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Executives

Gary Dvorchak – Senior Vice President-ICR, LLC

Charles Vinick – Chairman and Chief Executive Officer

Adrian G. Goldfarb – Chief Financial Officer

Analysts

Martin Cohen – Balanced Financial Securities

Bradley Grayson – Wells Fargo Advisors, LLC

Ecosphere Technologies, Inc. (OTCQB:ESPH) Q2 2012 Earnings Call August 2, 2012 4:30 PM ET

Operator

Good day and welcome to the Ecosphere Technologies’ Second Quarter 2012 Earnings Conference Call. Today’s conference is being recorded.

at this time, I would like to turn the conference over to Mr. Gary Dvorchak, Senior Vice President of ICR. Please go ahead, sir.

Gary Dvorchak

Thank you, Joanne, and thank you everyone for being on the call today. On the call today are Ecosphere’s Chairman and CEO, Charles Vinick; and our Chief Financial Officer, Adrian Goldfarb.

Before we begin, I’d like to remind everyone that this call is being webcast and is available under the events tab in the Investors section of our website at www.ecospheretech.com. The replay of the webcast will be available for one year. Also posted on our Investor Relations website is the earnings press release.

Neither advice you that some of the information discussed on this conference call and the Q&A session will contain forward-looking statements including our 2012 guidance or continuing relationship with Hydrozonix, and profitability from this relationship, delivery of units to Hydrozonix, the expansion of our Ozonix technology internationally, and in the other fields including treating water and coal-fired power plants and mining.

These forward-looking statements are not a guarantee of performance. the company’s actual results could differ materially from those contained in such statements. Several factors that could cause or contribute to such differences are described in detail and the risk factors contained in our Form 10-K filed on March 15, 2012 with the SEC as well as in our earnings release and subsequent SEC filings. These forward-looking statements speak only to the date of this call and the company undertakes no obligation to probably update any forward-looking statements unless required by law.

This conference call will include a discussion of adjusted EBITDA, which is non-GAAP financial measure. Reconciliations to the most directly comparable GAAP financial measure is provided on the Investor Relations section of the company’s website that can be found under the regulatory info category.

With that, let me now turn the call over to Charles. Charles?

Charles Vinick

Thank you, Gary. And thank everyone for joining our second quarter earnings conference call. I will start with a summary of our operating performance during Q2, and then discuss the conditions in our segment of oil and gas field services, as well as other initiatives to drive growth. I’ll then turn the call over to Adrian Goldfarb, our Chief Financial Officer for additional financial details, and to comment upon our guidance for 2012.

In Q2, we built upon the financial success we delivered in Q1. We grew net income 39%, earning $506,000 versus trailing quarter net income $365,000. For the first time in the company’s history, we’ve had consecutive profitable quarters. The rest of our financial metrics were equally strong, revenue growth was 264% year-over-year. Margins remain solid at 39% gross, and 10% operating. And our balance sheet is very strong with $2 million in unrestricted cash.

We have continued to reduce debt. We now have 35 systems in the field, eight of which are deployed by Hydrozonix. Per our contract, we expect to ship an additional four systems to Hydrozonix, during the reminder of 2012, as Hydrozonix builds its fleet, it is growing its business substantially with more customers and more water treated on a monthly basis.

Collectively, Ecosphere and Hydrozonix have now treated over 2 billion gallons of water and over 570 oil and natural gas wells. I want to take a moment to speak about the vision that we have for this long-term relationship with Hydrozonix. Hydrozonix is required to purchase eight Ozonix EF80 units per year to maintain their exclusivity in the onshore U.S. oil and gas market.

Hydrozonix provides all capital for manufacturing the unit, and pay the license fee per unit and covers manufacturing overhead. Their agreement with us also requires them to pay us a royalty based on their earnings before taxes. While we cannot give a precise date when they will reach positive EBIT and royalties will begin, we are confident that they are building a significant business and that both Hydrozonix and the Ecosphere will profit.

Please keep in mind that Ecosphere will receive royalties on all systems used by Hydrozonix, even if stop ordering or were to lose exclusivity sometime in the future. Meanwhile, our majority owned Energy Services Subsidiary, EES is performing exceptionally well. Field service revenue grew 20% year-over-year, and 5% over the trailing quarter as we processed more water for our customers. Gross margin in this business remains attractive at nearly 75%.

In 2011, EES was doing approximately 22% of our primary customers business in the Fayetteville Shale. In the first quarter of 2012, as we increased the number of multi-pad well side, on which we are treating their water, EES increased to doing approximately 25% of their work. And in the second quarter, we did over 30% of their work. Thus even in a down economy, with many E&P companies cutting back on their gas drilling program, EES as key customer is requesting that we significantly increased the work that we do for them above 30%.

I’d also like to address one issue about which we are asked repeatedly. With the price of natural gas so well, recently around $3 per million BTUs many are wondering of the slowdown in exploration will hurt our business. Hydraulic fracturing combined with horizontal drilling has opened up huge supplies of natural gas, and many natural gas producers are reducing exploration activities.

However, keep in mind that the fracturing process is also used to produce liquid natural gases such as ethane and propane and to produce oil. Prices remain firm for these liquids and there is extensive drilling activity in these so-called liquid plays. Oil well fracturing requires as much water as for dry gas, and our patented Ozonix technology is equally applicable for treating this water without chemical, and enabling recycling of produced waters.

Despite the concern around gas production that is worrying investors and weighing on many stocks including our own, our customers and Hydrozonix are following market trends, and are concentrating more of their capital resources in liquid plays. While Hydrozonix addresses the U.S. hydraulic fracturing market, we continue to see immense opportunities in international locations that are just starting to deploy horizontal drilling, and utilizing hydraulic fracturing techniques.

We are in numerous discussions with oil and gas producers around the world and we’ll formally announce any business relationships at the appropriate time.

Beyond treating water for hydraulic fracturing operations, we are also exploring opportunities treat water in coal-fired power plants. We are in active discussions with service providers to the utility industry, outlining various business structures through, which we can respond to these opportunities.

With respect to our mining and minerals initiative, we continue to discuss potential partnerships with several financiers and mine operators. This market is important to us, and we look forward to formally announcing our strategy at the appropriate time.

In a moment, I will turn the call over to Adrian Goldfarb to discuss our financial performance. But I first want to comment on Adrian’s status. Many of you saw the announcement that Adrian has been named President and CFO of the Information Systems Associates. ISA is based in Stuart, Florida, and developed Mobile Data Center Management systems, and also provides Professional Services based upon their MDCM systems.

Adrian officially started with ISA on July 1; we noted in both our 2011 10-K, and in the Q1 2012 10-Q. But Adrian has agreed to continue to work with us on a consulting basis until we complete our search for a new CFO. The search is ongoing and we are actively interviewing candidates.

Meanwhile, our Controller, Barbara Carabetta, is firmly on top of our finances and Adrian is working closely with her on a regular basis. We appreciate Adrian’s service to Ecosphere during the four years, he as served has CFO, and equally importantly we appreciate his assistance during this transition period. We are sure, he will find great success in his new position and we thank him.

Now let me turn the call over to Adrian, to discuss our financial results in more detail. Adrian?

Adrian G. Goldfarb

Thanks, Charles, and good afternoon, everyone. I’ll begin with our financial accomplishments in the second quarter, and then discuss our financial guidance for 2012.

As Charles mentioned, our revenue was up 264% versus the same period a year ago. In the second quarter of 2012, Ecosphere’s revenues were $8.6 million compared to $2.4 million in Q2 2011. Revenue growth was driven by our contract with Hydrozonix as well as field service revenue that increased 20%.Gross profit was $3.3 million, up 114% versus $1.6 million of gross profit in Q2 2011.

Selling, general and administrative expenses for Q2 were $2.5 million, up slightly from Q1 SG&A and down 21% of SG&A in the year ago quarter. The year-over-year reduction was primarily due to a decrease in stock-based compensation.

Q2 operating income was $885,000. After paying interest occurring preferred dividends, and accounted for other items including the minority interest in EES, our common shareholders were allocated net income of $506,000 in Q2. This is better than break-even per share and compares to the similar break-even per share in Q1 2012 at a loss of $0.01 per share in the year ago quarter.

Adjusted EBITDA including the add back of the stock-based compensation was totalled $1.6 million in the second quarter of 2012. This represents a 15X increase year-over-year and more than $100,000 increase over the adjusted EBITDA for Q1 2012 of $1.5 million. We continued to have a strong balance sheet. Our unrestricted cash balance was down slightly in Q1, but still solid at $2 million. Meanwhile, we reduced debt by over $0.5 million.

Now, let me explain certain items on our balance sheet. You may have noticed the line billings in excess of costs and estimated earnings on uncompleted contracts, which is new this quarter. This appeared because we used a percentage of completion method of accounting for the revenue associated with the manufacturing unit for Hydrozonix.

In the second quarter, one of our suppliers was late with the component delivery resulting in the acceptance with units 7 and 8 by Hydrozonix in early July. Under the percentage of completion method of revenue recognition, we recognized 97% of the total revenue from the manufacturing of units 7 and 8 in Q2, with the balance to be recognized in Q3. You may also note that our accounts receivable grew from Q1. The receivable increase as a function of timing and does not represent a collection risk. Despite the increased receivable position at June 30, we maintain a cash balance consistent with that of the trailing quarter.

Our general expectation is that units will be delivered to Hydrozonix on a 90-day bill cycle, and the commensurate revenue will be recognized within each quarter. Of course, it is possible we will have similar timing variances in the future, but those should be exceptions and [not to know] and should not have a significant impact on annual revenue projection.

Now, I’d like to turn up to our guidance for 2012 financial performance, which we're reaffirming at this time. At the start of the year, our outlook was revenue of approximately $28 million, gross profit of $14 million, and cash flow from operations of $3 million. Half way through the year, we believe that we are on target for meeting these projections. Overall results to date indicate that we may exceed the original guidance for the year, we will not be offering specific updated guidance at this time. We will continue to be conservative and forecasting due to the continuing uncertainty in the oil and gas markets as well as in the global financial market.

Now, we will take questions. Operator, please open up the call for Q&A?

Question-and-Answer Session

Operator

Thank you. (Operator Instructions) We'll take our first question from Nathan Sandberg, private investor.

Unidentified Analyst

Hello.

Charles Vinick

Hello, Nathan.

Unidentified Analyst

Well, so I'm just interested, what formulae do you use in determining (inaudible) stock options?

Adrian G. Goldfarb

I'm not sure I understand the question. In terms of a formula, are you talking about stock-based compensation or what is the question or reference to it, to clarify please?

Unidentified Analyst

Companies offer stock options, I know to as compensation, but they also offer to stockholders?

Charles Vinick

at this point, we have certainly, as part of compensation provided stock options as incentive compensation to senior employees and to the employee base as a whole, and that’s been reported in each of our filings and you have. We have not as a regular basis offered a stock to investors except on specific private placement arrangement for private placements that have been offered publicly and the like, and Adrian may have a comment to add to that if you would.

Adrian G. Goldfarb

Yeah. Thank you, Charles. When company was raising money two or three years ago, we did much of that raise, well, several raises through the uses of convertible notes and in some cases, they’ll stop, but mostly convertible notes. As an incentive to those people that put money into these quite replacements, because their stock is not open market, it’s a little bit more restricted in trading, an incentive it is often and many companies do this with what we call warrant coverage. And the $4 million that is used often is in the earlier stages, when the industry side risk is sometimes one or two times and then [after that] below that. and I think the last raise we did was 0.5 or 1 touch.

so if you're asking about a specific formula, there is no specific formula, but it’s determined at the time for what would make the investment attractive and not for someone’s put money into company. What I can't comment on is that now for more than a year, we have actually not raised any money and company is now operating because of it is cash flow positive, and not producing that income, there’s not been necessary for us to raise any additional money. So for at least 12, 15 months, we have not issued any further loss for stock option to invest it.

Unidentified Analyst

Interesting, thank you.

Adrian G. Goldfarb

Okay.

Operator

We’ll take our next question from Martin Cohen with Balanced Financial Securities.

Martin Cohen – Balanced Financial Securities

Hi, guys, this is Martin. When I noted in your first quarter Q, that one of the target market you were looking at within the municipal waste market, where there might be a recovery water, and I have a client company that deals in a waste type product, but they don’t have any kind of water technology complementary product for what they’re doing. And I’m wondering if you’re looking for strategic alliances in that sector of the market?

Charles Vinick

Well, thank you Martin. Yes, we continue to have conversations with a number of sectors, and one of those certainly is the municipal wastewater sector, and we do look for strategic partners to work into that to provide the application of our technology into that sector, and it should be appropriate. We would be interested in having such discussions.

Basically the Ozonix’s technology that we’re using in EF80, is that we’re using extensively in oil and gas has tremendous applicability in many industrial waste waters and municipal wastewater, and we are constantly being asked about it. We see a great future in it, and we can’t respond to every opportunity all of the time, but we think there is a tremendous opportunity for increasing the efficiency of many of the approaches to be this for wastewater application and also to providing our technology for use in a number of the – types of applications that exist in (inaudible) wastewater industry that’s kind of a long answer to your question but I think the answer is yes.

Martin Cohen – Balanced Financial Securities

Okay, just one final question, if my client somebody wanted to contact you to explore a potential relationship, who would be the business development person for them to connect with.

Adrian G. Goldfarb

I think on the press release you’ve seen for today's call that Jacqueline McGuire is listed as a marketing contact. He is certainly the appropriate contact for that and Ms. Charles Vinick is CEO and he would forward that to me and we can certainly respond.

Martin Cohen – Balanced Financial Securities

Okay, thanks an awful lot.

Adrian G. Goldfarb

You're welcome.

Operator

We will take our next question from Bradley Grayson with Wells Fargo.

Bradley Grayson – Wells Fargo Advisors, LLC

Hi, I have a question. So that every quarter as I understand there is two units believed delivered a Hydrozonix as part of the exclusive agreement, correct.

Adrian G. Goldfarb

Yeah, that's actually we call them units and EF80 is really a hydraulic fracturing system by itself because of the volume of water that it creates, but yes we refer to it as an EF80, and then each one as the unit, and under contract their minimum order third per quarter is two EF 80.

Bradley Grayson – Wells Fargo Advisors, LLC

Sure, yeah. I'm familiar with that. So the question is have they expressed any end demand that was would have them interested, increasing those orders. It seems like for the last couple of quarters, it just been kind of meeting the bare minimum, and if a virtue express the desire to ramp up – are you guys even capable of producing more than two per quarter at this point.

Adrian G. Goldfarb

Good question and thank you. Thank you for the question. We’re in continual discussions with Hydrozonix about the – what they see is the projections for their business, and the demand for units. They certainly anticipate from all that we know from them that the demand is increasing, and that's the demand for units is likely to also increase. So that's something we anecdotally hearing, they have not provided a level projection that would be reflected yet in our projections for increased numbers of orders.

But certainly the demand for a non-chemical water treatment system in the oil and gas field that allows and enables recycling of flow back and produced waters, is such that we anticipate that growth. And yes, we are fully capable of meeting that demand for increased manufacturing at a quarterly basis here for what we would see in the foreseeable future. If it ramp up multiple times and multipleXs that would be a tremendous problem to have and one that we would also find a solution too. But the short projection the immediate couple of years out, we see increased growth in demand, and we see an ability to meet that demand with manufacturing here in store.

Bradley Grayson – Wells Fargo Advisors, LLC

And one other quick one, if I may. Do you sense – when you look at the stock itself, are you guys motivated to do a reverse split or do you think there would be any benefit trying to get – would it even be feasible given the size of the company that try to get listed on anything other than the bulletin board or with that raise visibility to you that’s the thing in a consideration?

Adrian G. Goldfarb

I think from a photo tactical and strategic standpoint, our management team and our Board is looking at all of those options on a regular basis. You may recall that our management team and Board did go to the shareholders – it was 2009 and has asked for two-year window to do a river split and it was approved by the shareholders at that time, and we felt that the timing within that window was not appropriate, given the markets, and given a lot of the downturn in the markets to execute upon that opportunity that we had for reverse. we certainly are looking at it going forward. we do believe that with the growth at Ecosphere has experienced over the last year, two years that we really should be on a major exchange. and we're looking to do that, and we believe that strategically, such a reverse needs to be done in tandem with other growth features that are taking place. So we’re looking to put that together in a way that most protects our shareholders and builds and ensures the growth of the company and we will go to our shareholders with such a request at the appropriate time with all of those factors under consideration.

Bradley Grayson – Wells Fargo Advisors, LLC

Thank you.

Operator

(Operator Instructions) We’ll take our next question from [Guthrie Castle], private investor.

Unidentified Analyst

Hi guys. Thank you for taking the questions. One I could see in this breathe time from the release of your K, it looks sequentially there was about 200,000 increase in revenue quarter-over-quarter with the new units having been put into place. is that about – we should expect in the future in terms of increase and revenues as you deliver two units per quarter?

Adrian G. Goldfarb

Hi [Guthrie], it’s Adrian, I think the 200,000 obviously, it’s always welcome, increases in revenue. but I think that sort of increase in terms of the operating business right now is not really material in this more due to some costing variances in the units that we’re delivering if you’re speaking about the equipment sales and licensing. The field services obviously has been rising and we’re very pleased with the results from that particular unit. So, I think as far as expectation is a concern and I mentioned this in my comments earlier, we’re sticking to that guidance right now as we go through the end of the year and any significant material increase in revenue would come from either a massive increase in the field services business or more likely that additional units have been ordered. But we are not at the moment forecasting that with sticking – with our guidance as I mentioned in my earlier comments.

Unidentified Analyst

Okay. And just a follow-up question, it looks like your operating income was actually down sequentially. It was, I think over $1 million last quarter and it was $885,000 this quarter. I believe – so what do you attribute the decrease in operating income?

Adrian G. Goldfarb

Yeah, once again, there were some – I think I mentioned this in the last call. There were some timing variances with certain things that we have to invest in. As we build out the units, overhead increased slightly in Q2 as a result as we get more units into the field, and we work with those units, there was certain additional costs. However, what I can comment on it, as we get more experienced with these units, the manufacturing is getting more efficient.

And although there were some increases cost in Q2, we believe that that was really an anomaly, and we don’t expect that going forward. We continue to focus on not only keeping the manufacturing cost down in line with increasing revenues. And I would also point out that with field services, our field services continues to improve as far as the margins are concerned on there. And so overall I do expect that our margins were hold roughly in this area, all will improve as we increase revenue and hold that cost.

Unidentified Analyst

And just one quick follow-up to that, you had mentioned that there was a problem with the supplier in this quarter, is that problem solved or would you anticipate that could happen again.

Adrian G. Goldfarb

With respect to that Mr. Castle the problem is solved, and with a specific component supplier who is little late that cause to a ten day delay just happens that our delivery date is simultaneous with the end of the quarter. So you will see at this way, but it’s not a material change in it in south going forward.

Unidentified Analyst

Okay. Thank you very much. I’ll get back in. Thank you very much.

Adrian G. Goldfarb

Thank you.

Operator

(Operator Instructions) We’ll take our next question from (inaudible) Private Investor.

Unidentified Analyst

Once a contract with Southwestern Energy renewed this past spring, and there is any part of Newfield or Southwestern revenue come outside of the (inaudible) Hydrozonix?

Charles Vinick

Let me answer the second question first, and that is that all of the revenue from Newfield and Southwestern is outside of the relationship with Hydrozonix and that contract. So that’s all through EES and it’s reflected in U.S. field services. So you can see what that is. And then with respect to the work with Southwestern that is ongoing. There’s continual negotiation for how they’re going to do their work going forward, because they’re adjusting their agreements with all of their service providers, but we have growing business with them as I mentioned in my comments prior to the question-and-answer and that work continues on a contractual basis.

Unidentified Analyst

Is there still a relationship with BP?

Charles Vinick

There is not a relationship with BP, it hasn’t been for quite some years with respect to that you may recall that during the BP oil spill we were negotiating with them to provide services during the spill, which we build our technology could be exceptionally helpful and they did not contract with us for that. We have done some pilots for them earlier on and had a brief relationship, but we dont have direct relationships with them today.

Unidentified Analyst

Thank you.

Operator

We’ll take a follow-up from (inaudible) Private Investor.

Unidentified Analyst

Vinick thanks so much. For the last two quarters it seems like you all have attributed the net profit, congratulations on achieving net profits two quarters in a row. But it’s been attributed at least in part materially to a reduction in stock based compensation. Is that something that will continue in the future has there been a change in philosophy or in practices at the company with respect to stock based compensation? Just any color you could provide on that would be helpful?

Charles Vinick

Well, I think that with respect to that, there’s not been change in philosophy. I think it’s a function of timing. There were a number of contracts that work with most senior executives that have stock-based compensation some quarters ago, and that was reflected. But I think what you’re seeing now is quite standard for us. And I would say we’re not always seeing the profitability from the reduction in stock-based compensation, and that’s the component of it.

But in fact, we’re seeing it primarily an increase in our business and our reduction in our costs. That’s while not huge, it is certainly substantial when you compare it quarter-over-quarter and year-over-year from where we were two years ago. So kind of sitting in the CEO’s seat, I see tremendous increases and improvements more than increases, our balance sheet as a whole in our business and in the growth of our business.

Unidentified Analyst

Okay. That’s great to hear. Second question I’ve had with respect to how your units are actually being deployed both on the EES side and on the Hydrozonix side. Can you give some color on what percentage of your work is being devoted to oil, fracing versus gas fracing at this time, and how is the actual? I know you’ve said that quarters are moving in that direction, actual usage of your equipment. How is it evolving with respect to those changes?

Charles Vinick

I think what I’d like to do is that, we use one of your words, if I may and that is evolving. What we’re seeing is a trend and when it’s not just happening with us, it’s happening as I mentioned earlier throughout the industry that E&P companies are moving capital assets to areas where there are more liquid plays. We're seeing that definitely in the deployment of the Hydrozonix unit and we're seeing it with our customers in the field service business as well.

So that I can't give you a percentage, I don't have a percentage of the amount of activity in a given period of time its liquid versus more standards in dry wells if you will or dry gas areas. But certainly, a greater and greater percentage is moving into the liquid areas, because that's where the E&P companies are and they’re still finding a great demand for the service we provide and moving our units with theirs, and that’s happening across the board in EES and with Hydrozonix.

Unidentified Analyst

Is there any material differences in the effectiveness of your units, if they are employed in oil based fracing versus liquids based fracing versus gas based fracing?

Charles Vinick

They’re really having, the general question is no there is not, the general response is no there is not. But that’s a little bit almost too superficial one answer, because every play, every geographic area is different, influent water is different in the Permian basin than it is in the Bakken, different than it is in the Marcellus, different than it is in the Fayetteville Shale. We provide service in all of those areas and the treatment of water to eliminate the need for liquid biocides to reduce and eliminate bacteria and to prevent scaling is what our units can do very, very effectively in every play.

In addition because of the way we work with them, we allow a 100% recycling of that water again in every play. So that the effectiveness is different not because of liquid or dry, it’s because of the influent on how the give E&P company is using the F1 water, what their particular formulas are going down whole and for reuse. So it does very – shale place to shale play, but we are affected in every one of them and it depends really on the formulaic approach that E&P is using.

Unidentified Analyst

Okay, great. Can you say, what shale plays that you see of your units are most effective in (inaudible) yeah.

Charles Vinick

I really can’t – what I can say is that because of – where our customers are, our units are being used more today in the Permian Basin and the Fayetteville Shale then elsewhere but that’s more a function of the customers that we have had historically and the initial customers Hydrozonix currently has and that’s expanding the daily, so I really can’t give more of an answer or more color than that.

Unidentified Analyst

Okay, thank you. That's helpful, – I'll jump back in. Thank you very much.

Operator

(Operator Instructions) There are no further questions in the queue. At this time, I’d like to turn it back over to Mr. Charles Vinick for any additional or closing remarks.

Charles Vinick

Thank you, operator, and thank you all for your participation in today’s call, as well as for your continued support. We look forward to reporting to you again next quarter on our progress and I’d like to close by thanking you.

Operator

That concludes today’s conference. Thank you for participation.

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