board. In addition the Board granted existing members 312,500 options and cash settled SARS, and granted Advisory Board members 156,250 options and cash settled SARS, all exercisable at $0.48 and vesting on June 30, 2009, subject to continued service. All the options and cash settled SARS expire in five years.

In March 2008, the Company issued 1,078,000 options under the Option/Warrant exchange program. These options have a three year term, vest immediately and have an exercise price of $0.28 per share.

Employee Fixed Non-Plan Options


	For the Year December 31, 2008				For the Year December 31, 2007
	Shares		Weighted Average Exercise Price		Shares		Weighted Average Exercise Price
Outstanding at beginning of year	11,316,667		$	0.69	8,760,003		$	1.67
Granted	24,400,000		$	0.44	5,156,667		$	0.15
Exercised	––			––	––			––
Forfeited	(2,500,000	)	$	1.07	––			––
Expired	––			––	(2,600,003	)	$	3.00
Outstanding at end of year	33,216,667		$	0.47	11,316,667		$	0.69
Exercisable at end of year	14,625,000		$	0.48	11,316,667		$	0.69

Outstanding
Weighted average remaining contractual term				4.47				6.2
Aggregate intrinsic value			$	1,093,433			$	257,833
Weighted average grant date fair value			$	0.31			$	0.15

Exercisable
Weighted average remaining contractual term				4.47				6.2
Aggregate intrinsic value			$	998,433			$	257,833

Options granted under the Employee Fixed Non-Plan Options in 2007 related to commissions paid to senior management related to the sale of intellectual property, assets and inventory of the robotic coating removal technology. During the year ended December 31, 2007, the Company granted options to acquire 5,156,667 shares of common stock. The options vested immediately upon the closing of the UES sale and have exercise prices of $0.15 per share and expire in five years. The Company recorded an expense of $773,500 related to these options in 2007.

In April 2008 the Board of Directors granted options to purchase shares of the Company’s common stock to its Founder and Co-Chief Executive Officer (Co-CEO). Options were granted to purchase 7,000,000 shares at an exercise price of $0.30 per share, the fair market value on the date of the grant, over a five year term. Of the options granted, 2,000,000 vested immediately, 2,000,000 will vest over a three year period subject to continued employment on the applicable vesting date and 3,000,000 will vest over a three year term, subject to meeting specified milestones.

Additionally, in June 2008, the Board of Directors issued the Founder and Co-CEO options to purchase 3,300,000 shares of common stock at an exercise price of $0.50, the fair market value on the date of the grant, over a five year period. The options vest subject to meeting a specific milestone and also vest over a three year period also subject to continued employment on each applicable vesting date. The options were granted in tandem with cash settled stock appreciation rights (“SARS”). All of the SARS referred to in this Note lapsed when the Company increased the authorized capital in November 2008.

F- 28

ECOSPHERE TECHNOLOGIES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

FOR THE YEARS ENDED DECEMBER 31, 2008 AND 2007

In May 2008, the Company granted options to purchase 1,000,000 shares of common stock to its Senior Vice President of Engineering. These options are exercisable for five years at an exercise price of $0.30 per share, the fair market value on the date of the grant. The options vested 50% on date of grant and 50% will vest upon meeting a specified milestone. In June 2008, the Company also issued the Senior Vice President of Engineering options to purchase 330,000 shares of common stock and cash settled SARS exercisable at $0.50 per share, the fair market value on the date of the grant, and with a five year term. These options vest over three year period subject to continued employment on each applicable vesting date. The exercise of either the options or the SARS cancels the same number of the other security.

In June 2008, the Board of Directors also issued options to purchase 8,250,000 shares of common stock and cash settled SARS to the Company’s other Co-CEO exercisable at $0.50 per share, the fair market value on the date of the grant, over a five year term. Of the options and SARS, 2/3 will vest over a three year period subject to continued employment on the applicable vesting date, and the balance vest over a three year period upon meeting a specified milestone approved by the Board of Directors. The options will vest 2/3 over a three year period and 1/3 will begin vesting over a three year term upon the signing of a long term agreement with a major energy company or another significant milestone approved by the Board of Directors. The exercise of either the options or the SARS cancels the same number of the other security.

In June 2008, the Company issued its Chief Operating Officer and Senior Vice President of Administration options to purchase 500,000 and 300,000 shares of common stock and cash settled SARS, respectively, exercisable at $0.47 per share, the fair market value on the date of the grant, over a five year term. Of these options and SARS, 200,000 and 100,000, respectively, vest immediately, with the remainder vesting in equal installments over two years, subject to continued employment on each applicable vesting date.

In June 2008, the Company issued an employee options to purchase 300,000 shares of common stock and cash settled SARS, respectively, exercisable at $0.47 per share, the fair market value on the date of the grant, over a five year term. Of these options and SARS, 100,000 vested immediately, with the remainder vesting in equal installments over two years, subject to continued employment on each applicable vesting date. The employee resigned in December 2008 and as such 200,000 options were forfeited.

In July 2008, the Company issued an employee options to purchase 300,000 shares of common stock and cash settled SARS, respectively, exercisable at $0.47 per share, the fair market value on the date of the grant, over a five year term. Of these options and SARS, 100,000 vested immediately, with the remainder vesting in equal installments over two years, subject to continued employment on each applicable vesting date.

In August 2008, the Company’s Executive Vice President of Business Development was granted options to purchase 1,500,000 shares of the Company’s common stock. The options vest over three years, subject to continued employment and are exercisable 500,000 at $0.42 per share, 500,000 at $0.85 per share and 500,000 at $1.10. The options expire in five years. The fair market value of the Company’s stock on the date of grant was $0.42 per share.

In November 2008, the Company issued its Vice President of Field Operations options to purchase 300,000 and shares of common stock, exercisable at $0.38 per share, the fair market value on the date of the grant, over a five year term. Of these options 100,000 vest immediately, with the remainder vesting in equal installments over two years, subject to continued employment on each applicable vesting date.

In December 2008, the Company issued its Chief Financial Officer options to purchase 400,000 shares of common stock, exercisable at $0.27 per share, the fair market value on the date of the grant, over a five year term. These options vest in equal installments over three years, subject to continued employment on each applicable vesting date.

In March 2008, the Company issued 920,000 options under the Option/Warrant exchange program. These options have a three year term, vest immediately and have an exercise price of $0.28 per share.

F- 29

ECOSPHERE TECHNOLOGIES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

FOR THE YEARS ENDED DECEMBER 31, 2008 AND 2007

Non-Employee Fixed Non-Plan Options


	For the Year December 31, 2008				For the Year December 31, 2007
	Shares			Weighted Average Exercise Price	Shares		Weighted Average Exercise Price
Outstanding at beginning of year	5,495,000		$	1.20	5,495,000	$	1.20
Granted	2,353,741		$	0.32	––		––
Exercised	—			––	––		––
Forfeited	(4,045,000	)	$	1.23	––		––
Expired	––			––	––		––
Outstanding at end of year	3,803,741		$	0.59	5,495,000	$	1.20
Exercisable at end of year	3,242,000		$	0.62	5,495,000	$	1.20

Outstanding
Weighted average remaining contractual term				2.37			4.35
Aggregate intrinsic value			$	64,720		$	––
Weighted average grant date fair value			$	0.38		$	––

Exercisable
Weighted average remaining contractual term				1.94			4.35
Aggregate intrinsic value			$	64,720		$	––

In October 2008, the Company issued options to purchase 735,714 of common stock at an exercise price $0.42, the fair market value on the date of the grant, to two consultants for their current and future assistance in the development and application of the Ozonix technology to the oil and gas industry. The options vest 700,000 over a one year and 35,714 over three years and expire in five years.

In March 2008, the Company issued 1,618,000 options under the Option/Warrant exchange program. These options have a three year term, vest immediately and have an exercise price of $0.28 per share.

Warrants


Warrants	For the Year December 31, 2008
	Shares			Weighted Average Exercise Price
Outstanding at beginning of year	39,956,744		$	0.61
Granted	11,616,367		$	0.22
Exercised	(5,500,833	)	$	0.15
Forfeited	(6,251,501	)	$	1.12
Expired	(688,580	)	$	—
Outstanding at end of year	39,132,197		$	0.51
Exercisable at end of year	39,132,197		$	0.51

Outstanding and exercisable
Weighted average remaining contractual term				2.89
Aggregate intrinsic value			$	3,752,420

F- 30

ECOSPHERE TECHNOLOGIES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

FOR THE YEARS ENDED DECEMBER 31, 2008 AND 2007

Warrant Modification and New Warrants Issued in Connection with Debt Extinguishment in March 2007

In March 2007 a lender extended the maturity date of $1,000,000 convertible notes in exchange for, among other things, 2,000,000 new warrants and a reduction in the exercise price of 2,000,000 existing warrants to $0.48 from $1.25 per share. The new warrants were valued at a relative fair value of $323,256 (based upon a Black-Scholes fair value of $477,664 computed using a volatility of 120% (based on historical volatility), expected term of 5 years (based on the contractual term of these non-employee warrants), expected dividend rate of 0% and an interest rate of 4.46%) and recorded as a debt discount and additional paid-in capital. The modified warrants were valued at a relative fair value of $44,194 using a volatility of 144% (based on historical volatility), expected term of 4 years (based on the remaining contractual term of these non-employee warrants), expected dividend rate of 0% and an interest rate of 4.5%) and recorded as a de bt discount and additional paid in capital.

Warrant Modification in Connection with Debt Extinguishment in October 2007

In October 2007 certain convertible debentures of $5,595,238 was partially paid down (see Note 7). In connection with the pay down the exercise price of 11,372,435 warrants was lowered to $0.15 from $0.47 per share and such modification is treated as a termination of the old warrants and grant of new warrants. The new warrants were valued at a fair value of $3,087,924 using a Black-Scholes option pricing model but only the relative fair value of $1,045,260 is recorded as debt discount and additional paid-in capital pursuant to APB 14.

Warrant Modification in Connection with Debt Extinguishment in October 2007

In October 2007 certain debt and accrued interest totaling $943,393 ($889,624 principal and $53,771 interest) was exchanged for new convertible debt (see Note 7). Among other consideration (see Note 7 and common stock issuance above) one of the lenders received a reduction in the exercise price of 4,000,000 warrants to $0.15 from $0.48 per share. The Company recorded the relative fair value of $184,835 as a debt discount and additional paid-in capital.

New Warrant Grants in Connection with new Debt

In connection with new loans of $355,000 in late December 2007 the Company issued 710,000 warrants with an exercise price of $0.15 for one half and $0.20 for one half of the warrants. The warrants expire in one year and are vested immediately. The fair value of the warrants was estimated at $88,020 using a Black-Scholes option pricing method with the following assumptions: volatility of 118% (based on historical volatility), expected term of 5 years (based on the contractual term for non-employee warrants), dividend rate of 0% and an interest rate of 3.45%. The $88,019 was recorded as additional paid-in capital and debt discount to be amortized over the debt term.

Warrants to purchase 510,000 shares of common stock with an exercise price of $0.15 per share and a five year term were issued in connection with new convertible notes. The fair market value of these new warrants was calculated with the Black-Scholes method using a volatility of 92.5% to 94.9% , an expected term of 5 years and a discount rate of 2.23% to 2.49% resulting in a debt discount of $28,665.

In addition, the exercise price of 365,000 warrants, issued in connection with a previous financing, were modified from $0.20 per share to $0.15 per share. The fair market value of the modified warrants was calculated with the Black-Scholes method using a volatility of 117.95%, an expected term of 5 years and a discount rate of 3.45% resulting in an additional debt discount of $979.

Warrants to purchase 100,000 shares of common stock with an exercise price of $0.25 per share and a five year term were issued to a consultant. The warrants are exercisable 50% immediately and the remainder are exercisable on July 31, 2008. The fair market value of the warrants was calculated with the Black-Scholes method using a volatility of 98.3%, an expected term of 5 years and a discount rate of 2.69%. The fair market value, $7,161 was recorded as a prepaid expense and expensed in Q1 2008.

Warrants to purchase 610,000 shares of common stock with an exercise price of $0.15 per share and a five year term were issued to an individual as a finder’s fee in connection with the $355,000 convertible notes issued in 2007 and the $255,000 of convertible notes issued during the three months ended March 31, 2008. The fair market value of the warrants was calculated with the Black-Scholes method using a volatility of 94.9%, an expected term of

F- 31

ECOSPHERE TECHNOLOGIES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

FOR THE YEARS ENDED DECEMBER 31, 2008 AND 2007

5 years and a discount rate of 2.365. The fair market value, $50,946 was recorded as debt issuance cost and will be amortized to interest expense over the life of the convertible notes.

Warrants to purchase 110,000 shares of common stock with an exercise price of $0.15 per share and a five year term were issued in connection with $55,000 of new convertible notes. In addition, warrants to purchase 1,900,000 shares of common stock with an exercise price of $0.15 per share and a five year term, plus warrants to purchase 1,750,000 shares of common stock with an exercise price of $0.20 per share and a five year term were issued in connection with the issuance of $1,750,000 of new convertible notes. The fair market value of the warrants was calculated with the Black-Scholes method using a volatility of 113.59% to 139.42%, an expected term of 5 years and a discount rate of 2.75% to 3.73%. The relative fair market value of the warrants, $601,127 was recorded as additional debt discount and will be amortized over the life of the convertible notes.

During the three months ended June 30, 2008, the Company issued an additional 1,805,000 warrants to an individual as a finder’s fee in connection with the additional $1,805,000 received from these investors. The fair market value of these warrants was calculated with the Black-Scholes method using volatility of 113.59% to 139.42%, an expected term of 5 years and a discount rate of 2.75% to 3.73%. The fair market value of these additional warrants, $472,971 was recorded as debt issuance cost and will be amortized to interest expense over the life of the convertible notes.

Warrants to purchase 1,000,000 shares of common stock with an exercise price of $0.15 per share and a three year term were issued in connection with a new $1,000,000 note. The relative fair market value of these warrants was calculated with the Black-Scholes method using a volatility of 133.63% , an expected term of 3 years and a discount rate of 2.71% resulting in a debt discount of $182,576 which will be amortized to interest expense over the life of the note.

In July 2008, the Board granted the consulting company that provides CFO services to the Company, 650,000 warrants and cash settled SARS, exercisable at $0.45 per share and vesting over a three year period. All of the warrants vest each June 30 and December 31, subject to the Consulting Agreement remaining in effect on each applicable vesting date. Additionally, one-half of the options and SARS are subject to further vesting based upon the Company meeting a specified milestone. The fair market value of these new warrants was calculated with the Black-Scholes method using a volatility of 137.8% , an expected term of 5 years and a discount rate of 3.33% . The fair value of the warrants, $259,350 will be recognized over the vesting period.

In December 2008, warrants to purchase 666,667 shares of common stock, 500,000 with an exercise price of $0.38 per share and 166,667 at $0.40 per share, and all with a three year term were issued in connection with two new $1,000,000 notes. The relative fair market value of these warrants was calculated with the Black-Scholes method using a volatility from 130.2 to 140.56 % , an expected term of 3 years and discount rates from 1.15% to 1.6% of resulting in a debt discount of $190,076 which will be amortized to interest expense over the life of the note.

Warrant / Option Exchange Program

In connection with the Company’s warrant and option exchange program, the Company issued new three year options to purchase 2,534,000 shares of common stock, exercisable at $0.28 per share in exchange for the forfeiture of 6,251,501 warrants to purchase shares of common stock. The weighted average exercise price of the warrants forfeited was $0.96 and the weighted average remaining life of those warrants was 2.02 years. The fair market value of the new warrants calculated with the Black-Scholes method using a volatility of 124%, an expected life of 3 years and a discount rate of 2.27% resulted in an aggregate fair market value of $15,679 for those warrants/options where the new option value exceeded the old value. Company recorded $15,679 in non-cash option expense related to this exchange.

F- 32

ECOSPHERE TECHNOLOGIES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

FOR THE YEARS ENDED DECEMBER 31, 2008 AND 2007

A summary of the outstanding warrants previously issued for cash, financing, services and settlement as of December 31, 2008 is presented below:


	Shares
Warrants issued for cash		1,409,500
Warrants issued for financing		33,967,697
Warrants issued for services		3,665,000
Warrants issued in settlement of lawsuit		90,000
Outstanding at December 31, 2008		39,132,197

12.

INCOME TAXES

Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. At December 31, 2008, the Company has net operating losses (NOL) of approximately $45,636,000. The NOL expires during the years 2013 to 2028. In the event that a significant change in ownership of the Company occurs as a result of the Company’s issuance of common stock, the utilization of the NOL carry forward will be subject to limitation under certain provisions of the Internal Revenue Code. Management does not presently believe that such a change has occurred. Realization of any portion of the $21,705,780 of net deferred tax assets at December 31, 2008 is not considered more likely than not by management; accordingly, a valuation allowance has been established for the full amount.

The reconciliation of income tax benefit computed at the United States federal tax rate of 34% to income tax benefit is as follows:


	Year ended December 31,
	2008			2007
Tax benefit at the United States statutory rate	$	3,870,438		$	2,230,849
State income tax and other		662,540			238,071
Valuation allowance		(4,532,978	)		(2,468,920	)

Income tax benefits	$	—		$	—

Significant components of the Company’s deferred tax assets are as follow:


	Year ended December 31,
	2008			2007
Deferred tax assets:
Organizational costs, accrued liabilities, and other	$	460,668		$	445,087
Net operating loss carry forwards		18,545,724			14,717,878
Losses on extinguishment of debt		1,037,660			1,037,660
Compensation related to equity instruments issued for services		1,661,728			972,178
Valuation allowance		(21,705,780	)		(17,172,803	)

Net deferred tax asset	$	—		$	—

Reconciliation of the differences between income tax benefit computed at the federal and state statutory tax rates and the provision for income tax benefit for the years ended December 31, 2008 and 2007 is as follows:


	2008			2007
Income tax loss at federal statutory rate		(34.00	)%		(34.00	)%
State taxes, net of federal benefit		(3.63	)		(3.63	)
Nondeductible items		(1.14	)		—
Change in valuation allowance		38.77			37.63
		—	%		—	%

F- 33

ECOSPHERE TECHNOLOGIES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

FOR THE YEARS ENDED DECEMBER 31, 2008 AND 2007

13.

COMMITMENT AND CONTINGENCIES

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.

The Company had a long term relationship with Kamimura International Associates (KIA), a Washington D.C. based organization, whereby the principals at KIA agreed to assist the Company in developing the coating removal market in the Far East. The relationship resulted in the establishment of UltraStrip Japan, Ltd. (USJ), a company whose purpose was to market and deliver ship stripping services in Japan. The agreement with KIA was never formalized. In February 2007, KIA filed a lawsuit against the Company. In March 2007, the Company filed a Motion to Dismiss, Motion to Strike, and Motion for More Definite Statement. The Company intends to vigorously defend itself in this litigation; the Company believes that the plaintiff will not prevail. In 2008, the Company filed a counter claim to which KIA responded by filing a motion to dismiss. The motion to dismiss was rejected by the court. The Company has expensed and accrued an amount it re asonably estimates may be required to resolve any outstanding issues between the Company and KIA.

On August 3, 2007, Mr. Gordon Goodman, then President of ESI, the Company’s 90%-owned subsidiary, terminated his employment agreement for “good reason.” Under this agreement, he was to receive an annual salary of $165,000 per year. The agreement was entered into in May 2007 and was for a two-year term. After investigation of the circumstances, including the exchange of documents and Mr. Goodman’s deposition, the company determined that Mr. Goodman did not materially breach his employment agreement and the matter was amicably resolved. In July 2008, the Company entered into an arbitrated settlement agreement with Mr. Goodman resulting in a payment by the Company of $157,750.

Leases

The Company makes monthly lease payments of $12,354 under a month to month agreement for the Company’s Stuart, Florida location. The Company recognized rent expense of $148,248 related to this lease in 2008.

In August 2008, the Company entered into a lease agreement for the Company’s offices in New York. The lease agreement expires in May 2013. During the year ended December 31, 2008, the Company recognized rent expense of $59,668 related to this lease resulting in a balance of deferred rent of $4,126 as of December 31, 2008. Future minimum annual rents due under the lease are as follows:


Year	Amount
2009	$	168,846
2010		175,511
2011		182,176
2012		188,842
2013		64,428
	$	779,803

The Company also leases a copier under a capital lease which expires in 2010. Future minimum rentals under this lease amount to $42,120 in 2009 and $10,530 in 2010. During the year ended December 31, 2008, depreciation expense related to this asset amounted to $21,404.

F- 34

ECOSPHERE TECHNOLOGIES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

FOR THE YEARS ENDED DECEMBER 31, 2008 AND 2007

14.

OPERATING SEGMENTS

Pursuant to FAS 131, the Company defines an operating segment as:

A business activity from which the Company may earn revenue and incur expenses;

Whose operating results are regularly reviewed by the chief operating decision maker to make decisions about resources to be allocated to the segment and assess its performance; and

For which discrete financial information is available.

In 2005, the Company expanded its business offerings to include the water filtration technology business. Recognizing that each business offering applied to different markets, the Company established three operating entities or segments, which are defined as each business line that it operates. This however, excludes corporate headquarters, which does not generate revenue.

Our operating entities are defined as follows:

Ecosphere Systems, Inc. (ESI) which we organized in April 2005 to operate our water filtration system business;

Ecosphere Envirobotic Solutions, Inc. (EESI), formerly UltraStrip Envirobotic Solutions, Inc., which we organized in October 2005 to operate our coating removal business; and,

Ecosphere Energy Solutions, Inc. (EES) which we organized in November 2006. EES supports the field operations of the OzonixÔ process to recycle frac flowback for the oil and gas industry. In November 2008, the Company changed the name of EES to Ecosphere Energy Services, Inc.

The table below presents certain financial information by business segment for the year ended December 31, 2008:


	Ecosphere Systems, Inc.			Ecosphere Envirobotic Solutions, Inc.			Ecosphere Energy Services, Inc.			Segment Totals			Corporate			Consolidated Totals
Revenue from external customers	$	—		$	—		$	247,202		$	247,202		$	—		$	247,202
Interest expense and amortization of debt discount	$	—		$	—		$	(2,271	)	$	(2,271	)	$	(5,417,291	)	$	(5,419,562	)
Depreciation and amortization	$	(111,552	)	$	(5,722	)	$	(104,479	)	$	(221,763	)	$	(37,879	)	$	(259,642	)
Income Tax Expense	$	—		$	—		$	—		$	—		$	—		$	—
Net Income (loss)	$	(111,552	)	$	(5,722	)	$	(381,438	)	$	(498,712	)	$	(11,194,944	)	$	(11,693,656	)

Segment fixed assets & construction in process	$	865,375		$	25,824		$	1,824,612		$	2,715,811		$	1,010,188		$	3,725,999
Fixed asset additions (disposals) (net)	$	(112	)	$	1,880		$	1,504,637		$	1,506,405		$	78,910		$	1,585,315
Total Assets	$	309,848		$	1,871		$	1,883,508		$	2,195,227		$	1,063,626		$	3,258,853

F- 35

ECOSPHERE TECHNOLOGIES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

FOR THE YEARS ENDED DECEMBER 31, 2008 AND 2007

The table below presents certain financial information by business segment for the year ended December 31, 2007:


	Ecosphere Systems, Inc.			Ecosphere Envirobotic Solutions, Inc.			Ecosphere Energy Services, Inc.			Segment Totals			Corporate			Consolidated Totals
Revenue from external customers	$	—		$	750,007		$	—		$	750,007		$	—		$	750,007
Gain from sales of intellectual property and related assets, net	$	—		$	5,259,370		$	—		$	5,259,370		$	—		$	5,259,370
Interest expense and loss on extinguishment of debt	$	—		$	—		$	—		$	—		$	(5,750,197	)	$	(5,750,197	)
Depreciation and amortization	$	(72,071	)	$	(24,344	)	$	—		$	(96,405	)	$	(53,339	)	$	(149,744	)
Income Tax Expense	$	—		$	—		$	—		$	—		$	—		$	—
Non-cash compensation expense	$	—		$	—		$	—		$	—		$	(1,297,796	)	$	(1,297,796	)
Net Income (loss)	$	(72,071	)	$	600,351		$	(11,755	)	$	516,525		$	(7,077,845	)	$	(6,561,320	)

Segment fixed assets	$	865,487		$	23,944		$	—		$	889,431		$	931,278		$	1,820,709
Fixed asset additions (disposals) (net)	$	(466,329	)	$	(694,010	)	$	—		$	(1,160,339	)	$	236,374		$	(923,965	)
Total Assets	$	260,552		$	7,223		$	148,881		$	416,656		$	1,018,686		$	1,435,342

15.

MINORITY INTEREST

On May 10, 2007 the Company’s Board of Directors adopted a resolution terminating a Representation Agreement with an affiliate of a director of the Company ($30,000 per month and commissions) and transferred to the director, a 10% ownership of ESI, which as of the transfer date and as of December 31, 2007, had no revenue and a negative net worth. The Company fully funded the construction of the only asset of ESI, the mobile water filtration truck. The minority owner will share in any profits in ESI once they occur. Accordingly, the minority interest was zero at the agreement date. The Company will report on the results of operations once activity occurs in this entity.

16.

CONCENTRATION OF RISK

During the year ended December 31, 2008, the Company had 100% of its sales derived equally from two customers and from one revenue source, processing frac flowback water for the oil and gas industry. As of December 31, 2008, 100% of our accounts receivable are due from one customer.

During the year ended December 31, 2007, the Company had 91% of its sales, other than gain on sale of intellectual property and related assets, derived from one customer. With the UES asset sale, the entity is no longer a customer. The 2007 operating gain from sale of intellectual property and related assets, net, of $5,259,370 was a non-recurring transaction to one customer.

The Company maintains its cash in bank and financial institution deposits that at times may exceed federally insured limits. The Company has not experienced any losses in such accounts through December 31, 2008. As of December 31, 2008, the Company’s bank balances exceeded FDIC amounts by approximately $354,000.

17.

RELATED PARTY TRANSACTIONS

In connection with our organization in 1998, a corporation controlled by our Chief Executive Officer and Senior Vice President of Administration was owed $40,000. During the year ended December 31, 2007, we paid $14,000 of principal on this note payable. During the year ended December 31, 2008, we paid off the remaining principal balance of $26,000 plus accrued interest of $18,750.

During the years ended December 31, 2007 and 2006, the Company received funds from the issuance of convertible notes to the Chief Executive Officer and the Senior Vice President of Administration in the cumulative total amount of $620,000. As of December 31, 2007, $410,000 of such notes have been repaid. During the year ended December 31, 2008, the Company repaid the remaining $210,000.

F- 36

ECOSPHERE TECHNOLOGIES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

FOR THE YEARS ENDED DECEMBER 31, 2008 AND 2007

An unsecured note payable to a director, bearing interest at prime plus 2%, was modified during the three months ended June 30, 2008. Under the new agreement, the Company agreed to repay the principal balance of $374,423, plus annual interest of 7%, by making quarterly payments of $50,000. In connection with the agreement, the Company paid the director $69,789. See Note 7.

Since December 2007, an investor has advanced the Company $650,000 in exchange for one year, convertible secured notes, all with a conversion rate of $0.15 per share. In connection with the financings, the investor was issued five year warrants to purchase 980,000 and 320,000 shares of the Company’s common stock at exercise prices of $0.15 and $0.20, respectively. On June 17, 2008, after the investments had been made, the investor was appointed Chairman of the Board of Directors and Co-CEO. In November 2008, the investor became CEO of the Company. Additionally, the investor is entitled to a finder’s fee in the amount of $87,500 related to the additional $1,750,000 of convertible secured notes funded during the three months ended June 30, 2008, which he advised the Company he intended to take in common stock, once the Company has authorized capital and donate the shares to charity. In Septemb er 2008, the Company granted the issuance of 450,000 shares of common stock to the CEO, valued at $288,000, in repayment of the finder’s fees resulting in a loss on conversion of $200,500. As of December 31, 2008, the Company has issued 200,000 to charities and the remaining 250,000 shares are included in common stock issuable. During the time of the original investments of $665,000 the investor incurred legal fees of approximately $40,000 which were reimbursed to him by the Company during the year ended December 31, 2008. In August 2008, the CEO loaned the Company an additional $100,000 in exchange for a one year original issue discount convertible note, in the amount of $111,11, bearing interest of 11.1% and convertible in to common stock at the rate of $0.36 per share.

In June 2008, the Board of Directors approved the terms of new employment agreements with its Co-Chief Executive Officers and Chief Operating Officer. The Board of Directors approved a compensation package for the Chairman of the Board and Co-CEO consisting of an annual base salary of $250,000, increasing to $450,000 upon achievement of a significant milestone. This salary will either accrue or be payable in common stock until the Company has sufficient cash resources. He is also eligible to receive a performance bonus upon meeting an additional milestone. The Board also approved a new compensation package for the Founder and Co-CEO since his prior agreement had expired. The new agreement provides for a base annual salary of $325,000, increasing to $400,000 on January 1, 2009 and includes performance bonuses based upon meeting a number of milestones. The Board of Directors also approved a new compensation package for the Chief Operating Officer which provides for an annual base salary of $125,000.

In August 2008, an investor who previously loaned the Company $300,000 in exchange for one year secured convertible notes and 600,000 warrants was appointed as Executive Vice President of Business Development. Subsequent to his appointment, the investor employee loaned the company an additional $100,000 in exchange for a one year original issue discount convertible note, in the amount of $111,111, bearing interest of 11.1% and convertible in to common stock at the rate of $0.36 per share. In connection with his appointment, the investor employee was granted options to purchase 1,500,000 shares of the Company’s common stock. (See Note 11)

In September 2008, an investor who previously loaned the Company $50,000 in exchange for one year secured convertible notes and 100,000 warrants was appointed to the Board of Directors. Subsequent to his appointment, the investor director loaned the company an additional $180,000 in exchange for a one year original issue discount convertible note bearing interest of 11.1% and convertible into common stock at the rate of $0.36 per share. In connection with his appointment, the investor director was granted options to purchase 229,167 shares of the Company’s common stock at an exercise price of $0.48 per share. (See Note 11)

On July 3, 2008, the Company amended a Consulting Agreement with a consulting company in which the Company’s Chief Financial Officer ( the CFO) is president and 50% owner. Under the new Agreement, the Chief Financial Officer is devoting substantially all of his time and his company was also supplying the Company with its accounting service. The consulting fee was increased to $19,500 per month. Additionally, the Board granted the consulting company 650,000 options and cash settled SARS, exercisable a $0.45 per share over a three year period. All of the options vest each June 30 and December 31, subject to the Consulting Agreement remaining in effect on each applicable vesting date. Additionally, one-half of the options and SARS are subject to further vesting based upon the Company meeting a specified milestone. In December 2008, the Consulting Agreement was amended after a co-owner of the consulting co mpany accepted the position of CFO as a full-time employee of the Company. The

F- 37

ECOSPHERE TECHNOLOGIES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

FOR THE YEARS ENDED DECEMBER 31, 2008 AND 2007

Board approved a compensation package for the new CFO with an annual salary of $150,000 and granted the CFO options to purchase 400,000 shares of common stock at an exercise price of $0.27. The options vest over three years and have a five year term. The consulting company continues to provide accounting and financial reporting services for the Company at a monthly fee of $7,000.

18.

SIGNIFICANT TRANSACTION

On October 9, 2007 the Company sold the ship stripping and certain other assets of UES to Chariot Robotics LLC (“Chariot”) for cash of $6,200,000, and the assumption of a $1,400,000 note payable with a carrying value of $1,305,396, net of discount and approximately $135,000 of trade payables. As additional consideration, the Company received a five percent ownership interest in Chariot, LLC valued at $250,000 and paid the legal fees of the buyer by issuing shares of common stock. The UES patents relating to automobile and airplane stripping were not sold. The Company computed the gain from sale of intellectual property and related assets as follows:


Cash proceeds	$	6,200,000
Capital lease assumed by the buyer		1,305,396
Other liabilities assumed		135,000
5% Investment in Chariot, LLC		250,000
Settlement of other liabilities		26,040
Less: Carrying value of inventory, equipment and patents		(2,334,150	)
Value of shares issued to pay buyer’s legal fees		(322,916	)
Gain from sale of intellectual property and related assets, net	$	5,259,370

As part of the asset sale, the Company paid $250,000 of Chariot’s closing costs by issuing Chariot’s affiliates 1,041,666 shares of common stock valued at $0.24 per share with demand and piggyback registration rights. In addition, the Company incurred its own selling costs of approximately $500,000.

In order to sell the UES assets, the Company needed the consent of its senior convertible debenture holders. Prior to the sale, the Company entered into an Amendment and Waiver of the Securities Purchase Agreement with the holders of the debentures to repay $4,000,000 (which was paid in October 2007), and to reset the conversion price of the remaining notes (approximately $1,595,000) and the exercise price of all warrants to $0.15 in exchange for their consent to the UES asset sale.

Under the Management Compensation Adjustment Plan adopted in May 2006, the Company’s management team agreed to reduce salaries in exchange for options exercisable at $0.83 per share and commissions from a transaction like the UES sale. The members of the management team were entitled to receive $773,500 of commissions from the UES sale. On July 31, 2007, the board of directors granted management members options or restricted stock in lieu of cash, subject to vesting which occurred onOctober 9, 2007, when the UES asset sale closed. Based upon the elections of the management members, the Company has issued 5,156,667 five year options exercisable at $0.15 per share. The Company has recognized $773,500 in share-based compensation expense during the fourth quarter of 2007. (See Note 11)

With the closing of the UES asset sale, the $500,000 of convertible notes described in Note 6 and warrants issued to the holder had their conversion price and exercise price reduced to $0.15. In addition, the Company made a principal payment of $300,000.

With the closing of the UES sale, the Company also issued 200,000 shares to the holders of their 8% notes, 200,000 shares to the holders of their 12% notes, 157,637 shares to the Robotics Investment Group note holders, 50,000 shares to another note holder for exchange of old notes for new 10% one-year convertible notes with a conversion price of $0.15 per share.

19.

SUBSEQUENT EVENTS

Subsequent to December 31, 2008, the Company issued its CEO and Senior Vice President of Business Development, respectively, 190,894 and 61,733 shares of common stock, valued at market value on December 31, 2008, $0.31 per share, in payment of unpaid salary as of December 31, 2008.

F- 38

ECOSPHERE TECHNOLOGIES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

FOR THE YEARS ENDED DECEMBER 31, 2008 AND 2007

Since December 31, 2008, the Company has issued 403,251 shares of common stock upon the conversion of $60,000 of principal and $502 of accrued interest at a conversion rate $0.15 to holders of December 2006 convertible debentures.

In January 2009, the Company issued 40,915 shares of common stock upon the conversion of 49 shares of Series B Preferred Stock at the conversion rate of 835 share of common stock per share of Series B Preferred and a value of $323,881.

Effective February 1, 2009, the Company entered into a consulting agreement with a director, to assist the Company in getting government grants for environmentally friendly projects using the Company’s technologies. In consideration for entering into the agreement, the Company is paying the director a fee of $7,500 per month. In lieu of cash, the fee is being paid with five-year vested stock options or in shares of common stock at the director’s option. The agreement is for a six- month period and may be cancelled within 30 days’ notice by either the Company or the director. Additionally, if the Company receives government funding as a result of the director’s efforts (even if the term of his consulting agreement has expired), the director will receive a cash fee of 1% of the funds received.

In February 2009, the Company issued 333,333 shares of common stock upon the conversion by the holder of a convertible note in the amount of $50,000.

In February 2009, the Company’s Chief Financial Officer, arranged for additional financing of up to $150,000 for the Company through a limited liability company managed by him and his spouse. The notes are due in six months and bear interest at an annual rate of 18%. As of the date of this report, the Company has received $95,500 from this financing. The funds are coming from domestic and international investors and the CFO is receiving no benefit from the transaction. The funds are being secured by intellectual property of the Company.

In March 2009, the Company’s CEO advanced the Company $15,000 against future collections of accounts receivable.

F- 39