Attached files

file filename
EX-31.1 - THERMOENERGY CORPv182713_ex31-1.htm
EX-31.2 - THERMOENERGY CORPv182713_ex31-2.htm
EX-32.1 - THERMOENERGY CORPv182713_ex32-1.htm
EX-32.2 - THERMOENERGY CORPv182713_ex32-2.htm
 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C.  20549
 
FORM 10-K/A
(Amendement No. 1) 

x     ANNUAL REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended December 31, 2009

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 33−46104−FW

THERMOENERGY CORPORATION
(Exact Name of Registrant as specified in its Charter)
 
Delaware
 
71−0659511
(State or other jurisdiction of incorporation or organization)
 
(I.R.S. Employer Identification No.)

124 W. Capitol Avenue, Suite 880
Little Rock, Arkansas 72201
(Address of principal executive offices) (Zip Code)
 
(501) 376−6477
(Issuer’s telephone number, including area code)
 
SECURITIES REGISTERED UNDER SECTION 12(b) OF THE EXCHANGE ACT:
 
Common Stock, $0.001 par value per share

SECURITIES REGISTERED UNDER SECTION 12(g) OF THE EXCHANGE ACT:
None
 
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 x
 
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes o No x

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 o No x
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Website, 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 x 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
 
1


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 x

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

The aggregate market value of the common stock held by non−affiliates of the registrant was $8,555,587 computed by reference to the closing price of the common stock on June 30, 2009, the last trading day of the registrant’s most recently completed second fiscal quarter.
 

Indicate the number of shares outstanding of each of the registrant’s classes of common stock, as of the latest practicable date.
Class – Common Stock, $.001 par value
Outstanding at March 26, 2010 - 53,679,473 shares
 

 
2


THERMOENERGY CORPORATION
ANNUAL REPORT ON FORM 10-K
FOR THE FISCAL YEAR ENDED DECEMBER 31, 2009

 
       
Page
   
Explanatory Note
 
4
   
Forward Looking Information
 
4
         
PART  I
       
Item 1:
 
Business
 
5
Item 1A:
 
Risk Factors
 
12
Item 1B:
 
Unresolved Staff Comments
 
12
Item 2:
 
Properties
 
12
Item 3:
 
Legal Proceedings
 
12
 
 
 
 
 
PART II
       
Item 4:
 
Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
 
12
Item 5:
 
Selected Financial Data
 
13
Item 6:
 
Management’s Discussion and Analysis of Financial Condition and Results of Operations
 
14
Item 6A:
 
Quantitative and Qualitative Disclosures about Market Risk
 
19
Item 7:
 
Financial Statements and Supplementary Data
 
19
Item 8:
 
Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
 
19
Item 8A(T):
 
Controls and Procedures
 
19
Item 8B:
 
Other Information
 
21
         
PART III
       
Item 9:
 
Directors, Executive Officers and Corporate Governance
 
22
Item 10:
 
Executive Compensation
 
31
Item 11:
 
Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
 
38
Item 12:
 
Certain Relationships, Related Transactions and Director Independence
 
40
Item 13:
 
Principal Accountant Fees and Services
 
41
         
PART IV
       
Item 14:
 
Exhibits and Financial Statement Schedules
 
43
         
   
Signatures
 
44
         
   
Financial Statements:
   
   
Report of Independent Registered Public Accounting Firm
 
A-2
   
Consolidated Balance Sheets – December 31, 2009 and 2008
 
A-3
   
Consolidated Statements of Operations  – Years Ended December 31, 2009 and 2008
 
A-4
   
Consolidated Statements of Stockholders’ Equity (Deficit) – Years Ended December 31, 2009 and 2008
 
A-5
   
Consolidated Statements of Cash Flows – Years Ended December 31, 2009 and 2008
 
A-6
   
Notes to Consolidated Financial Statements
 
A-7
         
   
Index of Exhibits
 
B-1
 
3

 
EXPLANATORY NOTE
 
We are filing this Amendment No. 1 to our Annual Report on Form 10-K for the fiscal year ended December 31, 2009 for the purpose of amending Part III, Items 9, 10, 11, 12 and 13 to include information previously omitted from the original filing in reliance on General Instruction G to Form 10-K, which provides that registrants may incorporate by reference certain information from a definitive proxy statement filed within 120 days after the end of the relevant fiscal year.   Our definitive proxy statement for our 2010 Annual Meeting will not be filed within 120 days of the end of the fiscal year ended December 31, 2009.
 
Except for the inclusion of the information described above, this Amendment does not reflect events occurring subsequent to the filing of our original Annual Report on Form 10−K on March 31, 2010 or modify or update other information or exhibits to our Annual Report on Form 10−K other than Exhibits 31.1, 31.2, 32.1 and 32.2, which are being filed herewith.
 
CAUTIONARY STATEMENT REGARDING
FORWARD–LOOKING INFORMATION
 
This annual report on Form 10−K contains statements that are considered forward−looking statements. Forward−looking statements give the current expectations of forecasts of future events of the Company. All statements other than statements of current or historical fact contained in this annual report, including statements regarding the Company’s future financial position, business strategy, budgets, projected costs and plans and objectives of management for future operations, are forward−looking statements. The words “anticipate,” “believe,” “continue,” “estimate,” “expect,” “intend,” “may,” “plan,” and similar expressions, as they relate to the Company, are intended to identify forward−looking statements. These statements are based on the Company’s current plans, and the Company’s actual future activities and results of operations may be materially different from those set forth in the forward−looking statements. These forward−looking statements are subject to risks and uncertainties that could cause actual results to differ materially from the statements made. These include, but are not limited to, the risks and uncertainties associated with statements relating to: (i) the ability of the Company to fund its continued operations and development activities, primarily through the availability of debt and equity financing on terms that are acceptable or otherwise to the Company; (ii) the Company’s ability to commercialize its Technologies (as defined in Item 1, below); (iii) changes in government policy and in legislation and regulation of the waste treatment industry that adversely affect the Company’s business prospects; and (iv) general economic and market conditions.
 
Any or all of the forward−looking statements in this annual report may turn out to be inaccurate. The Company has based these forward−looking statements largely on its current expectations and projections about future events and financial trends that it believes may affect its financial condition, results of operations, business strategy and financial needs. The forward−looking statements can be affected by inaccurate assumptions or by known or unknown risks, uncertainties and assumptions.
 
The Company undertakes no obligation to publicly revise these forward−looking statements occurring after the date hereof. All subsequent written and oral forward−looking statements attributable to the Company or persons acting on its behalf are expressly qualified in their entirety by the cautionary statements contained in this annual report.
 
The Company’s filings with the Securities and Exchange Commission (the “Commission”), including its reports under the Securities and Exchange Act of 1934, as amended (the “Exchange Act”), can be found through the Company’s website at http://www.thermoenergy.com/investorInformation.html. The information contained in the websites of the Company and its subsidiaries is not deemed to be a part of this filing and the Company disclaims any incorporation by reference of such information herein.
 
4


PART I
 
ITEM 1.  Business
 
We are a clean technologies company engaged in the worldwide development of advanced municipal and industrial wastewater treatment systems and carbon reducing clean energy technologies.

Our wastewater treatment technologies are consolidated in our majority-owned subsidiary, CASTion Corporation ("CASTion"), a Massachusetts corporation.  CASTion is a developer and manufacturer of innovative wastewater treatment and recovery systems to industrial and municipal clients. Our process systems  not only meet local, state and federal environmental regulations,  but typically provide a rapid rate of return on investment by recovering and reusing expensive feedstocks, reducing contaminated wastewater discharge and recovering and reusing wastewater used in process operations. Our patented and proprietary platform technology is combined with off-the-shelf technologies to provide systems that are inexpensive, easy to operate and reliable. Our wastewater treatment systems have applications in aerospace, food and beverage processing, metal finishing, pulp & paper, petrochemical, refining, microchip and circuit board manufacturing, heavy manufacturing and municipal wastewater.  Additional information on our water technologies can be found on CASTion’s website at www.castion.com.

We are also the majority owner of a patented clean energy technology known as the Zero Emission Boiler System (“ZEBS”), formerly known as ThermoEnergy Integrated Power System (“TIPS”), which converts fossil fuels (including coal, oil and natural gas) and biomass into electricity without producing air emissions, and at the same time removes and captures carbon dioxide in liquid form for sequestration or beneficial reuse. In conjunction with our joint venture partner, Babcock Power, Inc., we have changed the name of our carbon reducing energy technology from TIPS to ZEBS.  As our joint venture continues to develop this technology for commercialization, we believe that the name change better reflects the broad application of this radical new technology to build new or retrofit old fossil fuel power plants globally with no emissions while capturing carbon dioxide as a liquid for ready sequestration far more economically than any other competing technology.  The ZEBS technology is consolidated in our majority-owned subsidiary, ThermoEnergy Power Systems, LLC (“TEPS”). We own 85% of TEPS; Alexander Fassbender, a former officer, owns 7.5% of TEPS; and the remaining 7.5% is owned by an unrelated third party.  On February 23, 2009, TEPS entered into a joint venture with Babcock Power, Inc. called Babcock-Thermo Carbon Capture, LLC ("BTCC") to commercialize the ZEBS process.  BTCC received an exclusive worldwide license to the ZEBS technology, and BTCC is currently designing a 600 megawatt power plant using the ZEBS technology.
 
ZEBS and the water technologies are collectively referred to as the “Technologies.” The economic and environmental matrix of our technologies represents a significant advancement in these key infrastructure industries.  Additional information can be found on our website at www.thermoenergy.com and on CASTion’s website at www.castion.com

We were founded in 1988, are incorporated under the laws of the State of Delaware, and have been a public company since 1992.  Our common stock was publicly traded on the Over-the-Counter Bulletin Board (“OTCBB”) under the symbol “TMEN.OB” until June 2, 2009, when we received from the Financial Industry Regulatory Authority a  Notice of Decision determining that our securities were not eligible for continued quotation on the OTCBB as a result of our failure to file an annual report or quarterly report by the due date three times in the prior twenty-four months.  Our common stock continues to trade on “pink sheets” under the symbol “TMEN.PK”.

Corporate Mission
 
Our mission is to become a significant force within the global municipal and industrial wastewater and power generation industries.
 
Water Technologies
 
Our new management team has refocused the Company on our key CAST and R-CAST patented technologies (described below) in our intellectual property portfolio pertaining to clean water.  The Company’s clean water technologies offer municipal and industrial clients superior economic and process advantages over conventional wastewater treatment methods. The Company’s water technologies include the following:
 
5

 
CASTion’s CAST, R-CAST and Proprietary Water Technologies
 
Our patented Controlled Atmosphere Separation Technology (“CAST” and “R-CAST”) systems can be utilized as an effective stand-alone wastewater or chemical recovery system, or as part of an integrated plant-wide recovery solution. The CAST wastewater and chemistry recovery system eliminates costly disposal of hazardous waste or process effluent. When used in a Zero-Liquid-Discharge (“ZLD”) application, we can recover nearly 90% of a customer’s valuable chemical resources or wastewater for immediate reuse or recycling at our customer’s facility. CAST concentrates mixed hazardous waste down to as little as 5% of its original volume for economical disposal or reclaim. CASTion’s water technologies fall into three major categories:

 
·
Compliance Systems – designed to meet strict local and federal regulatory mandates;
 
·
Primary Recovery Systems – designed to treat the majority of an operation’s wastewater for reuse and concentrated the contaminants; and
 
·
Final Recovery Systems – designed to treat the remaining concentrate contaminants for disposal or additional processing to achieve zero liquid discharge.

Systems integration is key to the success of any treatment or recovery project. Because of this, we provide significant value as a turnkey solution provider, thereby ensuring these “state-of-the-art” technologies operate effectively.
 
ARP
 
The Ammonia Recovery Process (“ARP technology”) captures ammonia from dilute waste streams and converts it into ammonium sulfate, a commercial grade fertilizer, which can be utilized in agriculture markets worldwide.  The ARP technology has been proven in more than 150 pilot tests nationwide.

ARP is a patented physical/chemical process, comprised of various patented and/or proprietary components, designed to remove and recover ammonia from  aqueous waste streams.  In large-scale field demonstration as well as laboratory tests, ARP has been proven to be a reliable, low−cost, environmentally effective method of treating wastewater discharge streams containing nitrogen in the form of ammonia. The ARP extracts ammonia out of  wastewater discharge streams from municipal, industrial  and livestock waste via RCAST and converts it into standard, commercial−grade, ammonium sulfate fertilizer. The Company is targeting one such ammonia  stream called "centrate";  a liquid product resulting from centrifuging anaerobically digested sewage sludge or animal waste.  Ammonia concentrations found in centrate  ranges from approximately 300 to 3,000 parts per million.  Such plants generate primary and waste activated sludges which are typically treated with anaerobic digestion and then dewatered. In the anaerobic digestion process, more than half of the nitrogen in organic nitrogen compounds is converted into ammonia.
 
Once the anaerobically digested sludge is dewatered,  the organically bound nitrogen stays with the sludge solids while virtually all of the aqueous ammonia  stays with the water portion or centrate. This centrate is typically recycled to the front of the wastewater treatment plant. ARP treats the centrate as a relatively concentrated ammonia stream, and returns a very low ammonia stream to the plant that is well below regulatory requirements. This reduction in the nitrogen load on the plant can increase the overall plant through-put by up to 30%. The removed and concentrated ammonia can thereafter be converted into ammonium sulfate, a commercial grade fertilizer. The primary markets for ARP are municipal and industrial wastewater treatment and  the treatment of wastewater discharge from large concentrated animal farming operations, including dairy, pork, beef and poultry facilities.

We signed our first commercial contract for a 500,000 gallon per day ARP system for New York City’s Bowery Bay Water Pollution Control Plant (“WPCP”). That project was cancelled in 2006 and is currently being moved to the 26th Ward WPCP on Jamaica Bay.  New York City filed a public notice of their intent to enter into a sole-source contract with us on February 18, 2009.  This project will be the first large-scale stand alone project ever implemented by the City of New York designed to prevent excess ammonia from flowing into Jamaica Bay.
 
We licensed one of our patented ARP technologies, the Ion Exchange ("IX"), from Battelle Memorial Institute (“BMI”).  Under the terms of the agreement, dated December 30, 1997, as amended, we agreed to pay to BMI the greater of 5% of revenues received from customers using the BMI technology or $1.00 per 1,000 U.S. gallons processed by the invention.  However, if we enter into a contract under which we or our sublicensee were to design, build, own or operate a facility licensed under the agreement, we would pay to BMI, subject to certain adjustments, a lump sum of 5% of the cost of the installed equipment at the time of commissioning the facility. The agreement provided that we would pay continuing royalties to BMI at a rate of 1.5% of all revenues, excluding certain amortization, received from the customers for such operation; however not less than $0.02 (two cents) per pound of ammonia recovered in the operation.  BMI could terminate the agreement with respect to a particular licensed territory (as described in the agreement) if we had not made sufficient sales to generate royalties to BMI of at least $25,000 per year in that particular territory.  We have not generated such sales to date.  The agreement expires upon the expiration of the patents for ARP technology, or at the discretion of BMI, if a contract is not in place to build a commercial facility to practice the ARP Technology within three years of the date of the agreement.   We have not incorporated IX as a component of our second generation ARP process designs.
 
6


Elements of the ARP technology relating to alkalinity recovery in municipal wastewater treatment plants is currently protected by patents that we license.    Under the terms of the license agreement, at the time when cumulative sales of the licensed products exceed $20 million, we agree to pay 1% of the net sales thereafter (as defined in the agreement).

Other technologies in our portfolio include:

ThermoFuel
 
The ThermoFuel Process ("TFP") is a renewable energy process that converts  digested or  waste activated sewage sludge (biosolids) into a high-energy fuel that can be converted into electricity for use on-site (or exported to the local power grid), or sold as a low-cost feedstock to third party industrial clients.  This Technology is an upgrade of our “STORS” process, which, along with the Company’s ARP technology, was proven in a two-year, $3 million large-scale demonstration project in Colton, CA  in 2000, which was sponsored and funded by the EPA.  The ThermoFuel process provides a cost-effective solution for biosolids disposal for municipal wastewater treatment.  ThermoFuel integrates advanced primary sludge digestion with hydrothermal treatment of waste activated sludge to expand the capacity of existing municipal wastewater facilities.  TFP is designed to be a compact, environmentally effective method of upgrading existing wastewater treatment plants to Exceptional Quality (“EQ”) Class A biosolids production without the use of storage tanks, ponds or lagoons, as is common  practice for municipal wastewater facilities.  EQ Class A biosolids denote the least health risk of human exposure as defined in the 40 CFR Part 503 Risk Assessment study of the EPA.  Over 95% of all municipal wastewater treatment plants in the U.S. currently produce Class B biosolids.  These biosolids do not meet required pathogen and vector attraction reduction requirements and, as such, pose a potential health risk in direct human contact.  The high energy and low moisture content of TFP fuel make it suitable for use as a fuel substitute or blending agent for power plants, municipal solid waste incinerators, cement kilns and similar applications.  The U.S. Patent & Trademark Office issued a patent for the Sewage Treatment System process on March 17, 2005.  The ThermoFuel process is covered in the same license as enhanced biogas.
 
ThermoFuel can be utilized as a stand-alone system or combined with our ARP or Enhanced Biogas Production technologies (described below) to provide a comprehensive and cost-effective method of upgrading existing wastewater treatment plants to produce 100% EQ Class A biosolids; a product which can then be safely applied to expired land, such as a landfill or mining reclamation, or converted on-site to energy via a gasification plant or boiler.  ThermoFuel allows wastewater treatment plant operators to control the incoming waste stream entirely on-site, with only clean water and saleable commodities leaving the plant. The primary target markets for ThermoFuel are municipal and industrial wastewater treatment facilities.
 
Enhanced Biogas Production
 
Our Enhanced Biogas Production process is a cost-effective method of processing and treating animal waste from concentrated animal farming that improves the efficiency of aerobic or anaerobic digesters in conventional wastewater treatment plants.  Our process retrofits existing wastewater treatment plants to recover excess ammonia from the digesters, making the plant run more efficiently.  Through this process, waste is converted into two saleable commodities:  Energy in the form of methane, and ammonium sulfate, a commercial-grade fertilizer.  It can be used as a stand-alone technology, together with our ARP technology, and/or together with our ThermoFuel process.  It can also be implemented with the Temperature Phased Anaerobic Digestion technology used by wastewater treatment plant operators to make more biogas and destroy pathogens.  Temperature phasing is a relatively new method adopted by wastewater treatment plant operators that uses two phases of anaerobic digestion.  In the high temperature phase, (around 120-140ºF) waste solids are disinfected and conditioned to reduce pathogens below threshold levels and solubilize some of the solids during the digestion phase.
 
The Enhanced Biogas Production process is currently protected by patents that we license exclusively.  Under the terms of the license agreement, at the time when cumulative sales of the licensed products exceed $20 million, we agree to pay 1% of the net sales thereafter (as defined in the agreement).  We may assign or transfer the Agreement to third parties with the licensee’s consent, not to be unreasonably withheld.
 
7

 
Energy Technologies
 
In addition to our Water Technologies, we are developing a new, advanced power plant design with our joint venture partner, Babcock Power, Inc., that offers a cost-effective and environmentally responsible solution to both carbon capture and global warming. The power technology is described below.
 
ZEBS
 
Zero Emission Boiler System, or “ZEBS” process, represents a novel thermodynamic approach in power plant design.  Based on reliable oxyfuel chemistry, it combines the combustion of carbonaceous fuels (coal, oil, natural gas or biomass) with essentially complete recovery of all by-products, including NOx, SOx, mercury, particulates, and carbon dioxide (CO2), which can then be used for sequestration or beneficial reuse.  The key element that differentiates ZEBS from conventional oxy-fuel designs is that combustion shifts the temperatures at which water, CO2, mercury and acid gases condense.  Gas-to-liquid nucleate condensation physics is then used to collect and remove the pollutants, while CO2 is recovered as a liquid through direct condensation to reduce harmful air emissions of acid gases, mercury, soot and CO2.  ZEBS is well-suited for new construction and offers a cost-effective way to upgrade many existing coal-fired power plants to zero air emission/carbon capture status.
 
The primary markets for the ZEBS process will be power generation plants for electric utilities and combined heat and power plants for industrial clients, many of which produce waste by-products that can be used as a feedstock for ZEBS.  Some of the industries in which ZEBS can be utilized include oil refineries, petrochemical processing plants and pulp and paper mills.  In March 2001, ThermoEnergy Power Systems was granted U.S. Patent No. 6,196,000 for ZEBS.  We also received a second U.S. patent relating to the ZEBS process (U.S. Patent No. 6,918,253).  Foreign patent applications have been filed in several countries, including Australia, Canada, China, the European Patent Office, India, Mexico, the Russian Federation and South Africa (collectively, the “International Applications”) as provided for by the Patent Cooperation Treaty.  To date, we have received notice of allowance from China and Russia and have paid the issue fee.  We typically obtain continuances in countries where permitted such as Canada and Japan.  Continuances are used to keep the patenting process alive in certain geographical markets until such time we deem the cash outlay on patenting costs and subsequent maintenance fees appropriate in that jurisdiction.  This preserves all rights, and we can request examination at the appropriate time.
 
Business Objectives and Strategy

Our business model is based on 1) new construction or retrofitting of existing wastewater treatment plants for federal, state and municipal governments, industrial clients as well as power generation plants for public and/or merchant utilities worldwide, 2) privatization contracts where we will build and operate, or build, own and operate municipal and/or industrial wastewater treatment and power plants, and 3) the generation and sales of emission credits for emissions including nitrogen, carbon and mercury either directly to end-users or via established public exchanges.  In instances where the client has sufficient skill to design, build and operate our technologies, we will enter into collaborative working relationships such as joint ventures, licenses and other similar agreements with companies that are well-established in our targeted markets, and can greatly expedite the commercialization of our technologies.
 
We previously completed large scale demonstration projects for ARP as well as other wastewater treatment technologies called NitRem/DSR and STORS, which we previously licensed from BMI, but we do not use these technologies.  Each of these projects was funded either by the United States government or by entities with which we have or had collaborative working relationships.  We were not required to make capital contributions to any of these demonstration projects and have not received any revenues or generated any income other than reimbursement for certain administrative and operating costs.  These demonstration projects have allowed us to develop, demonstrate and improve the Technologies without having to finance them itself.  From a competitive standpoint in the wastewater and sludge treatment markets, we believe that the ability to meet various state and federal environmental regulatory standards at lower capital requirements than traditional wastewater and sludge treatment solutions make ARP, ThermoFuel, and Enhanced Biogas Treatment technologies an attractive alternative solution for municipalities and certain industrial applications.  We continue to target those markets where state or federal regulations have been enacted and are enforcing municipal and corporate compliance for nitrogen/ammonia, sewage sludge by-products, and other chemical compounds where our technologies provide the most cost-effective and environmentally responsible solution.

We believe many of  these markets represent suitable opportunities for us to implement our primary business model of design, build, own and operate ("DBOO") wastewater facilities over a contracted period (anticipated to be a 10-20 year period).  Alternatively, we may license the Technologies to the client and enter into an operating contract for municipal-owned systems utilizing our Technologies over a similar time period.  Under these arrangements, we would seek to generate revenues and profits from a per unit tolling fee on the volume of waste processed by our technologies, as well as from the projected sale of the commodity byproducts (i.e. the high-energy fuel generated by ThermoFuel, the ammonium sulfate generated by ARP or selling the electricity and/or process steam produced using the high-energy fuel as a feedstock to the municipality or the local power grid.)
 
8


We completed grant contracts totaling $544,000 with the University of Nevada, Reno and RDS, LLC (a prime contractor of the U.S. Department of Energy) during 2006.  We subcontracted portions of the work on these grants to CANMET (Natural Resources − Canada); Reaction Systems Engineering, Ltd. (“RSE”); Kent, UK; and Stone and Webster, Inc. We completed a grant project totaling $1.4 million grant project with the Alaska Energy Authority in the second quarter of 2009.  The technical data generated by this grant as well as the data from the previous grants, is being used by BTCC to design the initial ZEBS demonstration plant.
 
Our long-term growth strategy also includes the acquisition of other companies whose products or services are related to our core businesses.  Ideally, these candidate companies would (a) already be a well-established participant in one or more of our targeted markets; (b) have ongoing revenues and profits; and (c) bring additional administrative and technical skills and expertise needed for us to achieve our corporate mission and continue our growth goals.
 
New York City Contract

We were awarded a $7 million contract on June 13, 2005 by New York City Department of Environmental Protection (“NYCDEP”) for a 500,000 gallon per day ARP facility to be located at the City’s Bowery Bay Water Pollution Control Plant (“WPCP”).  The project encountered problems at the Bowery Bay WPCP unrelated to our Technologies or operations and was cancelled in September 2006 until such time that NYCDEP could identify an alternative site.  Subsequently, we entered into negotiation with NYCDEP to enter into a new contract to move the project to the 26th Ward WPCP,  situated on Jamaica Bay, in Brooklyn.  Due to process costs and plant operational variances between the Bowery Bay and 26th Ward plant WPCP, the ARP project was enlarged to process up to 1.2 million gallons per day at a cost not to exceed $27.1 million.  We completed and submitted the redesign for the larger plant during the fourth quarter of 2008.  NYCDEP accepted the preliminary design and subsequently filed a public notice of their intent to enter into a sole source contract with us on February 18, 2009.  On August 5, 2009, the City’s Office of Management and Budget (“NYCOMB”) approved the new contract, and we expect to formally sign  the new contract and begin construction of the facility during 2010.  We believe that, based upon the proposed terms of the ARP contract, we would be able to meet the operational requirements of the contract, assuming that substantial additional financing from investors is obtained to meet our cash needs (see Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations – Liquidity and Capital Resources Discussion).  If the 26th Ward facility meets certain predetermined process and economic efficiencies, we intend to pursue additional contracts with New York City with respect to other facilities that will be needed in order to meet the terms of a Consent Decree entered against the City in 2002 pursuant to which the City is required to develop a plan to upgrade the plants to meet specific ammonia discharge limits set out in the Consent Decree.

We released an engineering study by HydroQual Inc., internationally renowned experts in water resources management, confirming the many economic and process advantages of using our patented ARP technology to greatly reduce the amount of ammonia currently being discharged from municipal and industrial wastewater treatment plants.  The study utilized the industry leading BioWin modeling software to support the report’s conclusion that ARP requires significantly less space, uses less energy and dramatically lowers both capital and operating costs for ammonia-nitrogen treatment relative to the use of conventional biological methods.
 
Thousands of tons of nitrogen, in the form of ammonia, are being discharged into local waterways every day by wastewater treatment plants throughout the United States and around the world.  Many states, as well as the federal government, have begun to regulate the amount of ammonia discharged to protect the environment.  While ammonia, in small amounts, is present in many industrial and household products, it is harmful to human health and extremely toxic to aquatic life in large doses.  The presence of ammonia in waterways and aquifers creates conditions resulting in the creation of “Dead Zones”; areas within a body of water where fish and shell fish cannot live. Currently, there are over 140 Dead Zones throughout the world including some of the nation’s leading bodies of water such as the Chesapeake Bay, Long Island Sound, Puget Sound, Gulf of Mexico and Narragansett Bay, among others. 

Recent Developments
 
In September 2009, we engaged in a financing transaction (“the 2009 Financing”) with an investor group consisting of The Quercus Trust, Empire Capital Partners, Robert S. Trump and Focus Fund L.P. which, if fully funded, would result in cash proceeds of $6.4 million to us.  The 2009 Financing provides for funding in four tranches, with the first and second tranche amounts totaling $3.2 million fully funded and the third and fourth tranche amounts totaling $3.2 million based on the occurrence of specified events.
 
9

 
In the first tranche funding of $1.68 million, we issued 8% Secured Convertible Promissory Notes in September 2009 identical in form and substance to our 8% Secured Convertible Promissory Note issued to the Focus Fund L.P. on July 31, 2009, which was amended to provide for a conversion price of $0.24 per share and a maturity date of December 31, 2010.  In addition, our outstanding Convertible Promissory Notes payable to the investors in the original aggregate principal amount of $3,550,000 were amended to conform to the same terms as the 8% Secured Convertible Promissory Notes.  The security for all of the 8% Secured Convertible Promissory Notes is our 85% interest in ThermoEnergy Power Systems.

In the second tranche funding of $1.4 million, we issued shares of Series B Convertible Preferred Stock in November 2009 at a price of $2.40 per share.  Upon the closing of the second tranche funding, the outstanding principal and accrued interest on all of the 8% Secured Convertible Promissory Notes automatically converted into shares of our Series B Convertible Preferred Stock.  Each share of Series B Convertible Preferred Stock is convertible, at any time at the discretion of the holder, into ten shares of our Common Stock.  Except with respect to the election of the Board of Directors, holders of Series B Convertible Preferred Stock will vote on an as-converted basis together with the Common Stock holders on all matters.  The term sheet provides that our Board of Directors will consist of seven members.  Four Directors will be elected by holders of our Series B Convertible Preferred Stock (three to be designated by Quercus and one by Robert S. Trump), and three Directors will be elected by the holders of our Common Stock.

We issued Common Stock warrants with an aggregate exercise price equal to 200% of the principal amount invested to the investors at the closing of each tranche.  The warrants have a five year term and provide for an exercise price of $.50 per share.

The 2009 Financing also provides, among other things, for the following:  (i) the reduction of the exercise price to $.50 for the Company’s outstanding warrants held by the investors which have an exercise price greater than $.50 and were issued in conjunction with Convertible Notes which were amended in accordance with the term sheet; (ii) the dismissal of the litigation filed by Quercus against us; (iii)  the execution of mutual general releases of all prior claims (whether or not yet asserted); (iv) the removal of the registration payment arrangements with Quercus; (v) the employment of a new Chief Executive Officer and Chief Financial Officer; and (vi) the termination of all existing employment agreements with our executive officers.

On September 28, 2009, litigation filed in Arkansas against us by the Quercus Trust was dismissed. On September 30, 2009, litigation filed in Delaware against us by the Quercus Trust was dismissed.  See Note 15 of Notes to Consolidated Financial Statements for additional information.

On March 10, 2010, we entered into a Bridge Loan Agreement, effective March 1, 2010, with our principal investors pursuant to which the investors agreed to make bridge loans to us up to $2.7 million prior to the satisfaction of the conditions to the closing of the third and fourth tranches of the Series B financing.  We issued 3% Secured Convertible Promissory Notes in the principal amount of each investor’s funding commitment (the “Bridge Notes”).  The Bridge Notes bear interest at the rate of 3% per annum and are due and payable on February 28, 2011.

Patents and Patents Pending
 
We own or license all of our technologies, including the technologies discussed previously in this document.
 
License Payments to Battelle Memorial Institute

During 2005, we made the strategic decision to cancel existing license agreements with BMI for STORS, NitRem and DSR technologies in a move designed to fully concentrate our resources on only those technologies that management believes have significant long-term commercial potential.
 
Research and development activities with respect to STORS, NitRem and ARP have generally been conducted by BMI, although BMI did not conduct any research and development activities in 2005, 2006 or 2007. We conduct research and development activities as it relates to product improvement on several of its key water/wastewater process systems in our Worcester, MA facility.  License expenditures totaled $40,000 for the years ended December 31, 2008 and 2007 based upon a minimum royalty schedule.  We do not expect any future annual minimum royalty payments to BMI.
 
10


Employees
 
As of December 31, 2009, we had 23 full-time employees, located primarily in the Worcester, MA fabrication facility and the corporate headquarters in Little Rock, AR.  None of our employees are represented by a labor union.  We have experienced no work stoppages, and management believes our employee relationships are generally good.
 
Competition
 
Our Technologies are intended to enable the wastewater treatment and power generation industries to comply with state and federal clean water and clean air regulatory requirements in the United States.  We believe that these industries are dominated by process methods developed in the 1940s and 1950s, with only minor improvements since that time.  It is our belief that local, state and federal regulatory mandates, as well as amendments to previously enacted clean water regulations (see Government Regulation, below) have rendered the majority of these process methods ineffective, either from an economic or process efficiency standpoint, in meeting  these mandates, especially as they relate to greenhouse gas ("GHG") reduction. Yet, conventional wisdom continues to enable these technologies  to compete with our Technologies for share of the wastewater treatment market.  Competitive factors affecting us include entrenchment and familiarity of the older technologies within our target markets.  Likewise, individuals with purchasing authority within our target markets are not as familiar with our Technologies and may be hesitant to adopt them in their municipal or industrial facilities.  Plant operators have attempted to meet the regulatory requirements by optimizing existing process methods rather than adopting new technologies, including ours.  The cost of developing new technologies and the ability of new companies to enter the wastewater treatment and power generation industries are barriers to entry for new or developing companies.  The established companies in the wastewater treatment and power generation markets who attempt to meet the regulatory mandates by modifying conventional technologies comprise our principal competition.  However, there can be no assurance that there will not be additional competitors in the future or that such competitors will not develop technologies that are superior to ours.
 
Government Regulation
 
There are many federal, state and local statutes and regulations enacted to protect and restore water and air quality. Federal legislation directed at improving water quality include programs established under the Clean Water Act of 1977, as amended, the Coastal Zone Management Act of 1972, as amended, the 1990 and 1996 Farm Bills, the Ocean Dumping Ban Act, and the Clean Water and Watershed Restoration Initiative.  The regulations established under these plans are intended to improve existing water quality programs.  In order to comply with these regulations, municipal and industrial wastewater treatment facilities are seeking more cost-effective methods of wastewater treatment.

We believe that the policy relating to environmental issues relevant to clean air and clean water regulations under President Obama is favorable toward implementation and enforcement.  Management believes that current leaders in both the House of Representatives and the Senate are also far more favorable to environmental issues, which will result in the passage of new legislation relevant to clean air and clean water as well as increased enforcement of existing regulatory requirements by the EPA and U.S. Department of Justice.  Management believes that should the legislative environment improve, there will be additional opportunities for us to market and develop the Technologies.
 
Notwithstanding the uncertainty created by these regulatory and administrative initiatives, we believe that some of the proposals should provide it with additional potential customers for our ZEBS process once development is complete, who desire to meet the regulatory limits and are motivated by the possible economic benefits of selling “credits” under a cap and trade program.
 
Our Technologies are very attractive in the global marketplace, where clean water and clean air regulations of some countries are more stringent than those in effect in the United States.  The marketability of the ZEBS technology was significantly expanded with the ratification of the Kyoto Protocol by 141 nations, which took effect in February of 2005.  As the Kyoto Protocol emission reductions are phased in through 2012, many older coal-fired power plants will be among the first affected by the new regulations.  Many of these plants utilize boiler designs that are 20 years old or more, making any upgrade using conventional combustion technology highly improbable.  Collectively, these plants represent an enormous sunk-cost for utilities and industry, creating an ideal opportunity for any new retrofit technology that could potentially be required to keep these plants operational.  While there are a number of post-combustion carbon capture technologies currently under development,  management is unaware of any other  primary combustion technology currently available or nearing commercial  deployment capable of achieving zero air emissions as well as capturing greater than 95% of carbon dioxide.  There can be no assurance, however, that a competing technology or technologies will not be developed in the future or that the passage of more stringent clean air requirements will result in our Technologies being used in either the United States or abroad, or that the current trend of domestic and international environmental legislation will continue.

11


Item 1A.  Risk Factors
 
Disclosures required under this item are not applicable, as the Company has elected to follow the reduced disclosure requirements as a smaller reporting company, as defined in Rule 12b-2 of the Exchange Act.
 
ITEM 1B.  Unresolved Staff Comments

Not applicable.
 
ITEM 2.  Properties
 
Our principal executive offices are located at 124 West Capitol Avenue, Suite 880, Little Rock, Arkansas, where we lease approximately 1,200 square feet from an unaffiliated third party under a three year lease. We also lease approximately 20,000 square feet of space under a five year lease in Worcester, Massachusetts from an unaffiliated third party which is our primary business office.  In the event either of these leases is not extended or renewed, we believe that we can find comparable facilities in the same geographic area at lease rates comparable to those it currently pays.  We do not own any real property.
 
ITEM 3.  Legal Proceedings
 
None.
 
 
12

 
PART II
 
Item 4.  Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
 
Market Information
 
The Common Stock was traded on the OTC Bulletin Board. The stock symbol was TMEN.OB and the transfer agent is Registrar & Transfer Company, Cranford, New Jersey 07016.  On June 2, 2009 we received from the Financial Industry Regulatory Authority a  Notice of Decision determining that our securities were not eligible for continued quotation on the OTC Bulletin Board as a result of our failure to file an annual report or quarterly report by the due date three times in the prior twenty-four months.  Our common stock continues to trade on “pink sheets” under the symbol “TMEN.PK”.  The ranges of the high and low bid prices for the Common Stock for the four quarters of 2008 and 2009 are shown below.
 
   
High
   
Low
 
Year Ended December 31, 2008
           
First Quarter
 
$1.08
   
$0.64
 
Second Quarter
 
$1.55
   
$0.87
 
Third Quarter
 
$1.15
   
$0.53
 
Fourth Quarter
 
$0.68
   
$0.45
 
             
Year Ended December 31, 2009
           
First Quarter
 
$0.80
   
$0.35
 
Second Quarter
 
$0.70
   
$0.27
 
Third Quarter
 
$0.41
   
$0.27
 
Fourth Quarter
 
$0.42
   
$0.27
 
 
Holders
 
At March 26, 2010, the number of holders of record of the issued and outstanding common stock of the Company was 1,206.
 
Dividends
 
We have never paid any cash dividend on our Common Stock and do not anticipate paying cash dividends in the near future. Any such dividend payment is at the discretion of our Board of Directors and would depend on our earnings, financial condition and other business and economic factors affecting us at that time which the Board of Directors may consider relevant.
 
ITEM 5.  Selected Financial Data

Not applicable.

13

 
ITEM 6.  Management’s Discussion and Analysis of Financial Condition and Results of Operations

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

Overview

We are a clean technologies company engaged in the worldwide development of advanced municipal and industrial wastewater treatment systems and carbon reducing clean energy technologies.

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

We are also the majority owner of a patented clean energy technology known as the Zero Emissions Boiler System (“ZEBS”), formerly known as ThermoEnergy Integrated Power System (“TIPS”), which converts fossil fuels (including coal, oil and natural gas) and biomass into electricity without producing air emissions, and at the same time removes and captures carbon dioxide in liquid form for sequestration or beneficial reuse.  In conjunction with our joint venture partner, Babcock Power, Inc., we have changed the name of our carbon reducing energy technology from TIPS to ZEBS.  As our joint venture continues to develop this technology for commercialization, we believe that the name change better reflects the broad application of this radical new technology to build new or retrofit old fossil fuel power plants globally with no emissions while capturing carbon dioxide as a liquid for ready sequestration far more economically than any other competing technology.  We, through our majority-owned subsidiary, ThermoEnergy Power Systems, LLC, entered into a joint venture with Babcock Power, Inc. called Babcock-Thermo Carbon Capture, LLC ("BTCC") to obtain the resources necessary to facilitate the development and commercialization of this technology.

We currently generate recurring revenues from the sale and development of wastewater treatment systems.  We enter into contracts with our customers to provide a wastewater treatment solution that meets the customer’s present and future needs.  Our revenues are tied to the size and scale of the wastewater treatment system required by the customer, as well as the progress made on each customer contract.  From time to time, we receive funding from federal grants to continue the development of ZEBS; however, there can be no assurance that such grants will be available to us in the future.

There are many federal, state and local statutes and regulations enacted to protect and restore water and air quality. Federal legislation directed at improving water quality include programs established under the Clean Water Act of 1977, as amended, the Coastal Zone Management Act of 1972, as amended, the 1990 and 1996 Farm Bills, the Ocean Dumping Ban Act, and the Clean Water and Watershed Restoration Initiative.  The regulations established under these plans are intended to improve existing water quality programs.  In order to comply with these regulations, municipal and industrial wastewater treatment facilities are seeking more cost-effective methods of wastewater treatment.  We believe that the legislative environment will create additional opportunities to market our Technologies.

We own or license all of the Technologies that we use in our business.

Research and Development
 
Research and development activity is an integral part of our business activity.  We continue to conduct research and development of water/wastewater treatment products and services at our Worcester, MA facility in a number of areas including testing various waste streams for potential clients and other third parties, Chemcad and Aspen modeling for the ZEBS process, centrate testing related to the Company’s New York project and ARP process flow modifications.  In addition, we will continue to participate in joint research and development activities with Babcock Power, Inc through our BTCC joint venture.

Liquidity and Capital Resources
 
We have historically lacked the financial and other resources necessary to market the Technologies or to build demonstration projects without the financial backing of government or industrial partners.  During 2009 and 2008, we have funded our operations primarily from the sale of  convertible debt, preferred stock and restricted stock, generally from stockholders and other related parties who are sophisticated investors in clean technology.  Although we will require substantial additional funding to continue existing operations, we are optimistic in our ability to obtain capital and debt financing.
 
14


Cash used in operations amounted to $3,816,000 and $6,781,000 for the years ended December 31, 2009 and 2008, respectively.  The reduction in cash used from operations in 2009 is primarily the result of our cost cutting measures in 2009, which have reduced continuing operating expenses by more than $2 million.  Cash used by investing activities included an investment in our joint venture with Babcock Power of $50,000 for the year ended December 31, 2009 and purchases of property and equipment of $153,000 for the year ended December 31, 2008.

At December 31, 2009, we did not have sufficient working capital to satisfy our anticipated operating expenses for the next 12 months. As of December 31, 2009, the Company had a cash balance of approximately $1.1 million and current liabilities of approximately $12.0 million, which consisted primarily of convertible debt in default of $4.1 million (net of $104,000 of debt discounts), contingent liability reserves of $3.05 million and unpaid payroll taxes of $2.6 million.

As more fully described in Note 4 of Notes to the Consolidated Financial Statements, we and an investor group engaged in a financing transaction (“the 2009 Financing”) that, if fully funded, would result in cash proceeds of $6.25 million.  The 2009 Financing originally provided for funding in four tranches, with the first and second tranche amounts totaling $3.05 million based on specified time periods and the third and fourth tranche amounts totaling $3.2 million based on the occurrence of specified events.  The first tranche of funding in the amount of $1.68 million was completed in September 2009, and the second tranche of funding totaling $1.4 million was completed in November 2009.

On March 10, 2010, we entered into a Bridge Loan Agreement, effective March 1, 2010, with six of the investors who are parties to the 2009 Financing pursuant to which the investors agreed to make bridge loans to us up to $2.7 million.  We issued 3% Secured Convertible Promissory Notes in the principal amount of each investor’s funding commitment (the “Bridge Notes”).  The Bridge Notes bear interest at the rate of 3% per annum and are due and payable on February 28, 2011.  The entire unpaid principal amount, together with all interest then accrued and unpaid under each Bridge Note, is convertible, at the election of the holder thereof, into shares of Common Stock at a conversion price of $0.24 per share.

The Bridge Loan Agreement amends the 2009 Financing (see Note 9) such that the investors shall surrender the Bridge Notes as payment for the Third Tranche Closing and/or the Fourth Tranche Closing upon the occurrence of certain events.  The Agreement also makes further amendments to the Series B Convertible Preferred Stock financing to provide for additional warrant coverage based on  the amounts advanced and makes changes to funding commitments among the various investors.

The Bridge Notes contain other conventional provisions, including for the acceleration of repayment obligations upon the occurrence of certain specified Events of Default.  The Bridge Notes are secured by a lien on all of our assets except for the shares of our subsidiary, CASTion Corporation (in which no security interest has been granted).

As more fully discussed in Note 14 of Notes to Consolidated Financial Statements, in 2009 we discovered that the former Chief Financial Officer (“CFO”) failed to file our payroll tax returns and pay the related payroll taxes since he assumed his officer position in 2005.  This resulted in an accrual during the fourth quarter of 2008 of an additional $1,064,000 of payroll taxes (resulting in total unpaid payroll taxes of $2,022,000) and $2,105,000 of estimated interest and penalties for late filing of the tax returns and nonpayment of the payroll taxes.  In 2009, we accrued an additional $246,000 of interest and penalties.  We are currently in negotiations with the applicable state and federal taxing authorities to schedule payment of these outstanding taxes.  We may become subject to tax liens if we cannot satisfactorily settle the outstanding payroll tax liabilities.  Furthermore, due to the actions of the CFO, we may also face criminal and/or civil action with respect to the impact of the payroll tax matters.  We cannot predict what, if any, actions may be taken by the respective tax authorities, the Securities and Exchange Commission or other parties or the effect the actions may have on the Company’s results of operations, financial condition or cash flows.

Because of our financial condition, there can be no assurance that we will be able to obtain the funding necessary to continue its operations and development activities.

Critical Accounting Policies and Estimates
 
We have identified the policies and estimates below as critical to our current and future business operations and the understanding of our results of operations. For a detailed discussion on the application of these and other significant accounting policies, see the Notes to Consolidated Financial Statements included elsewhere herein. These policies and estimates are considered "critical" because they either had a material impact or they have the potential to have a material impact on our financial statements, and because they require significant judgments, assumptions or estimates. The preparation of our financial statements in this Annual Report on Form 10-K requires us to make estimates and judgments that affect both the results of operations as well as the carrying values of our assets and liabilities. Some of our accounting policies require us to make difficult and subjective judgments, often as a result of the need to make estimates of matters that are inherently uncertain. We base estimates on historical experience and/or on various other assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities as of the date of the financial statements that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions, making it possible that a change in these estimates could occur in the near term. Set forth below is a summary of our most critical accounting policies.
 
15

 
Principles of consolidation and basis of presentation

The consolidated financial statements include the accounts of ThermoEnergy and our wholly-owned subsidiaries. All significant intercompany accounts and transactions have been eliminated in consolidation. Results of operations of companies purchased are included from the dates of acquisition.

The preparation of financial statements in conformity with generally accepted accounting principles 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 revenue and expenses during the reporting period.  Actual results could differ from those estimates.

Revenue recognition

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

In circumstances when we cannot estimate the final outcome of a contract, or when we cannot reasonably estimate revenue, we utilize the percentage-of-completion method based on a zero profit margin until more precise estimates can be made.  If and when we can make more precise estimates, revenues will be adjusted accordingly and recorded as a change in an accounting estimate.  For the year ended December 31, 2009, we have recorded one contract which represented approximately 80% of our revenues utilizing the percentage-of-completion method based on a zero profit margin.

Costs and estimated earnings in excess of billings on uncompleted contracts, which were not significant at December 31, 2009 and 2008, represent revenues recognized in excess of amounts billed and are included in accounts receivable.  Billings in excess of costs and estimated earnings on uncompleted contracts, which amounted to $398,000 and $264,000 at December 31, 2009 and 2008, respectively, represent amounts billed in excess of revenues earned and are included in deferred revenue.

Accounts receivable, net

Accounts receivable are recorded at their estimated net realizable value.  Receivables related to our contracts and grants have realization and liquidation periods of less than one year and are therefore classified as current.  The allowance for doubtful accounts totaled $9,000 at December 31, 2009. There was no such allowance at December 31, 2008.  Our method for estimating its allowance for doubtful accounts is based on judgmental factors, including known and inherent risks in the underlying balances, adverse situations that may affect the customer’s ability to pay and current economic conditions.  Amounts considered uncollectible are written off based on the specific customer balance outstanding.

Inventory

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

We evaluate our inventory for excess and obsolescence on an annual basis.  In preparing our evaluation, we look at the expected demand for our products for the next three to twelve months in order to determine whether such equipment requires a change in the inventory reserve in order to record the inventory at net realizable value.  Based on this evaluation, we establish and maintain a reserve so that inventory is appropriately stated at the lower of cost or net realizable value.  Inventory reserves totaled $74,000 at December 31, 2009.  There was no inventory reserve at December 31, 2008.
 
16


Property and equipment

Property and equipment are stated at cost and are depreciated over the estimated useful life of each asset.  Depreciation is computed using the straight-line method.  We evaluate long-lived assets based on estimated future undiscounted net cash flows or other fair value measures whenever significant events or changes in circumstances occur that indicate the carrying amount may not be recoverable.  If that evaluation indicates that an impairment has occurred, a charge is recognized to the extent the carrying amount exceeds the discounted cash flows or fair values of the asset, whichever is more readily determinable.  During the year ended December 31, 2008, we recorded asset impairment charges of $105,116 related to property and equipment (primarily a mobile ARP unit).

Debt issue costs

Debt issue costs incurred during 2008 are amortized using the effective interest rate method over the life of the related debt.  Debt issue costs, net of amortization, amounted to $152,000 at December 31, 2008, and are included in Other Assets in the Consolidated Balance Sheets.  All debt issue costs were written off during 2009.

Contingencies
 
We accrue for costs relating to litigation, including litigation defense costs, claims and other contingent matters, including liquidated damage liabilities, when such liabilities become probable and reasonably estimable.  Such estimates may be based on advice from third parties or on management’s judgment, as appropriate.  Revisions to contingent liability reserves are reflected in income in the period in which different facts or information become known or circumstances change that affect our previous assumptions with respect to the likelihood or amount of loss.  Amounts paid upon the ultimate resolution of contingent liabilities may be materially different from previous estimates and could require adjustments to the estimated reserves to be recognized in the period such new information becomes known.
 
Stock options

We account for stock options in accordance with Accounting Standards Codification (“ASC”) Topics 505 and 718 (formerly Statement of Financial Standards No. 123 (Revised 2004), “Share-Based Payment.”)  This Statement requires that the cost of all share-based payments to employees, including grants of employee stock options, be recognized in the financial statements based on their fair values on the measurement date, which is generally the date of grant.  Such cost is recognized over the vesting period of the awards.  We use the Black-Scholes option pricing model to estimate the fair value of stock option awards.

Income taxes

We use the liability method of accounting for income taxes. Under this method, deferred tax assets and liabilities are determined based on the differences between financial reporting and tax basis of assets and liabilities and are measured using enacted rates and laws that will be in effect when the deferred tax assets or liabilities are expected to be realized or settled. A valuation allowance for deferred tax assets is provided if it is more likely than not that all or a portion of the deferred tax assets will not be realized.

Series B Convertible Preferred Stock

The Company initially accounted for its Series B Convertible Preferred Stock by allocating the proceeds based on the relative fair value of the Series B Convertible Preferred Stock and the warrants issued to the investors, and then to any beneficial conversion features contained in the Preferred Stock.  The Company determined the initial value of the Series B Convertible Preferred Stock and investor warrants using valuation models it considers to be appropriate.  Because the Series B Convertible Preferred Stock has an indefinite life, it is classified within the stockholders’ equity (deficit) section of the Company's consolidated balance sheet.  The value of the warrants and beneficial conversion features are considered a “deemed dividend” and are added as a component of net loss attributable to common stockholders on the Company’s consolidated statement of operations.
 
17


Effect of New Accounting Pronouncements
 
In the third quarter of 2009, we adopted the Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) as the source of authoritative generally accepted accounting principles (“GAAP”) for nongovernmental entities.  The ASC does not change GAAP but rather takes the numerous individual pronouncements that previously constituted GAAP and reorganizes them into approximately 90 accounting topics, and displays all topics using a consistent structure. Citing particular content in the ASC involves specifying the unique numeric path to the content.  The adoption of ASC did not have any effect on our consolidated results of operations, financial position or cash flows.

On January 1, 2009, we adopted FASB ASC Topic 815-40 "Determining Whether an Instrument (or Embedded Feature) is indexed to an Entity's Own Stock" (formerly EITF 07-5). ASC Topic 815-40 provides guidance on determining whether an instrument (or an embedded feature) is indexed to an entity’s own stock, which would qualify as a scope exception under prior authoritative literature FASB No. 133, “Accounting for Derivative Instruments and Hedging Activities.”  ASC 815-40 is effective for fiscal years beginning after December 15, 2008.  We adopted ASC topic 815-40 on January 1, 2009 and as such some of our outstanding warrants that were previously classified in equity were reclassified to liabilities as of January 1, 2009, as these warrants contain down round provisions and were no longer deemed to be indexed to the Company’s own stock.  See Note 2 of the Notes to Consolidated Financial Statements for further discussion.

During the second quarter of 2009, we adopted ASC 855, “Subsequent Events” (formerly Statement of Financial Accounting Standards (“SFAS”) No. 165, “Subsequent Events”) which establishes general standards of accounting for and disclosure of events that occur after the balance sheet date but prior to the issuance of the financial statements.  The adoption of this standard did not have a material impact on our consolidated results of operations, financial position, cash flows or disclosures.

During the first quarter of 2009, we adopted ASC 805, “Business Combinations” (“ASC 805”) (formerly SFAS No. 141 (R), “Business Combinations”).  ASC 805 establishes principles and requirements for how an acquirer recognizes and measures in its financial statements the identifiable assets acquired, including goodwill, the liabilities assumed and any non-controlling interest in the acquiree.  The Statement also establishes disclosure requirements to enable users of the financial statements to evaluate the nature and financial effects of the business combination.  The impact of adopting ASC 805 did not have a material impact on our consolidated results of operations, financial position, cash flows or disclosures.
 
During the first quarter of 2009, we adopted SFAS No. 160, “Noncontrolling Interests in Consolidated Financial Statements”, which is now included in ASC 810, “Consolidations”.  This Statement requires ownership interests in subsidiaries held by others to be clearly identified, labeled and presented in the consolidated balance sheet within equity but separate from the parent company's equity.  SFAS 160 also affects the accounting requirements when the parent company either purchases a higher ownership interest or deconsolidates the equity investment.  As discussed in Note 10, we reclassified $1,662,000 of noncontrolling interest in CASTion Corporation as of December 31, 2008 from liabilities to stockholders’ equity (deficit) on our Consolidated Balance Sheet, and we reduced consolidated stockholders’ equity (deficit) by approximately $2,282,000 during the first quarter of 2009 as a result of acquiring the minority interest in our subsidiary, CASTion Corporation, on January 5, 2009.
 
Results of Operations

Comparison of Years Ended December 31, 2009 and 2008

Contract and grant income increased by $2,286,000 to $4,016,000 in 2009 compared to $1,730,000 in 2008.  This increase is related to increased wastewater systems activity in our CASTion subsidiary, as we secured and performed substantial work on one major contract in 2009.  Consequently, cost of contract and grant income increased by $1,613,000 to $4,013,000 in 2009 compared to $2,400,000 in 2008.

General and administrative expenses and professional fees totaled $4,831,000 in 2009, a decrease of $2,137,000 compared to 2008.  The decrease was the result of cost cutting measures taken during 2009 and an accrual of $1,064,000 of payroll taxes during the fourth quarter of 2008 that did not repeat in 2009.  Selling expenses totaled $533,000 in 2009, an increase of $128,000 compared to 2008.  The increase is primarily related to increased commissions on our revenue base in 2009.  Contingency accruals totaling $3,334,000 in 2008 related to estimated interest and penalties on our unpaid payroll taxes did not repeat in 2009.  Stock option expense was $663,000 in 2009, a decrease of $1,019,000 compared to 2008.  The decrease was due to extending the vesting period of options issued in 2009; options issued in 2008 were immediately vested and exercisable.  Expenses related to the issuance of warrants totaled $1,925,000 in 2009, an increase of $492,000 compared to 2008.
 
18


Because of our various debt issuances and the restructuring of convertible debt into preferred stock in 2009, we recognized a loss on the extinguishment of debt of $3,285,000, which is primarily related to amortization of debt discounts for beneficial conversion features and warrants issued with the various debt issuances.  In 2009, we were required to change our accounting for certain warrants issued to investors as derivative liabilities.  As a result, we record income on these derivative instruments totaling $937,000 which resulted from the net change in fair value.  Interest expense in 2009 totaled $2,687,000 in 2009, an increase of $1,064,000 compared to 2008, due to the large number of debt issuances during 2009 which were later converted to preferred stock.

Comparison of Years Ended December 31, 2008 and 2007

Contract and grant income increased by $1,108,000 during 2008 compared to 2007 due primarily to an increase of $981,000 in contract income at the CASTion subsidiary.  CASTion was acquired by the Company on July 2, 2007 and, therefore, only six months of its revenue were included in the year ended December 31, 2007.  Grant income increased by $127,000 during 2008 compared to 2007.  Cost of contract and grant income increased by $1,344,000 during 2008 compared to 2007 which resulted in the $236,000 increase in the gross operating loss during 2008.

General and administrative expenses increased by $1,417,000 during 2008 compared to 2007 due primarily to the impact of the accrual of $1,064,000 of payroll taxes during the fourth quarter of 2008.  See Note 14 of Notes to Consolidated Financial Statements for additional information regarding this matter.  During the year ended December 31, 2007, the Company recorded a goodwill impairment charge of $10,665,000 relating to the 2007 acquisition of CASTion (see Note 10 of Notes to Consolidated Financial Statements for additional information).  Contingency accruals increased significantly during 2008 compared to 2007 due primarily to the estimated interest and penalties on the Company’s $2,022,000 of unpaid payroll taxes at December 31, 2008.  See Note 14 of Notes to Consolidated Financial Statements for additional information regarding contingency accruals.  Compensation expense associated with the issuance of stock options increased by $778,000 during 2008 compared to 2007 due primarily to the increase in the option term to ten years for the 2008 grants compared to three years for the 2007 grants.
 
ITEM 6A.  Quantitative and Qualitative Disclosures About Market Risk

Not applicable.
 
ITEM 7.  Financial Statements and Supplementary Data
 
See the Company’s financial statements for the years ended December 31, 2009 and 2008, beginning on page A-1.
 
ITEM 8. Changes in and Disagreements With Accountants on Accounting and Financial Disclosure

None.
 
ITEM 8A(T). Controls and Procedures
 
Management's Report On Internal Control Over Financial Reporting

Our Management is responsible for establishing and maintaining an adequate system of internal control over financial reporting as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Securities Exchange Act of 1934, as amended (“Exchange Act”). The Company’s internal control over financial reporting should provide reasonable assurance to our Management and Board of Directors regarding the reliability of financial reporting and the reliability, preparation and fair presentation of published financial statements. Our internal control over financial reporting should be supported by a program of appropriate reviews by Management, written policies and guidelines, careful selection and training of qualified personnel, and a written Code of Ethics adopted by our Board of Directors, applicable to all Directors, officers and employees.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements and even when determined to be effective, can only provide reasonable assurance with respect to financial statement preparation and presentation. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
 
19


The Audit Committee of our Board of Directors meets with the independent public accountants and management periodically to discuss internal control over financial reporting and auditing and financial reporting matters. The Audit Committee reviews with the independent public accountants the scope and results of the audit effort. The Audit Committee also meets periodically with the independent public accountants without management present to ensure that the independent public accountants have free access to the Audit Committee.

Our Chief Executive Officer and Chief Financial Officer have assessed the effectiveness of our internal control over financial reporting as of December 31, 2009.  In making this assessment, Management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control – Integrated Framework. Based on Management’s assessment, we believe the Company did not maintain effective internal control over financial reporting as of December 31, 2009. Specifically, we have determined that our internal controls as of December 31, 2009 were deficient in that (i) we had not adequately allocated resources to ensure that necessary internal controls were implemented and followed, (ii) our period-end reporting process did not provide sufficiently timely and accurate financial statements and required disclosures, (iii) there was a lack of segregation of duties in our significant accounting functions, (iv) our contract administration and accounting procedures were deficient, and (v) our former Chief Financial Officer engaged in acts that resulted in significant adjustments to the 2008 consolidated financial statements and subjected us to potential criminal and/or civil action with respect to the impact of our unpaid payroll tax matters.  The former Chief Financial Officer resigned on August 3, 2009 following a vote by our Board of Directors to terminate his employment for cause.
 
Management has discussed its conclusions regarding the inadequacy of internal controls with the Audit Committee and with representatives of our independent public accountants and intends to address the remediation process for the material weaknesses noted and our Section 404 reporting responsibilities in 2010.

This annual report does not include an attestation report of the Company’s independent registered public accounting firm regarding internal control over financial reporting.  Management’s report was not subject to attestation by the Company’s registered public accounting firm pursuant to temporary rules of the Securities and Exchange Commission that permit the Company to provide only Management’s report in this annual report.

Disclosure Controls and Procedures and Internal Control Over Financial Reporting

Disclosure controls and procedures are designed with the objective of ensuring that information required to be disclosed in the Company’s reports filed under the Exchange Act, such as this report, is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms. Disclosure controls and procedures are also designed with the objective of ensuring that such information is accumulated and communicated to the Company’s Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure.

Evaluation of Disclosure Controls and Procedures

As of the end of the period covered by this report, we carried out an evaluation, under the supervision and with the participation of our Chief Executive Officer and Chief Financial Officer, of the effectiveness of disclosure controls and procedures as defined in Rules 13a-15(e) and 15d-15(e) of the Exchange Act. Based on such evaluation, our Chief Executive Officer and Interim Chief Financial Officer have concluded that as of the end of the period covered by this report, our disclosure controls and procedures were not effective at meeting their objectives in that our period-ending reporting process did not provide sufficiently timely and accurate financial statements and disclosures.

Changes in Internal Controls

There were no changes in our internal controls over financial reporting that occurred during our most recently completed fiscal quarter that materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
 
20

 
ITEM 8B. Other Information
 
We held our Annual Meeting of Stockholders on December 15, 2009.  The matters voted upon at this meeting and the number of shares cast for and against each item are as follows:

1.
To elect the following people to the Board to Directors:
 
Director
For
Withheld
Dennis C. Cossey
28,764,671
8,878,277
J. Winder Hughes III
32,217,092
5,425,856
Arthur S. Reynolds
32,238,927
5,404,021

2,
To amend the Company’s Articles of Incorporation to increase the number of authorized shares of Common Stock to 300,000,000:

For
Withheld
Abstain
32,336,707
4,317,528
988,712

3,
To ratify the appointment of Kemp & Company as independent registered public accountants for the Company for 2009:

For
Withheld
Abstain
33,809,942
2,577,738
1,255,267

21

 

ITEM 9.  Directors, Executive Officers and Corporate Governance

Directors and Executive Officers
 
The following biographical descriptions set forth certain information with respect to our directors and our executive officers who are not directors.

Name
 
Position
     
Dennis C. Cossey
 
Director, Chairman of the Board
     
Cary G. Bullock
 
Director, President and Chief Executive Officer
     
David Anthony
 
Director
     
J. Winder Hughes III
 
Director
     
Shawn R. Hughes
 
Director
     
Arthur S. Reynolds
 
Director
     
Teodor Klowan, Jr.
 
Executive Vice President, Chief Financial Officer, Treasurer and Secretary
     
David Delasanta
 
President, CASTion Corporation

Dennis C. Cossey, age 64, has served as a director of the Company since 1988 and as Chairman of our Board of Directors since 1990. Since March 1, 2010, he has held the title “Executive Chairman.”  Mr. Cossey was our Chief Executive Officer from 1988 through January 27, 2010.  Mr. Cossey also serves as a member of the Boards of Directors of our subsidiaries, CASTion Corporation and ThermoEnergy Power Systems LLC.  Prior to joining the Company, Mr. Cossey served in executive and marketing positions at a number of companies, including IBM and Peter Kiewit Sons.  Mr. Cossey is a member of several industry professional groups including the US Naval Institute, the New York Academy of Sciences, the National Safety Council, the American Chemical Society, the Asia Pacific Water Council, the International Power Producers Forum and the Association of Energy Engineers.  Mr. Cossey has testified before Congress on various environmental issues.  Mr. Cossey brings to the Board deep experience in the management of publicly-financed research and operating projects and in the development and maintenance of government relationships on the federal, state and municipal levels.

Cary G. Bullock, age 64, was appointed as our President and Chief Executive Officer and was elected to our Board of Directors on January 27, 2010.  Mr. Bullock also serves as Chief Executive Officer and a member of the Board of Directors of our subsidiary, ThermoEnergy Power Systems LLC, as a member of the Board of Managers of Babcock-Thermo Carbon Capture LLC, our joint venture with Babcock Power, Inc., and as a member of the Board of Directors of our subsidiary, CASTion Corporation.  Prior to becoming our President and CEO, Mr. Bullock had been employed by GreenFuel Technologies Corporation, serving as Chief Executive Officer from February 2005 through July 2007 and as Vice President for Business Development from July 2007 through January 2009; he was a member of the Board of Directors of GreenFuel Technologies Corporation from February 2005 through August 2009. In May 2009, GreenFuel Technologies ceased business operations and made an assignment of its assets to a trustee for the benefit of its creditors.   From February 2009 through January 2010, Mr. Bullock served a variety of clients as an independent consultant and business advisor.  Prior to joining GreenFuel Technologies, Mr. Bullock was Chairman and Chief Executive Officer of Excelergy Corporation, Vice President of KENETECH Management Services and President of its affiliate, KENETECH Energy Management, Inc., Chairman and Chief Executive Officer of Econoler/USA Inc., Vice President of Engineering and Operations and Principal Engineer of Xenergy Inc., Director of Special Engineering and a Senior Engineer at ECRM, Inc. and a Senior Engineer at Sylvania Electronics Systems.  Mr. Bullock received an A.B. from Amherst College and an S.B. and an S.M. from Massachusetts Institute of Technology.  Having worked as a senior executive in several early stage energy companies, Mr. Bullock brings to the Board extensive industry and strategic experience.
 
 
22

 

David Anthony, age 49, has been a director of the Company since October 2009.  Mr. Anthony also serves as a member of the Board of Managers of Babcock-Thermo Carbon Capture LLC, our joint venture with Babcock Power, Inc., and as a member of the Board of Directors of our subsidiary, CASTion Corporation.  Since 2003, he has been Managing Director of 21 Ventures, LLC, a VC management firm providing seed, growth and bridge capital for technology ventures.  Mr. Anthony sits on numerous boards, including: Axion Power International, Inc.; Clean Power Technologies Inc.; Solar EnerTech Corp.; Energy Focus, Inc.; Advanced Hydro, Inc.; Advanced Telemetry, LLC; Aero Farm Systems LLC; Applied Solar LLC; BioPetroClean, Inc.; Expansion Media, LLC; ETV Motors, Ltd.; Graphene Energy, Inc.; Gravity Power, LLC; GreenRay, Inc.; Lightwave Power, Inc.; Magenn Power, Inc.; ReGen Power Systems LLC; Safe Hydrogen, LLC; Variable Wind Solutions Ltd.; Agent Video Intelligence Ltd.; and Command Speech Ltd.  Prior to 21 Ventures, Mr. Anthony launched Notorious Entertainment, a developer of multimedia brands.  Mr. Anthony received a B.A. in Economics from George Washington University and an M.B.A. from Dartmouth College.  Mr. Anthony brings to the Board extensive public company corporate governance and venture capital experience.

J. Winder Hughes III, age 51, has been a director of the Company since July 2009 (except for the period from January 27, 2010 to February 5, 2010).  Mr. Hughes also serves as a member of the Board of Managers of Babcock-Thermo Carbon Capture LLC, our joint venture with Babcock Power, Inc., and as a member of the Board of Directors of our subsidiary, CASTion Corporation.  Since 1995, Mr. Hughes has served as the managing partner of Hughes Capital Investors, LLC, which manages private assets and raises money for small public companies.  He formed the Focus Fund, LP in 2000 (with Hughes Capital as the fund manager), which is a highly-concentrated equity partnership that focuses on publicly-traded emerging growth companies.  From November 2007 to November 2009, Mr. Hughes was a director of Viking Systems, Inc, a manufacturer of surgical tools.  From 1983 to 1995, Mr. Hughes was an investment executive, first with Kidder Peabody & Co. and subsequently with Prudential Securities.  Mr. Hughes holds a B.A. in Economics from the University of North Carolina at Chapel Hill.  Mr. Hughes brings to the Board significant experience with capital raising, corporate restructuring, and managing strategic business relationships.

Shawn R. Hughes, age 49, has been a director of the Company since October 2009.  He previously served as a member of our Board of Directors from September 2008 until January 2009.  Mr. Hughes also serves as a member of the Board of Directors of our subsidiary, CASTion Corporation.  He served as President and Chief Operating Officer of the Company from January 1, 2008 to January 27, 2010. From June 15, 2007 through December 31, 2007, he was employed by us to assist the Chief Executive Officer in administering corporate affairs and overseeing all of our business operating functions. From November 2006 to May 2007, Mr. Hughes served as President and Chief Operating Officer of Mortgage Contract Services.  From 2001 to 2006, Mr. Hughes served as Chief Executive Officer of Fortress Technologies.  Mr. Hughes holds a B.S.B.A. from Slippery Rock University and an M.B.A. from Florida State University.  Mr. Hughes brings to the Board extensive experience in executive management and strategic planning.
 
 
23

 

Arthur S. Reynolds, age 66, has been a director of the Company since October 2008.  He also serves as a member of the Board of Directors of our subsidiary, CASTion Corporation.  From August 3, 2009  through November 16, 2009, Mr. Reynolds served as our interim Chief Financial Officer, and except during that period, has been Chairman of the Audit Committee of the Board of Directors.  He is the founder of Rexon Limited of London and New York where, since 1999, he has served as managing director. Mr. Reynolds was founder and, from 1997 to 1999, managing partner of London-based Value Management & Research (UK) Limited.   Mr. Reynolds was the founder and, from 1982 to 1997, served as managing director of Ferghana Financial Services Limited.  Prior thereto, Mr. Reynolds held executive positions at Merrill Lynch International Bank Limited, Banque de la Société Financière Européene, J.P. Morgan & Company and Mobil Corporation.  Mr. Reynolds is a director of Apogee Technology, Inc.  Mr. Reynolds holds an A.B. from Columbia University, a M.A. from Cambridge University, and an M.B.A. in Finance from New York University.  Mr. Reynolds brings to the Board extensive financial and executive experience across multiple sectors, with special strength in the international arena.

Teodor Klowan, Jr., age 41, was appointed as our Executive Vice President, Secretary and Treasurer on November 2, 2009 and became our Chief Financial Officer on November 16, 2009.  He also serves as Clerk and Treasurer of our subsidiary, CASTion Corporation.  Mr. Klowan has been a certified public accountant since 1991.  From November 2007 through February 2009 he was Chief Financial Officer and from May 2006 to November 2007 he was Vice President, Corporate Controller and Chief Accounting Officer of Nestor, Inc., a publicly held automated speed and red light technology company.  On June 3, 2009, a receiver was appointed by the Rhode Island Superior Court for the business and assets of Nestor, Inc.   Mr. Klowan was Corporate Controller of MatrixOne, Inc. in 2005 and Corporate Controller and Chief Accounting Officer at Helix Technology Corporation from 1999 to 2004. He was Assistant Corporate Controller of Waters Corporation from 1996 to 1999. Prior to 1996, Mr. Klowan worked in management and staff positions at Banyan Systems, Inc. and Ernst & Young.  Mr. Klowan holds a B.A. in Accounting from Bryant University and an M.B.A. in International Finance from Clark University.
 
David W. Delasanta, age 59, has been President of our subsidiary, CASTion Corporation, since December 15, 2008;  prior to assuming that position he was our Senior Vice President of Marketing. Before joining ThermoEnergy in 2008, Mr. Delasanta had 30 years of experience in the environmental and energy fields.  From March 1997 to April 2007, he was Regional Vice-President, Business Development for Shaw Group, a major environmental and energy engineering firm.  From 1994 to 1997, he was Regional Director of Government Business Development  for ICF Kaiser Engineers.  Prior to 1994, he served in various management, sales and marketing positions at RESNA Industries, Air & Water Technologies, ACUREX, and SynGas Systems, and as a consultant with DHR, a Washington DC consulting company where, among other things, he managed the technical support contract for the Department of Energy’s National Energy Plan for coal gasification.  Mr. Delasanta holds a B.S. in Physics from Providence College, a M.S. in Environmental Engineering from Washington University in St. Louis and an M.B.A. from San Jose State University.
 
 
24

 

Pursuant to our Certificate of Incorporation, as amended, the holders of our Series B Convertible Preferred Stock are entitled to elect four members of our Board of Directors (the Series B Directors), which Series B Directors are subject to removal only by a vote of the holders of not less than 66⅔% of the then-outstanding shares of Series B Convertible Preferred Stock voting as a separate class; any vacancy created by the resignation or removal of a Series B Director may be filled either by (i) the vote or consent of the holders of a majority of the then-outstanding shares of Series B Convertible Preferred Stock or (ii) the unanimous vote or consent of the remaining Series B Directors.  The holders of our Common Stock, voting together with the holders of our Series A Preferred Stock, are entitled to elect three members of our Board of Directors (the Common Stock Directors), which Common Stock Directors are subject to removal only by a vote of the holders of a majority of the then-outstanding shares of Common Stock (taken together as a single class with the then-outstanding shares of Series A Preferred Stock); any vacancy created by the resignation or removal of a Common Stock Director may be filled either by (i) the vote or consent of the holders of a majority of the then-outstanding shares of Common Stock and Series A Preferred Stock (voting or consenting together as a single class) or (ii) the unanimous vote or consent of the remaining Common Stock Directors.  The holders of our Series B Convertible Preferred Stock are parties to a Voting Agreement dated as of November 19, 2009, pursuant to which they have agreed to vote all of their shares of Series B Convertible Preferred Stock for the election to our Board of Directors of three persons designated by The Quercus Trust and one person designated by Robert S. Trump.  The Series B Directors are David Anthony and J. Winder Hughes III (both of whom are designees of The Quercus Trust) and Shawn R. Hughes (who is the designee of Robert S. Trump); one Series B Directorship is vacant.  The Common Stock Directors are Cary G. Bullock, Dennis C. Cossey and Arthur S. Reynolds.  All directors serve terms of one year.

The Executive Employment Agreement of our President and Chief Executive Officer, Cary G. Bullock, provides that, during the term of his employment, Mr. Bullock will be elected to serve on our Board of Directors.

None of our directors or executive officers is related by blood or marriage to any other director or executive officer.
 
Committees of the Board of Directors
 
Compensation and Benefits Committee.  The Compensation and Benefits Committee consists of Mr. Anthony, as Chairman, Mr. Shawn Hughes, and Mr. Winder Hughes.  This committee makes recommendations to the Board of Directors on compensation generally, executive officer salaries, bonus awards, stock option grants, special awards and supplemental compensation.  The Compensation and Benefits Committee consults generally with management on matters concerning executive compensation and other compensation issues where Board of Directors or shareholder action is contemplated.  The Board has determined that all of the members of the Compensation and Benefits Committee are independent.
 
Audit Committee.  The Audit Committee consists of Mr. Reynolds, as Chairman, Mr. Winder Hughes, and Mr. Anthony.  This committee oversees the Company’s financial reporting process and internal controls.  The Audit Committee is governed by a written charter approved by the Board of Directors.  The charter sets out the Audit Committee’s membership requirements and responsibilities.  A copy of the Audit Committee charter was provided to shareholders as Annex A to the Company’s 2007 proxy statement.  As part of its duties, the Audit Committee consults with management and the Company’s independent registered public accounting firm during the year on matters related to the annual audit, internal controls, the published financial statements and the accounting principles and auditing procedures being applied.  The Audit Committee selects the Company’s registered public accounting firm, reviews the independent registered public accounting firm’s audit fees, discusses relationships with the auditor, and reviews and approves in advance non-audit services to ensure no compromise of independence.  The Board has determined that Messrs. Anthony and Hughes are “independent directors” and that all of the members are audit committee financial experts (as defined in Item 407(d)(5)(ii) of Regulation S-K).  Mr. Reynolds is not considered independent due to his service as interim Chief Financial Officer during the period August 3, 2009 through November 16, 2009 but, because of Mr. Reynolds’s prior service as an independent member of the Audit Committee, the extraordinary circumstances under which he agreed to serve as interim Chief Financial Officer, and the brief period of such service, the Board of Directors has determined that Mr. Reynolds will be able to exercise independent judgment as a member of the Audit Committee and that his service as Chairman of the Audit Committee is in the best interests of the Company and its shareholders.
 
 
25

 

Nominating Committee.  The directors elected by the holders of our Common Stock and our Series A Convertible Preferred Stock (Messrs. Bullock, Cossey, and Reynolds) serve as the Nominating Committee, with Mr. Cossey serving as Chairman.  The Nominating Committee identifies the individuals to be nominated for election to the Board of Directors by the holders of our Common Stock and our Series A Convertible Preferred Stock.  In considering candidates, the Nominating Committee seeks to assure that the Board of Directors will include persons with a variety of skills and experience, including at least one director with expertise in the areas of science and technology in which the Company operates and at least one director who qualifies as an audit committee financial expert.  The Nominating Committee does not have a charter.  The Nominating Committee will consider director candidates recommended by the shareholders if a nominating shareholder complies with the following requirements.  If a shareholder wishes to recommend a candidate to the Nominating Committee for consideration as a candidate for election to the Board of Directors, the shareholder must submit in writing to the Nominating Committee the nominee’s name and a brief resume setting forth the nominee’s business and educational background and qualifications for service, and a notarized consent signed by the recommended candidate stating the recommended candidate’s willingness to be nominated and to serve.  This information must be delivered to the Chairman of the Nominating Committee at the following address: ThermoEnergy Corporation, 124 W. Capitol Avenue, Suite 880, Little Rock, Arkansas 72201, and must be received no later than December 31 in any year to be considered as a potential director nominee at the Annual Meeting of Shareholders for the following year.  The Nominating Committee may request additional information if it determines a potential candidate may be an appropriate nominee.
 
Ad hoc Executive Search Committee.  During the period from October 15, 2009 through January 27, 2010, a special committee comprised of  Mr. Reynolds, as Chairman, Mr. Anthony and Mr. Winder Hughes, was appointed by the Board of Directors to conduct searches for suitable candidates for the positions of Chief Executive Officer and Chief Financial Officer, to review resumes and interview selected candidates, to recommend to the Board of Directors individuals for appointment to such offices and to negotiate employment agreements with the successful candidates.  At the recommendation of the ad hoc Executive Search Committee, Teodor Klowan, Jr. was appointed Executive Vice President and Chief Financial Officer in November 2009 and Cary G. Bullock was appointed President and Chief Executive Officer in January 2010.  The Committee dissolved upon the appointment of Mr. Bullock.
 
Audit Committee Report
 
The Audit Committee reviews the financial reporting process of ThermoEnergy Corporation (the “Company”) on behalf of the Board of Directors.  Management has the primary responsibility for the financial statements and the reporting process, including the system of internal controls.  The Company’s independent public accountants are responsible for performing an independent audit of the Company's consolidated financial statements in accordance with generally accepted auditing standards and to issue a report thereon.  The Audit Committee monitors these processes.
 
The composition of the Audit Committee changed significantly during the period commencing January 1, 2009, due to the temporary departure from the Audit Committee of Arthur S. Reynolds during his service as interim Chief Financial Officer from August 3, 2009 through November 16, 2009, the resignation of Paul A. Loeffler as a director on October 15, 2009, the appointment of  J. Winder Hughes III to the Audit Committee on July 28, 2009 (and his appointment as interim Chairman of the Audit Committee during Mr. Reynolds’s service as interim CFO), the appointment of David Anthony to the Audit Committee on October 15, 2009, the resignation of J. Winder Hughes as a member of the Audit Committee on January 27, 2010, and the appointment of Shawn R. Hughes to the Audit Committee on January 27, 2010.
 
 
26

 

In May 2009, Kemp & Company, a Professional Association (“Kemp”), which was then our independent public accounting firm, made the Audit Committee aware of the following disagreements between Kemp and Andrew T. Melton who was, at the time, our Chief Financial Officer, on matters of accounting principles or practices, financial statement disclosures or auditing scope or procedures, which disagreements, if not resolved to Kemp’s satisfaction, would have caused Kemp to make reference to the subject matter of such disagreements in its report on our financial statements for the fiscal year ended December 31, 2008:

(i)         Payroll tax adjustments:  Mr. Melton did not agree with Kemp’s estimated adjustment for penalties and interest with respect to unpaid payroll taxes.  Following termination of Mr. Melton’s employment, our interim Chief Financial Officer and our Board of Directors discussed the matter with Kemp and the matter was resolved to Kemp’s satisfaction;

(ii)         Debt covenant violations:  Mr. Melton would not agree to classify our Convertible Promissory Note to The Quercus Trust in the original principal amount of $2,000,000 as in default at December 31, 2008 due to the violation of certain covenants relating to unpaid payroll taxes and the non-disclosure of such violations.  Following termination of Mr. Melton’s employment, our interim Chief Financial Officer and the Audit Committee discussed the matter with Kemp and the matter was resolved to Kemp’s satisfaction; and

(iii)         Failure to provide requested audit information:  Mr. Melton refused to provide critical audit documentation to Kemp.  Following termination of Mr.  Melton’s employment, our interim Chief Financial Officer and the Audit Committee discussed the matter with Kemp, our interim Chief Financial Officer provided all of the requested information to Kemp, and the matter was resolved to Kemp’s satisfaction.
 
 Kemp also brought to the attention of the Audit Committee a number of potential illegal acts which they believed Mr. Melton had committed in his capacity as our Chief Financial Officer.
 
The Audit Committee engaged special legal counsel to investigate the information brought to our attention by Kemp and, through special legal counsel, engaged an independent public accounting firm to perform a forensic audit of our corporate financial records.  Based on the results of that forensic audit and on the investigation by special legal counsel, on July 31, 2009 the Audit Committee recommended to the Board of Directors that Mr. Melton be removed from office for cause due to the commission of material violations of law with respect to the Company’s obligations to file and pay federal and state employment and unemployment tax returns.  On August 3, 2009, the Board of Directors accepted Mr. Melton’s resignation as an officer and director of the Company.
 
 At the request of the Board of Directors, Arthur S. Reynolds, then the Chairman of the Audit Committee, agreed to serve as interim Chief Financial Officer following termination of Mr. Melton’s employment.  Mr. Reynolds served as interim Chief Financial Officer from August 3, 2009  until the appointment of Teodor Klowan, Jr. to that office on November 16, 2009.
 
 
27

 

As a result of the above-described matters, the completion of our financial statements for the fiscal year ended December 31, 2008 was delayed until October 2009, and the Corporation was  unable to file on time its Annual Report on Form 10-K  for such fiscal year and its Quarterly Reports on Form 10-Q  for the periods ended March 31, 2009 and June 30, 2009.
 
With respect to the fiscal year ended December 31, 2009, the Audit Committee met frequently and held extensive discussions with management and the independent public accountants.  Management represented to us that the Company’s consolidated financial statements for such fiscal year were prepared in accordance with generally accepted accounting principles, and the Audit Committee has reviewed and discussed the audited financial statements and related disclosures with management and the independent public accountants, including a review of the significant management judgments underlying the financial statements and disclosures.  The Audit Committee also discussed with the independent public accountants the matters required to be discussed by Statement on Auditing Standards No. 61 (Codification of Statements on Auditing Standards, AU 380), as amended.
 
In addition, the Audit Committee discussed with the independent public accountants that firm’s  independence from the Company and its management, and also considered whether the non-audit services performed during fiscal year 2009 by the independent public accountants were compatible with maintaining the accountants’ independence.  The independent public accountants have provided to the Committee the written disclosures and letter required by the Independence Standards Board Standard No. 1 (Independence Discussions With Audit Committees).
 
The Committee discussed with the Company's independent public accountants the overall scope and plans for its audit. The Committee met with the independent public accountant, with and without management present, to discuss the results of its examinations, the evaluations of the Company’s internal controls, and the overall quality of the Company’s financial reporting.
 
Based on the reviews and discussions referred to above, the Committee recommended to the Board of Directors, and the Board approved, that the audited financial statements be included in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2009, for filing with the Securities and Exchange Commission.
 
In consultation with the Company’s management and the independent public accountants, the Audit Committee determined that the Company’s internal controls and reporting as of December 31, 2009 were deficient in that (i) the Company had not allocated adequate resources to ensure that necessary internal controls were implemented and followed throughout the Company, (ii) the Company’s period-end reporting process did not provide sufficiently timely and accurate financial statements and required disclosures, (iii) there was a lack of segregation of duties in the Company’s significant accounting functions, (iv) the Company’s contract administration and accounting procedures were deficient, and (v) the Company’s former Chief Financial Officer engaged in acts that resulted in significant adjustments to the 2008 consolidated financial statements and subjected the Company to potential criminal and/or civil action with respect to the impact of the Company’s unpaid payroll tax matters.  The Audit Committee has met with Teodor Klowan, Jr.,  the Company’s recently-appointed Chief Financial Officer, to discuss the deficiencies in internal controls and reporting  and is working with Mr. Klowan to implement new controls and to address the identified deficiencies.
 
 
28

 
 
The Company’s independent public accountants report to us and to the Board.  The Audit Committee has sole authority to appoint (subject to shareholder ratification) and to terminate the engagement of the independent public accountants.  The Audit Committee has approved the dismissal of Kemp and Company as the Company’s independent auditing firm and the appointment of CCR LLP as the Company’s principal independent accountants to audit our financial statements for the fiscal year ending December 31, 2010.
 
April 15, 2010
 
 
Audit Committee
   
 
Arthur S. Reynolds, Chairman
 
David Anthony
 
Shawn R. Hughes

Shareholder Communications
 
The Board of Directors does not have a formal policy for shareholder communications to the Board of Directors.  The small size of the Board of Directors and the simple administrative structure of ThermoEnergy permits shareholders to have easy access to ThermoEnergy’s management and its directors for any communications, including those pertaining to director nominations as set forth above.  Shareholder inquiries, suggestions and other communications may be directed to the Chairman of our Board of Directors at ThermoEnergy Corporation, 124 W. Capitol Avenue, Suite 880, Little Rock, Arkansas 72201.
 
Code of Ethics
 
A copy of the Company’s Code of Business Conduct and Ethics, including provisions that apply to our Chief Executive Officer and our Chief Financial Officer, may be obtained free of charge by making a written request to Investor Relations, ThermoEnergy Corporation, 124 W. Capitol Avenue, Suite 880, Little Rock, Arkansas 72201.
 
Attendance at the Annual Meeting and at Board and Committee Meetings
 
Although we do not have a requirement that all members of the Board of Directors attend the Annual Meeting of Shareholders, such attendance is strongly encouraged.  Six of the seven directors then in office attended the 2009 Annual Meeting of Shareholders. During the fiscal year ended December 31, 2009, the Board of Directors held 17 meetings and every director attended at least 75% of those meetings. During 2009, the Audit Committee held 9 meetings and the Compensation and Benefits Committee held 4 meetings, and all members of those committees attended at least 75% of the meetings of their respective committees. The Nominating Committee did not hold any meetings during the fiscal year ended December 31, 2009.
 
Section 16(a) Beneficial Ownership Reporting Compliance
 
Section 16(a) of the Securities Exchange Act of 1934, as amended  requires our executive officers and directors and persons who own more than 10% of our Common Stock to file reports of ownership and changes in ownership with the SEC. Such executive officers, directors and shareholders are also required by SEC rules to furnish us with copies of all Section 16(a) forms they file. Based on information supplied to us and filings made with the SEC, during the fiscal year ended December 31, 2009 the following executive officers and directors failed to make Section 16(a) filings on a timely basis:

 
29

 

Director or Officer
 
Number of Delinquent Filings
 
Number of Transactions
Dennis C. Cossey
 
1
 
1
Alexander G. Fassbender
 
1
 
1
J. Winder Hughes III
 
3
 
3
Shawn R. Hughes
 
2
 
3
Teodor Klowan, Jr.
 
2
 
1
Andrew T. Melton
 
1
 
1
Arthur S. Reynolds
 
5
 
5

Compensation of the Board
 
Directors do not receive cash compensation for serving on the Board or its committees.  Non-employee directors are awarded annual grants of non-qualified stock options.  All directors are reimbursed for their reasonable expenses incurred in attending all board meetings.  We maintain directors and officers liability insurance.
 
The following table shows compensation for the fiscal year ended December 31, 2009 to our directors who were not also named executive officers:
 
Director Compensation (1)
 
   
Fees Earned or
   
Option Awards
       
Name
 
Paid in Cash
   
($) (2)
   
Total ($)
 
Paul A. Loeffler
 
none
   
none
    $ 0  
 
none
   
none
    $ 0  
Martin A. Roenigk
 
none
   
none
    $ 0  
David Gelbaum
 
none
    $ 9,192 (3)   $ 9,192  
David Anthony
 
none
    $ 9,192 (4)   $ 9,192  
J. Winder Hughes III
  $ 60,000 (5)   $ 17,920 (6)   $ 77,920  
David A. Field
 
none
    $ 7,457 (7)   $ 7,457  
Joseph P. Bartlett
 
none
    $ 9,192 (8)   $ 9,192  

(1)
Certain columnar information required by Item 402(m) of Regulation S-K has been omitted for categories where there was no compensation awarded to, or paid to, the named executive officers required to be reported in such columns during 2009 or 2008.
(2)
The amounts in the column “Options Award” reflect the dollar amount recognized for financial statement reporting purposes in accordance with FAS 123R. Assumptions used in the calculation of these amounts are included in Note 9 and Note 10 to the Company’s consolidated financial statements for the fiscal year ended December 31, 2009.  The amounts shown exclude the impact of any forfeitures related to service-based vesting conditions.  The actual amount realized by the director will likely vary based on a number of factors, including the Company’s performance, stock price fluctuations and applicable vesting.
(3)
An option to purchase 30,000 shares of Common Stock at an exercise price of $0.37 per share was granted to Mr. Gelbaum on October 15, 2009; this option expired when Mr. Gelbaum resigned from our Board of Directors.
(4)
An option to purchase 30,000 shares of Common Stock at an exercise price of $0.37 per share was granted to Mr. Anthony on October 15, 2009; this option expires on October 15, 2019 (subject to Mr. Anthony’s continued service on our Board of Directors through the date of our 2010 Annual Meeting).
(5)
We paid Mr. Hughes a fee for certain consulting services prior to his election to our Board of Directors.
(6)
An option to purchase 30,000 shares of Common Stock at an exercise price of $0.33 per share was granted to Mr. Hughes on July 28, 2009; this option expires on July 28, 2019.  An option to purchase an additional 30,000 shares of Common Stock at an exercise price of $0.39 per share was granted to Mr. Hughes on December 15, 2009; this option expires on December 15, 2019 (subject to Mr. Hughes’s continued service on our Board of Directors through the date of our 2010 Annual Meeting).

 
30

 

(7)
An option to purchase 30,000 shares of Common Stock at an exercise price of $0.299 per share was awarded to Mr. Field on December 28, 2009; this option expired when Mr. Field resigned from our Board of Directors.
(8)
An option to purchase 30,000 shares of Common Stock at an exercise price of $0.37 per share was granted to Mr. Bartlett on October 15, 2009; this option expired when Mr. Bartlett resigned from our Board of Directors.

ITEM 10.  Executive Compensation

Summary Compensation Table

The table set forth below summarizes the compensation earned by our named executive officers in 2009 and 2008.

Executive Compensation (1)

Name and Principal Position
 
Year
 
Salary
($)
   
Option
Awards

($)
(2)
   
All Other
Compensation

($)
(3)
   
Total
($)
 
                             
Dennis C. Cossey
 
2009
  $ 228,750     $ 0     $ 41,944     $ 270,694  
Chairman and CEO
 
2008
  $ 295,000     $ 774,093     $ 24,653     $ 1,093,746  
                                     
Andrew T. Melton
 
2009
  $ 79,166     $ 0     $ 31,933     $ 111,099  
Executive Vice President and CFO (4)
 
2008
  $ 250,000     $ 83,159     $ 24,466     $ 357,635  
                                     
Alexander G. Fassbender
                                   
Executive Vice President and
 
2009
  $ 232,500     $ 0     $ 23,184     $ 255,684  
Chief Technology Officer  
2008
  $ 295,000     $ 437,372     $ 109,000     $ 841,372  
                                     
Shawn R. Hughes
 
2009
  $ 229,167     $ 143,000     $ 39,833     $ 412,000  
President and Chief Operating Officer
 
2008
  $ 275,000     $ 76,600     $ 12,000     $ 363,300  
                                     
Arthur S. Reynolds
 
2009
  $ 105,000     $ 138,856     $ 0     $ 243,856  
Interim CFO (5)
 
2008
    n/a       n/a       n/a       n/a  

 
(1)
Certain columnar information required by Item 402(m) of Regulation S-K has been omitted for categories where there was no compensation awarded to, or paid to, the named executive officers required to be reported in such columns during 2009 or 2008.
 
(2)
The amounts in the column “Options Award” reflect the dollar amount recognized for financial statement reporting purposes in accordance with FAS 123R. Assumptions used in the calculation of these amounts are included in Note 9 and Note 10 to the Company’s consolidated financial statements for the fiscal year ended December 31, 2009.
 
(3)
The amounts in the column “All Other Compensation” reflect the following items: automobile expenses, medical and insurance reimbursement, temporary living expenses, moving relocation expense reimbursement and salary to executive officers’ spouses.
 
(4)
Mr. Melton’s employment as Executive Vice President and Chief Financial Officer terminated on August 3, 2009
 
(5)
Mr. Reynolds served as interim Chief Financial Officer from August 3, 2009 through November 16, 2009.  The information for 2008 does not reflect compensation paid to Mr. Reynolds during that year in his capacity as a member of the Board of Directors.

 
31

 

Outstanding Equity Awards at December 31, 2009

The following table summarizes information concerning outstanding equity awards held by the named executive officers at December 31, 2009.  No named executive officer exercised options in the fiscal year ended December 31, 2009.

   
Stock Option Awards
   
Securities
 
Securities
       
   
Underlying
 
Underlying
       
   
Unexercised
 
Unexercised
 
Option
 
Option
   
Options (#)
 
Options (#)
 
Exercise
 
Expiration
Name
 
Exercisable
 
Unexercisable
 
Price ($)
 
Date
                 
Dennis C. Cossey
    250,000  
none
  $ 1.22  
6/10/2010
      560,000  
none
  $ 1.29  
9/15/2010
      150,000  
none
  $ 0.94  
1/20/2011
      350,000  
none
  $ 1.11  
1/02/2011
      797,500  
none
  $ 1.75  
6/30/2018
      250,000  
none
  $ 1.50  
2/27/2019
                     
Andrew T. Melton
    150,000  
none
  $ 1.22  
6/10/2010
      40,000  
none
  $ 0.90  
9/15/2010
      150,000  
none
  $ 0.94  
1/20/2011
      350,000  
none
  $ 1.11  
1/02/2011
      7,500  
none
  $ 1.75  
6/30/2018
      250,000  
none
  $ 1.50  
2/27/2019
                     
Alexander G. Fassbender
    250,000  
none
  $ 1.22  
6/10/2010
      440,000  
none
  $ 1.29  
9/15/2010
      150,000  
none
  $ 0.94  
1/20/2011
      350,000  
none
  $ 1.11  
1/02/2011
      412,500  
none
  $ 1.75  
6/30/2018
      250,000  
none
  $ 1.50  
2/27/2019
                     
Shawn R. Hughes
    250,000  
none
  $ 1.50  
2/27/2019
      600,000  
none
  $ 0.24  
9/16/2019
                     
Arthur S. Reynolds
    48,232  
none
  $ 0.31  
07/31/2014
      45,455  
none
  $ 0.33  
08/31/2014
      40,541  
none
  $ 0.37  
09/30/2014
      46,875  
none
  $ 0.32  
10/31/2014
      500,000  
none
  $ 0.50  
11/30/2014
      30,000  
none
  $ 1.24  
10/03/2018
      40,000  
none
  $ 1.24  
06/30/2019
   
none
 
30,000  
  $ 0.39  
12/15/2019
 
 
32

 

Equity Compensation Plan Information
 
The following table sets forth the securities that are authorized for issuance under our equity compensation plans as of December 31, 2009:
 
Plan Category
 
(A)
Number of securities to be
issued upon exercise of
outstanding options, warrants
and rights
   
(B)
Weighted-average exercise
price of outstanding options,
warrants and rights
   
(C)
Number of securities
remaining available for future
issuance under equity
compensation plans
(excluding securities reflected
in column A)
 
                   
Equity Compensation plans approved by security holders
                 
                   
2008 Incentive Stock Plan
    3,850,000     $ 0.67       6,150,000  
                         
Equity Compensation plans not approved by security holders
                       
                         
Stock options
    7,413,800     $ 1.43       0  
                         
Total
    11,263,800     $ 1.17       6, 510,000  

Employment Contracts and Agreements
 
We have written employment agreements with each of our senior executives. Set forth below are descriptions of the agreements with each of our current executive officers and with each person who was an executive officer on December 31, 2009.
 
Dennis C. Cossey.  Our Executive Employment Agreement with our Executive Chairman,  Dennis C. Cossey,  provides for an annual base salary of $150,000, with eligibility for performance bonuses, from time to time, in accordance with incentive compensation arrangements to be established by the Compensation Committee of our Board of Directors.  Mr. Cossey’s employment is terminable by either party upon 30 days’ written notice; provided that we may terminate Mr. Cossey’s employment immediately for “Cause” (as such term is defined in the Executive Employment Agreement) and Mr. Cossey may terminate his employment immediately for “Good Reason” (as such term is defined in the Executive Employment Agreement) or with 60 days’ written notice upon his “Retirement” (as such term is defined in the Executive Employment Agreement).  If Mr. Cossey’s employment is terminated for any reason other than (i)  by us for Cause or (ii) voluntarily by Mr. Cossey without Good Reason, Mr. Cossey will be entitled to receive severance payments of $12,500 per month for twelve months following the termination of his employment, and we will keep in force for such twelve-month period all health insurance benefits afforded to Mr. Cossey and his family at the time of termination.  Mr. Cossey’s Executive Employment Agreement contains other conventional terms, including covenants relating to the confidentiality and non-use of our proprietary information, and a provision prohibiting Mr. Cossey, for a period of one year following the termination of his employment, from competing against us or soliciting our customers or employees.  Mr. Cossey’s Executive Employment Agreement supersedes Mr. Cossey’s Employment Agreement dated as of September 14, 2005 which provided, among other things, for a contract term of five years (extended, each month for an additional month), with a beginning base compensation of $200,000 (in 2005) for Mr. Cossey and minimum annual 15% increases in compensation.  The prior employment agreement also provided that Mr. Cossey would be eligible for discretionary incentive compensation of up to 100% of his base salary, as determined by the Compensation and Benefits Committee.  The prior employment agreement also entitled Mr. Cossey to periodic performance-based compensation upon the occurrence of certain unusual, but significant, events, including but not limited to the acquisition of new technology, the execution of new contracts in excess of 20% of existing revenues and other events as determined by the Compensation and Benefits Committee.  In addition, the prior employment agreement provided that, upon a change in control of the Company, Mr. Cossey would have been entitled to receive a lump sum payment of five years’ base compensation from the date of such change of control, as well as an immediate vesting of all unvested stock options and/or restricted stock grants.
 
 
33

 

Cary G. Bullock.  On January 27, 2010, we entered into an Executive Employment Agreement with our President and Chief Executive Officer, Cary G. Bullock, pursuant to which we agreed to pay him a base salary of $200,000, with eligibility for performance bonuses, from time to time, in accordance with incentive compensation arrangements to be established by the Compensation Committee of our Board of Directors.  Mr. Bullock’s employment is terminable by either party upon 30 days’ written notice; provided that we may terminate Mr. Bullock’s employment immediately for “Cause” (as such term is defined in the Executive Employment Agreement) and Mr. Bullock may terminate his employment immediately for “Good Reason” (as such term is defined in the Executive Employment Agreement).  If Mr. Bullock’s employment is terminated for any reason other than (i) by us for Cause or (ii) voluntarily by Mr. Bullock without Good Reason, Mr. Bullock will be entitled to receive severance payments of $16,667 per month for six months following the termination of his employment, and we will keep in force for such six-month period all health insurance benefits afforded to Mr. Bullock and his family at the time of termination.  Mr. Bullock’s Executive Employment Agreement contains other conventional terms, including covenants relating to the confidentiality and non-use of our proprietary information, and a provision prohibiting Mr. Bullock, for a period of six months or one year following the termination of his employment (depending on the circumstances of termination), from competing against us or soliciting our customers or employees. 
 
Teodor Klowan, Jr.   On November 2, 2009 we entered into an Executive Employment Agreement with our Executive Vice President and Chief Financial Officer, Teodor Klowan, Jr., pursuant to which we agreed to pay him an annual base salary of $175,000, with eligibility for performance bonuses, from time to time, in accordance with incentive compensation arrangements to be established by the Compensation Committee of our Board of Directors.  Mr. Klowan’s employment is terminable by either party upon 30 days’ written notice; provided that we may terminate Mr. Klowan’s employment immediately for “Cause” (as such term is defined in the Executive Employment Agreement) and Mr. Klowan may terminate his employment immediately for “Good Reason” (as such term is defined in the Executive Employment Agreement).  If Mr. Klowan’s employment is terminated for any reason other than (i) by us for Cause or (ii) voluntarily by Mr. Klowan without Good Reason, Mr. Klowan will be entitled to receive severance payments of $14,583 per month for six months following the termination of his employment, and we will keep in force for such six-month period all health insurance benefits afforded to Mr. Klowan and his family at the time of termination.  Mr. Klowan’s Executive Employment Agreement contains other conventional terms, including covenants relating to the confidentiality and non-use of our proprietary information and a provision prohibiting Mr. Klowan, for a period of one year following the termination of his employment, from competing against us or soliciting our customers or employees.  
 
 
34

 

Alexander G. Fassbender.  Our employment agreement with Alexander G. Fassbender, who was our Executive Vice President and Chief Technology Officer until March 3, 2010, provided for a continuous three-year term (subject to our right to terminate the annual extensions upon 60 days’ written notice), with a beginning base compensation of $135,000 (in 1998) with 15% annual increases, capped at $250,000, after which annual increases will be determined on the basis of changes in the consumer price index. Mr. Fassbender was also eligible for discretionary incentive compensation of up to 50% of his base salary, as determined by the Compensation and Benefits Committee of our Board of Directors. Upon the termination of his employment following a change in control of the Company, Mr. Fassbender was entitled to a lump sum payment equal to 2.99 years’ base compensation in effect on the date of such change of control.  The employment agreement also contained certain restrictive covenants protecting trade secrets and prohibiting Mr. Fassbender from competing with us or soliciting our customers or employees for a period of one year after the termination of his employment.
 
Shawn R. Hughes.  On September 16, 2009 we entered into an Executive Employment Agreement with Shawn R. Hughes, who was, until January 27, 2010, our President and Chief Operating Officer.  The agreement provided that term of Mr. Hughes’s employment expired on the earlier of (i) the date on which the Company had appointed both a new Chief Executive Officer as successor to Dennis C. Cossey and a new Chief Financial Officer as successor to Arthur S. Reynolds or (ii) March 31, 2010 (in either case, the “Termination Date”); provided, however, that the Termination Date was extended until February 28, 2010 to permit Mr. Hughes to assist in the transition of authority to Cary G. Bullock, our new President and CEO.  Mr. Hughes’s Executive Employment Agreement provided for a base salary of $150,000 per annum, with an entitlement to a bonus, upon completion of a certain contract involving our subsidiary, CASTion Corporation, in an amount equal to 10% of CASTion’s gross profits on such contract.  Pursuant to the agreement, we are obligated to make severance payments in the amount of $20,834 per month to Mr. Hughes during the period from March 1, 2010 through February 28, 2011.  The agreement also contained certain restrictive covenants protecting trade secrets and prohibiting Mr. Hughes from competing with us or soliciting our customers or employees for a period of one year after the termination of his employment.
 
Compensation Discussion and Analysis
 
Philosophy and Objectives

The objective of our executive compensation program is to attract, retain and motivate the talented and dedicated executives who are critical to our goals of continued growth, innovation, increasing profitability and, ultimately, maximizing shareholder value.   We provide these executives with what we believe to be a competitive total compensation package consisting primarily of base salary and long-term equity incentive compensation.  Our executive compensation program aims to provide a risk-balanced compensation package which is competitive in our market sector and, more importantly, relevant to the individual executive.
 
Our policy for allocating between long-term and currently-paid compensation is to ensure adequate base compensation to attract and retain personnel, while providing incentives to maximize long-term value for our Company and our shareholders.   Accordingly, (i) we provide cash compensation in the form of base salary to meet competitive cash compensation norms and (ii) we provide non-cash compensation, primarily in the form of stock option awards, to encourage superior performance against long-term strategic goals.  Although on occasion we grant cash bonuses, we do not maintain a formal short-term incentive plan, as our strategic philosophy is to focus on long-term goals. The Compensation and Benefits Committee of our Board of Directors believes this compensation structure focuses our executives’ attention primarily on long-term stock price appreciation, rather than short-term results, and yet enables us to recruit and retain talented executives by ensuring that their annual cash compensation in the form of base salary is competitive with the annual cash compensation paid by other similarly situated companies.

 
35

 
 
Executive Compensation Process

We have recently entered into employment agreements with all of our executive officers.  These agreements provide for payment of base compensation at a rate negotiated at the time of the agreement, with eligibility for cash bonuses from time to time upon achievement of certain performance goals to be established through discussions with the Compensation and Benefits Committee of our Board of Directors (in the case of our Chief Executive Officer) or with such Committee and our Chief Executive Officer (in the case of the other executive officers).  The employment agreements with our Chief Executive Officer and our Chief Financial Officer, both our whom have been recently hired, also provide for an initial grant of stock options, with provision for future grants of stock options at the discretion of the Compensation and Benefits Committee of our Board of Directors.

In negotiating the employment agreements of our executive officers and establishing their base compensation, the ad hoc Executive Search Committee (which had primary responsibility for recruitment of our Chief Executive Officer and our Chief Financial Officer), the Compensation and Benefits Committee and management considered the practices of comparable companies of similar size, geographic location and market focus. We did not utilize any standard executive compensation index or engage the services of a compensation consultant in setting executive compensation, although management, the ad hoc Executive Search Committee and the Compensation and Benefits Committee analyzed publicly available compensation data.
 
In determining each component of each executive’s compensation, numerous factors particular to the executive are considered, including:
 
 
• 
The individual’s particular background, including prior relevant work experience;

 
• 
The market demand for individuals with the executive’s specific expertise and experience;

 
• 
The individual’s role with us;  and

 
• 
Comparison to other executives within our Company.
 
Elements of Compensation
 
Executive compensation consists of the following elements:
 
Base Salary.  Base salary is established based on the factors discussed above. Our general compensation philosophy, as described above, is to offer a competitive package of base salary plus long-term, equity-based incentive compensation. Because we place emphasis on the long-term equity-based portion of our compensation package, we believe that the cash portion of our executive’s compensation is below the average of the range of annual cash compensation (base salary plus annual non-equity incentive compensation) for executives in similar positions with similar responsibilities at comparable companies.

Bonuses.  Cash bonuses and non-equity incentive compensation are generally not a regular or important element of our executive compensation strategy, and we focus instead on stock-based awards designed to reward long-term performance.
 
 
36

 

Stock Option and Stock-Based Awards.  We believe that long-term performance is best stimulated through an ownership culture that encourages such performance through the use of stock-based awards. The ThermoEnergy Corporation 2008 Incentive Stock Plan was established to provide certain of our employees, including our executive officers, with incentives to help align those employees’ interests with the interests of shareholders and with our long-term success. Our Board of Directors believes that the use of stock options and other stock-based awards offers the best approach to achieving our long-term compensation goals. While the 2008 Incentive Stock Plan provides for a variety of stock-based awards, to date we have relied exclusively on stock options to provide equity incentive compensation. We believe that stock options most effectively focus the attention of our executives and management on long-term performance and stock price appreciation. Stock options granted to our executive officers have an exercise price equal to the fair market value of our common stock on the grant date. Our stock options typically vest 25% on the first anniversary of grant and thereafter in equal quarterly installments over an additional three-year period, and generally expire ten years after the date of grant. Stock option grants to our executive officers are made in connection with the commencement of employment, in conjunction with an annual review of total compensation and, occasionally,  to meet special retention or performance objectives. Proposals to grant stock options to our executive officers are made by our CEO to the Compensation and Benefits Committee. The Compensation and Benefits Committee considers the estimated Black-Scholes valuation of each proposed stock option grant in determining the number of shares subject to each option grant. In light of the significance we place on equity-based incentive compensation, in January 2010 our Board of Directors amended the 2008 Incentive Plan (subject to shareholder approval at our next Annual Meeting) to increase the number of shares of our common stock available for grant under such Plan from 10,000,000 to 20,000,000.
 
We have not adopted stock ownership guidelines.
 
Other Compensation.  Our executive officers are not eligible to participate in, and do not have any accrued benefits under, any Company-sponsored defined benefit pension plan. They are eligible to, and in some cases do, participate in defined contributions plans, such as a 401(k) plan, on the same terms as other employees.   In addition, consistent with our compensation philosophy, we intend to continue to maintain our current benefits and perquisites for our executive officers; however, the Compensation and Benefits Committee in its discretion may revise, amend or add to the officer’s executive benefits and perquisites if it deems it advisable. We believe these benefits and perquisites are currently lower than median competitive levels for comparable companies. Finally, all of our executives are eligible to participate in our other employee benefit plans, including medical, dental, life and disability insurance.
 
Tax Implications
 
Section 162(m) of the Internal Revenue Code of 1986, as amended, limits the deductibility on our tax return of compensation of over $1,000,000 to certain of our executive officers unless, in general, the compensation is paid pursuant to a plan which is performance-related, non-discretionary and has been approved by our shareholders. We periodically review the potential consequences of Section 162(m) and may structure the performance-based portion of our executive compensation to comply with the exemptions available under Section 162(m). We believe that options granted under our 2008 Incentive Stock Plan will generally qualify as performance-based compensation under Section 162(m). However, we may authorize compensation payments that do not comply with these exemptions when we believe that such payments are appropriate and in the best interest of the shareholders, after taking into consideration changing business conditions or the officer’s performance.

 
37

 

ITEM 11.  Security Ownership by Certain Beneficial Owners, Directors and Executive Officers
 
The following table sets forth certain information as of March 26, 2010 with respect to beneficial ownership of our Common Stock by each shareholder known by the Company to be the beneficial owner of more than 5% of our Common Stock and by each of our directors and executive officers and by all of the directors, nominees for election as director, and executive officers as a group.
 
Beneficial Owners
 
Amount and Nature
of Beneficial
Ownership (1)
   
Percent of
Class (2)
 
             
Directors and Officers
           
             
David Anthony
           
2105 Natalie Lane
           
Birmingham, Alabama 35244
    0       *  
                 
Cary G. Bullock
               
10 New Bond Street
               
Worcester, Massachusetts  01606
    0       *  
                 
Dennis C. Cossey
               
124 West Capitol Avenue, Suite 880
               
Little Rock, Arkansas 72201
    3,751,049 (3)     6.7 %
                 
David W. Delasanta
               
10 New Bond Street
               
Worcester, Massachusetts  01606
    137,500 (4)     *  
                 
J. Winder Hughes III
               
PO Box 389
               
Ponte Vedra, Florida  32004
    10,865,820 (5)     17.8 %
                 
Shawn R. Hughes
               
717 South Edison Avenue
               
Tampa, Florida 33606
    952,500 (6)     1.8 %
                 
Teodor Klowan, Jr.
               
10 New Bond Street
               
Worcester, Massachusetts  01606
    0       *  
                 
Arthur S. Reynolds
               
230 Park Avenue, Suite 1000
               
New York, New York 10169
    751,103 (7)     1.4 %
                 
All executive officers and directors as a group
(8 persons)
    16,457,972 (8)     25.3 %
                 
Other 5%  Beneficial Owners
               
                 
David Gelbaum and Monica Chavez Gelbaum
               
Quercus Trust
               
1835 Newport Blvd.
               
A109-PMC 467
               
Costa Mesa, California  92627
    44,867,554 (9)     49.3 %

 
38

 

Security Investors, LLC
           
One Security Benefit Place
           
Topeka, Kansas 66636
    3,607,800 (10)     6.7 %
                 
Robert S. Trump
               
89 10th Street
               
Garden City, New York 11530
    28,151,230 (11)     37.1 %
                 
Estate of P.L. Montesi
               
3504 North Hills Boulevard
               
North Little Rock, Arkansas 72116
    3,048,650 (12)     5.5 %
                 
Elise C. Roenigk
PO Box 230
Eureka Springs, Arkansas 72632
    5,650,921 (13)     9.7 %
                 
The Focus Fund
               
PO Box 389
               
Ponte Vedra, Florida  32004
    10,835,820 (14)     17.8 %
                 
Empire Capital Management and Affiliates
               
One Gorham Island, Suite 201
               
Westport, Connecticut 06880
    21,948,031 (15)     30.3 %
                 
Kevin B. Kimberlin
c/o Spencer Trask
               
535 Madison Avenue
               
New York, NY  10022
    7,955,816 (16)     13.8 %
                 
*   Less than 1%
               
 
(1)
Includes shares as to which the identified person  or entity directly or indirectly, through any contract, arrangement, understanding, relationship or otherwise, has or shares voting power and/or investment power, as these terms are defined in Rule 13d-3(a) of the Exchange Act.   Shares of Common Stock underlying options to purchase shares of Common Stock and securities convertible into shares of Common Stock, which were exercisable or convertible on, or become exercisable or convertible within 60 days after, March 26, 2010 are deemed to be outstanding with respect to a person or entity for the purpose of computing the outstanding shares of Common Stock owned by the particular person and by the group, but are not deemed outstanding for any other purpose.
(2)
Based on 53,538,090 shares of Common Stock issued and outstanding on March 26, 2010 plus, with respect to each individual or entity (but not with respect to other individuals or entities), the number of shares of Common Stock underlying options to purchase shares of Common Stock and securities convertible into shares of Common Stock, held by such individual or entity which were exercisable or convertible on, or which become exercisable or convertible within 60 days after, March 26, 2010.
(3)
Includes 2,357,500 shares issuable upon exercise of options.
(4)
All shares are issuable upon exercise of options.
(5)
Includes 10,835,820 shares owned by, or issuable to The Focus Fund.  Mr. Hughes is the Managing Director of The Focus Fund and may be deemed to be the beneficial owner of the securities held by such fund; he disclaims beneficial ownership of such securities except to the extent of his pecuniary interest therein.  Also includes 30,000 shares issuable upon exercise of options.
(6)
Includes 850,000 shares issuable upon exercise of options and warrants.
(7)
Includes 570,000 shares issuable upon exercise of options and warrants.  Also includes  181,103 shares issuable upon the exercise of warrants held by Christine Reynolds, Mr. Reynolds’s wife.  Mr. Reynolds disclaims beneficial ownership of the shares issuable to Mrs. Reynolds.
(8)
Includes shares issuable upon exercise of options and warrants, conversion of shares of Series B Convertible Preferred Stock, and conversion of convertible debt, as detailed in notes (3) through (7) above.
(9)
This beneficial ownership information  is based on information contained in Amendment No. 7 to the Statement on Schedule 13D filed by The Quercus Trust and Mr. and Mrs. Gelbaum as its trustees on  March 17, 2010.  Includes 14,586,210 shares issuable upon conversion of shares of Series B Convertible Preferred Stock, 17,920,000 shares issuable upon the exercise of warrants and 5,000,000 shares issuable upon conversion of convertible debt.

 
39

 

(10)
This beneficial ownership information is based on information contained in Amendment No. 2 to the Statement on  Schedule 13G filed by Security Investors, LLC on February 12, 2010.
(11)
Includes 8,116,670 shares issuable upon conversion of shares of Series B Convertible Preferred Stock, 11,711,104 shares issuable upon the exercise of warrants and 2,500,000 shares issuable upon conversion of convertible debt.
(12)
Includes shares owned directly by the estate of Mr. Montesi and by various members of Mr. Montesi’s family. Also includes 1,797,500 shares of issuable upon the exercise of options.
(13)
Includes 80,000 shares issuable the exercise of options, 1,500,000 shares issuable upon the exercise of warrants, and 3,401,322 shares issuable upon conversion of convertible debt.
(14)
Includes 2,560,820 shares issuable upon conversion of shares of Series B Convertible Preferred Stock, 4,458,333 shares issuable upon the exercise of warrants, and 416,667 shares issuable upon conversion of convertible debt.
(15)
This beneficial ownership information is based on information contained in Amendment No. 4 to the Statement on Schedule 13G filed by the group consisting of Empire Capital Management LLC and its affiliates on  March 22, 2010.  Includes 7,596,853 shares issuable upon conversion of  outstanding shares of Series B Convertible Preferred Stock and 11,347,607 shares of Common Stock  issuable upon the exercise of warrants.
(16)
This beneficial ownership information is based on information contained in Amendment No. 1 to the Statement on Schedule 13D filed by Mr. Kimberlin on  July 22, 2008.  Includes 50,000 shares issuable upon the exercise of warrants and 4,252,015 shares issuable upon conversion of convertible debt.

ITEM 12.  Certain Relationships and Related Transactions, and Director Independence

Certain Relationships and Related Transactions
 
We are a party to a license agreement with Alexander G. Fassbender, who until March 3, 2010 was our Executive Vice President and Chief Technology Officer, under which Mr. Fassbender has granted to us an exclusive license in the patents and patent applications for ThermoFuel and Enhanced Biogas Production in the United States and certain foreign countries.  We are required to pay to Mr. Fassbender a royalty of 1% of net sales after the cumulative sales of all licensed products exceed $20,000,000.  In December 2007, Mr. Fassbender waived certain termination rights under the license agreement, agreed that we can assign or transfer the license without his consent in connection with a merger or a sale of all or a portion of our business and assets, and agreed that he would not transfer his interest in the license agreement without our consent.
 
We are members, along with Mr. Fassbender and Mr. Fassbender’s ex-wife, of a limited liability company, ThermoEnergy Power Systems, LLC (“TEPS”), which owns  the ZEBS technology and which is a 50% member of Babcock-Thermo Carbon Capture, LLC, our joint venture with Babcock Power.  We hold an 85% ownership interest in TEPS and Mr. Fassbender and his ex-wife each own a 7.5% membership interest.  The Operating Agreement of TEPS provides, among other things, that the interests of Mr. Fassbender and his ex-wife cannot be diluted and that Mr. Fassbender will not be obligated to make capital contributions to TEPS other than his initial contribution of intellectual property.
 
The Company and Rexon Limited, a company controlled by Arthur S. Reynolds, a member of our Board of Directors, entered into a consulting agreement on August 21, 2009, pursuant to which Mr. Reynolds provided services as our interim Chief Financial Officer.  Under the Consulting Agreement, the Company paid Rexon a retainer of $15,000 per month, reimbursed Rexon for all reasonable and customary expenses incurred by it in connection with Mr. Reynolds’s services, and issued to Rexon warrants, on the first business day of each month, commencing on August 1, 2009 and continuing through November 1, 2009, for the purchase of that number of shares of Common Stock determined by dividing (i) $15,000 by (ii) the market price per share of the Common Stock on such date. The consulting agreement with Rexon terminated on November 16, 2009 upon the appointment of Teodor Klowan, Jr. as our Chief Financial Officer; under the consulting agreement, we are obligated to continue payment of the $15,000 monthly retainer to Rexon for six months following termination.   Pursuant to the consulting agreement, upon the successful consummation of our Series B Preferred Stock financing, we paid Rexon a success fee of $30,000 in cash, issued to Mr. Reynolds a five-year warrant for the purchase of up to 500,000 shares of our Common Stock at an exercise price of $0.50 per share, and agreed to pay Mr. Reynolds an additional amount of $53,000, payable in five roughly equal monthly installments commencing in June 2010.
 
 
40

 

Our Board of Directors has adopted a policy whereby all transactions between us and any of our affiliates, officers, directors, principal shareholders and any affiliates of the foregoing must be approved in advance by the disinterested members of the Board of Directors based on a determination that the terms of such transactions are no less favorable to us than would prevail in arm’s-length transactions with independent third parties.

Board Determination of Independence
 
Our securities are not listed on a national securities exchange or on an inter-dealer quotation system which has requirements that a majority of the board of directors be independent.  In determining which directors and which members of committees are “independent,” our Board of Directors has voluntarily adopted the independence standards set forth in the Marketplace Rules of the Nasdaq Stock Market.  Our Board of Directors has determined that, in accordance with these standards, two of our current Directors, David Anthony and J. Winder Hughes III are “independent directors.”  Further, six persons who served as members of our Board of Directors for a portion of the fiscal ended December 31, 2009 (Joseph P. Bartlett, David Gelbaum, David Fields, Paul A. Loeffler, Louis J. Ortmann and Martin A. Roenigk) were “independent directors.” Although Shawn R. Hughes and Arthur S. Reynolds do not satisfy the independence standards that we have adopted because each of them, during part or all of the fiscal year ended December 31, 2009, served as an executive officer, our Board of Directors believes that neither Mr. Hughes nor Mr. Reynolds currently has a relationship that would interfere with the exercise of independent judgment in carrying out the responsibilities of a director. In determining the independence of our directors, the Board of Directors considered all transactions in which we and any director had any interest, including those discussed under “Certain Relationships and Related Transactions” above.
 
ITEM 13.  Principal Accountant Fees and Services.
 
Policy on Audit Committee Pre-Approval of Audit and Permissible Non-Audit Services of Independent Public Accountants

The Audit Committee of our Board of Directors  reviews and approves in advance any audit and permitted non-audit services to be provided by our principal independent public accountants. The Audit Committee has the sole authority to make these approvals.

The following describes the current policies and procedures of the Audit Committee with respect to pre-approval of audit and permissible non-audit services:

Audit Services.  All audit services must be pre-approved by the Audit Committee.  The Audit Committee approves the annual audit services engagement and, if necessary, any changes in terms, conditions, and fees resulting from changes in audit scope, company structure, or other matters.  Pre-approval is generally provided for up to one year and any pre-approval is detailed as to the particular service or category of services and is generally subject to a specific budget. The Audit Committee may also grant pre-approval for other audit services, which are those services that only the independent public accountant reasonably can provide.

41

 
Non-Audit Services.  The Audit Committee's policy is to pre-approve all permissible non-audit services provided by the independent public accountants.  These services may include audit-related services, tax services and other services.  The independent public accountants and management are required to periodically report to the Audit Committee regarding the extent of services provided by the independent public accountants in accordance with this pre-approval, and the fees for the services performed to date.  The Audit Committee may also pre-approve particular services on a case-by-case basis.
 
Fees billed to us by Kemp & Company Professional Association, our independent public accountants for fiscal years 2009 and 2008 were comprised of the following:
 
Audit Fees. Kemp & Company’s fee for its audit of our annual financial statements, review of the financial statements included in our quarterly reports on Forms 10−Q, audits of statutory filings, comfort letter procedures and review of other regulatory filings for 2009 and 2008 were $106,000 and $97,000, respectively.
 
Audit Related Fees. No fees were billed to us for audit related services in 2009 or 2008.
 
Tax Fees. Kemp & Company’s fees for tax services provided to us, including tax compliance, tax advice and planning, totaled $4,000 in each of 2009 and 2008.
 
All Other Fees. No other fees were billed to us by Kemp & Company in 2009 or 2008 for “other services.”

In accordance with the Audit Committee’s pre-approval policy, all audit services performed by Kemp & Company during 2008 and 2009 were approved at the time such firm was engaged to serve as our independent public accounts for such fiscal years.  The Audit Committee reviewed and approved, as consistent with our policies and procedures, the tax services performed for us in 2008 and 2009 by Kemp & Company.

42

 
PART IV

ITEM 14.  Exhibits, Financial Statement Schedules

(a)
The following documents are filed as part of this report:
 
(1)
The financial statements of the Company and accompanying notes, as set forth in the contents to the financial statements annexed hereto, are included in Part II, Item 7.
 
(2)
All financial statement schedules are omitted, as the Company has elected to follow the reduced disclosure requirements as a smaller reporting company, as defined in Rule 12b-2 of the Exchange Act.
 
(3)
Exhibits numbered in accordance with Item 601 of Regulation S-K and filed herewith.  See Index to Exhibits on Page B-1.
 
43

 
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.

THERMOENERGY CORPORATION
(Registrant)

/s/ Teodor Klowan, Jr., CPA
   
April 30, 2010
Teodor Klowan, Jr., CPA
Executive Vice President and Chief Financial Officer
     
 
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.
  
*
 
Director and Chairman of the Board
 
April 30, 2010
Dennis C. Cossey
       
         
         
/s/ Cary G. Bullock
 
Director, President and Chief Executive Officer
 
April 30, 2010
Cary G. Bullock
 
(Principal Executive Officer)
   
         
         
/s/ Teodor Klowan, Jr., CPA
 
Executive Vice President and Chief Financial Officer
 
April 30, 2010
Teodor Klowan, Jr., CPA
 
(Principal Financial and Accounting Officer)
   
         
         
*
 
Director
 
April 30, 2010
David Anthony
       
         
         
*
 
Director
 
April 30, 2010
J. Winder Hughes III
       
         
         
*
 
Director
 
April 30, 2010
Shawn R. Hughes
       
         
         
*
 
Director
 
April 30, 2010
Arthur S. Reynolds
       
         
* By /s/ Cary G . Bullock        
 
Attorney - in - Fact
       
 
44

 
THERMOENERGY CORPORATION
 
CONSOLIDATED FINANCIAL STATEMENTS
 
Years ended December 31, 2009 and 2008
 
With
 
Report of Independent Registered Public Accounting Firm
 
A-1


Report of Independent Registered Public Accounting Firm

Board of Directors
ThermoEnergy Corporation
 
We have audited the accompanying consolidated balance sheets of ThermoEnergy Corporation and subsidiaries as of December 31, 2009 and 2008, and the related consolidated statements of operations, stockholders’ equity (deficit) and cash flows for the years then ended.  These financial statements are the responsibility of the Company’s management.  Our responsibility is to express an opinion on these 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 audit to obtain reasonable assurance about whether the financial statements are free of material misstatement.  An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements.  An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall 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 ThermoEnergy Corporation and subsidiaries as of December 31, 2009 and 2008, and the consolidated results of their operations and their cash flows for the years then ended, in conformity with accounting principles generally accepted in the United States of America.

The accompanying consolidated financial statements have been prepared assuming the Company will continue as a going concern.  As discussed in Note 13 to the consolidated financial statements, the Company has incurred net losses since inception and will require substantial capital to continue commercialization of the Company’s technologies and to fund the Companies liabilities, which included $2,621,000 of unpaid payroll taxes, $4,133,000 of convertible debt in default (net of debt discounts of $104,000) and $3,053,000 of contingent liability reserves at December 31, 2009.  These conditions raise substantial doubt about the Company’s ability to continue as a going concern.  Management’s plans in regard to these matters are also described in Note 13 to the consolidated financial statements.  The consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty.

As discussed in Note 2 to the consolidated financial statements, the Company changed its method of evaluating when adjustment features within financial instruments are considered to be equity due to the adoption of new accounting requirements issued by the Financial Accounting Standards Board as of January 1, 2009.


/s/ Kemp & Company, a Professional Association
Little Rock, Arkansas
March 30, 2010
 
A-2


THERMOENERGY CORPORATION
CONSOLIDATED BALANCE SHEETS
(in thousands, except share and par value amounts)

   
December 31,
2009
   
December 31,
2008
 
ASSETS
           
Current Assets:
           
Cash
 
$
1,109
   
$
115
 
Accounts receivable, net
   
7
     
111
 
Inventories, net
   
74
     
164
 
Other current assets
   
205
     
164
 
Total Current Assets
   
1,395
     
554
 
                 
Property and equipment, net
   
241
     
305
 
Other assets
   
74
     
176
 
                 
Total Assets
 
$
1,710
   
$
1,035
 
                 
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
               
Current Liabilities:
               
Accounts payable
 
$
812
   
$
204
 
Short-term borrowings
   
     
873
 
Convertible debt in default
   
4,133
     
3,478
 
Contingent liability reserves
   
3,053
     
3,334
 
Deferred revenue
   
398
     
264
 
Other current liabilities
   
3,627
     
2,713
 
Total Current Liabilities
   
12,023
     
10,866
 
                 
Long Term Liabilities:
               
Deferred comp retirement plan for officers, net of current portion
   
229
     
261
 
Warrant liability
   
2,559
     
 
Convertible debt
   
1,370
     
992
 
Total Long Term Liabilities
   
4,158
     
1,253
 
                 
Total Liabilities
   
16,181
     
12,119
 
                 
Stockholders' Equity (Deficit):
               
Preferred Stock, $0.01 par value, 20,000,000 shares authorized:
               
Class A Preferred Stock, liquidation value of $1.20 per share: designated:
               
10,000,000 shares;  issued and outstanding: 208,334 shares in 2009 and 2008
   
2
     
2
 
Class B Preferred Stock, liquidation preference of $2.40 per share: designated:
               
4,371,287 shares; issued and outstanding: 3,037,954 shares in 2009
   
30
     
 
Common Stock, $.001 par value:  authorized - 300,000,000 shares;
               
issued: 53,763,270 shares in 2009 and 50,247,537 shares in 2008;
               
outstanding: 53,679,473 shares in 2009 and 50,163,740 shares in 2008
   
54
     
50
 
Additional paid-in capital
   
66,711
     
58,810
 
Accumulated deficit
   
(81,268
)
   
(68,284
)
                 
Total ThermoEnergy Corporation Stockholders' Equity (Deficit)
   
(14,471
)
   
(9,422
)
Noncontrolling interest
   
     
(1,662
)
                 
Total Stockholders’ Equity (Deficit)
   
(14,471
)
   
(11,084
)
                 
TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY (DEFICIT)
 
$
1,710
   
$
1,035
 

See notes to consolidated financial statements.
 
A-3


THERMOENERGY CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except share and per share amounts)

   
Year Ended December 31,
   
2009
   
2008
 
             
Contract and grant income
 
$
4,016
   
$
1,730
 
Less: cost of contract and grant income
   
4,013
     
2,400
 
Gross operating income (loss)
   
3
     
(670
)
                 
Operating Expenses:
               
General and administrative
   
3,071
     
5,534
 
Selling expenses
   
533
     
405
 
Contingency accruals
   
     
3,334
 
Option expense
   
663
     
1,682
 
Warrant expense
   
1,925
     
1,331
 
Professional fees
   
1,760
     
1,434
 
Total operating expenses
   
7,952
     
13,720
 
                 
Loss from operations
   
(7,949
)
   
(14,390
)
                 
Other income (expense):
               
Interest income
   
     
29
 
Loss on extinguishment of debt
   
(3,285
   
 
Derivative investment income
   
937
     
 
Interest expense
   
(2,687
   
(1,623
Total other income (expense)
   
(5,035
)
   
(1,594
)
                 
Net loss before minority interest in subsidiary
   
(12,984
)
   
(15,984
)
Minority interest in subsidiary
   
     
248
 
                 
                 
Net loss
 
$
(12,984
)
 
$
(15,736
)
Deemed dividend on Series B Convertible Preferred Stock
   
(2,749
)
   
 
                 
Net loss attributable to common stockholders
 
$
(15,733
)
 
$
(15,736
)
                 
Loss per share attributable to common stockholders, basic and diluted
 
$
(0.30
)
 
$
(0.34
)
                 
Shares used in computing loss per share, basic and diluted
   
52,742,611
     
46,372,059
 

See notes to consolidated financial statements.
 
A-4

 
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)
(in thousands, except share and per share amounts)
Years Ended December 31, 2009 and 2008
 
   
ThermoEnergy Corporation Stockholders' Equity (Deficit)
             
   
Series A
Convertible
Preferred
Stock
   
Series B
Convertible
Preferred
Stock
   
Common
Stock
   
Additional
Paid-In
Capital
   
Accumulated
Deficit
   
Noncontrolling
Interest
   
Total
 
                                           
Balance (Deficit) January 1, 2008
  $ 53     $ -     $ 40     $ 50,794     $ (52,548 )   $ (1,414 )   $ (3,075 )
                                                         
Warrants issued for services
                            1,331                       1,331  
Issuance of 220,000 shares of Common Stock for services
                            277                       277  
Cashless exercise of 4,662,639 warrants for 1,854,984 shares of Common Stock
                    2       (2 )                     -  
Exercised 741,493 warrants for 741,493 shares of Common Stock
                    1       473                       474  
Stock grants issued to officers (250,000 shares at $1.11 per share)
                    1       278                       279  
Stock options issued to officers, directors and employees
                            1,682                       1,682  
Converted Preferred Stock to Common Stock (5,051,668 shares)
    (51             5       46                       -  
Convertible Note converted to Common Stock (1,146,036 shares at $0.50 per share)
                    1       572                       573  
Common Stock Issued for interest payments (124,172 shares at $0.47 per share)
                            58                       58  
Warrants and beneficial conversion feature issued with convertible notes
                            3,301                       3,301  
                                                         
Net loss
                                    (15,736     (248 )     (15,984 )
                                                         
Balance (Deficit) December 31, 2008
  $ 2     $ -     $ 50     $ 58,810     $ (68,284 )   $ (1,662 )   $ (11,084 )
                                                         
Cumulative effect of change in accounting principle
                            (3,195 )                     (3,195 )
Stock options issued to officers, directors and employees
                            663                       663  
Modification of warrants
                            1,691                       1,691  
Warrants issued for services
                            148                       148  
Common Stock Issued for interest payments (313,005 shares)
                            109                       109  
Issuance of 345,000 shares of Common Stock for services
                            188                       188  
Issued 1,428,571 shares of Common Stock for cash
                    2       498                       500  
Issued 435,442 shares of Common Stock and warrants to acquire CASTion's noncontrolling interest
                    1       268                       269  
Purchase of CASTion shares from noncontrolling interest
                            (2,282 )             1,662       (620 )
Warrants and beneficial conversion feature issued with convertible notes and Series B Preferred Stock
                            4,211                       4,211  
Convertible Note converted to Common Stock (768,535 shares at $.75 per share)
                    1       576                       577  
Convertible Notes and accrued interest converted to Series B Preferred Stock (2,454,621 shares at $2.40 per share), net of value of acquired beneficial conversion features
            24               3,632                       3,656  
Issued 583,333 shares of Series B Preferred Stock for cash
            6               1,394                       1,400  
                                                         
Net Loss
                                    (12,984 )             (12,984 )
                                                         
Balance (Deficit) December 31, 2009
  $ 2     $ 30     $ 54     $ 66,711     $ (81,268 )   $ -     $ (14,471 )
 
See notes to consolidated financial statements.
 
A-5

 
THERMOENERGY CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)

   
Year Ended December 31,
   
2009
   
2008
 
             
Operating Activities:
           
Net loss
 
$
(12,984
)
 
$
(15,736
)
Adjustment to reconcile net loss to net cash used in operating activities:
               
Options issued to officers and directors
   
663
     
1,682
 
Warrant expense
   
1,823
     
1,331
 
Warrants issued for services
   
148
     
 
Common stock issues for services
   
188
     
 
Loss on extinguishment of debt
   
3,285
     
 
Change in fair value of warrant liability
   
(937
)
       
Depreciation
   
64
     
65
 
Provision for inventory reserves
   
74
     
 
Contingency accruals
   
     
3,334
 
Impairment charges - property and equipment
   
     
105
 
Minority interest in subsidiary
   
     
(248
)
Stock issued for services
   
     
277
 
Amortization of discount on convertible debt
   
1,364
     
1,090
 
Other
   
     
40
 
Increase (decrease) in cash arising from changes in assets and liabilities:
               
Accounts and notes receivable
   
104
     
149
 
Inventories
   
16
     
20
 
Other current assets
   
(41
   
75
 
Other assets
   
     
(19
)
Accounts payable
   
608
     
(640
)
Deferred revenue
   
134
     
(194
)
All other current liabilities
   
1,707
     
1,931
 
Deferred compensation retirement plan
   
(32
)
   
(43
)
 
               
Net cash used in operating activities
   
(3,816
)
   
(6,781
)
                 
Investing activities:
               
Investment in joint venture
   
(50
   
 
Purchase of property and equipment
   
     
(153
)
                 
Net cash used in investing activities
   
(50
)
   
(153
)
                 
Financing Activities:
               
Proceeds from short-term borrowings
   
     
1,000
 
Payments on short-term borrowings
   
     
(200
)
Proceeds from issuance of Common Stock and warrants
   
500
     
474
 
Proceeds from issuance of Preferred Stock and warrants
   
1,400
     
 
Proceeds from convertible promissory notes
   
3,260
     
2,750
 
Payments on convertible promissory notes
   
(300
)
   
 
Debt issue costs
   
     
(160
)
                 
Net cash provided by financing activities
   
4,860
     
3,864
 
                 
Net change in cash
   
994
     
(3,070
)
Cash, beginning of year
   
115
     
3,185
 
Cash, end of year
 
$
1,109
   
$
115
 

See notes to consolidated financial statements.
 
A-6

THERMOENERGY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2009
 
Note 1:  Organization and summary of significant accounting policies

Nature of business

ThermoEnergy Corporation (“the Company”) was incorporated in January 1988 for the purpose of marketing and developing advanced municipal and industrial wastewater treatment and carbon reducing clean energy technologies.

We are the majority owner of a patented clean energy technology known as the Zero Emission Boiler System (“ZEBS”), formerly known as ThermoEnergy Integrated Power System (“TIPS”), which converts fossil fuels (including coal, oil and natural gas) and biomass into electricity without producing air emissions, and at the same time removes and captures carbon dioxide in liquid form for sequestration or beneficial reuse.  We, through our majority-owned subsidiary, ThermoEnergy Power Systems, LLC, entered into a joint venture with Babcock Power, Inc. in 2009 called Babcock-Thermo Carbon Capture, LLC ("BTCC") to obtain the resources necessary to facilitate the development and commercialization of this technology.

The Company acquired a majority stake in CASTion Corporation (“CASTion”), a Massachusetts corporation, on July 2, 2007.  The acquisition of CASTion resulted in the Company becoming primarily a “water company” with many patented and proprietary Water Technologies.  CASTion’s patented Controlled Atmosphere Separation Technology (“CAST”) systems are utilized as an effective stand-alone wastewater or chemical recovery system, or as part of an integrated recovery solution. The CAST wastewater and chemistry recovery system eliminates costly disposal of hazardous waste or process effluent. The Zero-Liquid-Discharge program can recover nearly 100% of a customer’s valuable chemical resources or wastewater for immediate reuse or recycling at our customer’s facility.  The Company acquired the remaining minority interest in CASTion Corporation on January 5, 2009. (see Note 10)

Principles of consolidation and basis of presentation

The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries.  All significant intercompany accounts and transactions have been eliminated in consolidation. Results of operations of companies purchased are included from the dates of acquisition. Certain prior year amounts have been reclassified to conform to current year classifications.

The preparation of financial statements in conformity with generally accepted accounting principles 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 revenue and expenses during the reporting period.

Revenue recognition

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

In circumstances when the Company cannot estimate the final outcome of a contract, or when the Company cannot reasonably estimate revenue, the Company utilizes the percentage-of-completion method based on a zero profit margin until more precise estimates can be made.  If and when the Company can make more precise estimates, revenues will be adjusted accordingly and recorded as a change in an accounting estimate.  For the year ended December 31, 2009, the Company has recorded one contract which represented approximately 80% of its revenues utilizing the percentage-of-completion method based on a zero profit margin.

Costs and estimated earnings in excess of billings on uncompleted contracts, which were not significant at December 31, 2009 and 2008, represent revenues recognized in excess of amounts billed and are included in accounts receivable.  Billings in excess of costs and estimated earnings on uncompleted contracts, which amounted to $398,000 and $264,000 at December 31, 2009 and 2008, respectively, represent amounts billed in excess of revenues earned and are included in deferred revenue.
 
A-7

THERMOENERGY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2009

Accounts receivable, net

Accounts receivable are recorded at their estimated net realizable value.  Receivables related to the Company’s contracts and grants have realization and liquidation periods of less than one year and are therefore classified as current.  The allowance for doubtful accounts totaled $9,000 and $0 at December 31, 2009 and 2008, respectively.  The Company’s method for estimating its allowance for doubtful accounts is based on judgmental factors, including known and inherent risks in the underlying balances, adverse situations that may affect the customer’s ability to pay and current economic conditions.  Amounts considered uncollectible are written off based on the specific customer balance outstanding.

Inventory

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

We evaluate our inventory for excess and obsolescence on an annual basis.  In preparing our evaluation, we look at the expected demand for our products for the next three to twelve months in order to determine whether such equipment requires a change in the inventory reserve in order to record the inventory at net realizable value.  Based on this evaluation, we establish and maintain a reserve so that inventory is appropriately stated at the lower of cost or net realizable value.  Inventory reserves totaled $74,000 and $0 at December 31, 2009 and 2008, respectively.

Property and equipment

Property and equipment are stated at cost and are depreciated over the estimated useful life of each asset. Depreciation is computed primarily using the straight-line method. The Company evaluates long-lived assets based on estimated future undiscounted net cash flows or other fair value measures whenever significant events or changes in circumstances occur that indicate the carrying amount may not be recoverable. If that evaluation indicates that an impairment has occurred, a charge is recognized to the extent the carrying amount exceeds the discounted cash flows or fair values of the asset, whichever is more readily determinable.  During the year ended December 31, 2008, the Company recorded asset impairment charges of $105,116 related to property and equipment (primarily a mobile ARP unit).

Debt issue costs

Debt issue costs incurred during 2008 are amortized using the effective interest rate method over the life of the related debt.  Debt issue costs, net of amortization, amounted to $0 and $152,000 at December 31, 2009 and 2008, respectively, and are included in Other Assets in the Company’s Consolidated Balance Sheets.

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

The Company accounts for stock options in accordance with Accounting Standards Codification (“ASC”) Topics 505 and 718 (formerly Statement of Financial Standards No. 123 (Revised 2004), “Share-Based Payment.”)  This Statement requires that the cost of all share-based payments to employees, including grants of employee stock options, be recognized in the financial statements based on their fair values on the measurement date, which is generally the date of grant.  Such cost is recognized over the vesting period of the awards.  The Company uses the Black-Scholes option pricing model to estimate the fair value of stock option awards.
 
A-8

THERMOENERGY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2009

Income taxes

The Company uses the liability method of accounting for income taxes. Under this method, deferred tax assets and liabilities are determined based on the differences between financial reporting and tax basis of assets and liabilities and are measured using enacted rates and laws that will be in effect when the deferred tax assets or liabilities are expected to be realized or settled. A valuation allowance for deferred tax assets is provided if it is more likely than not that all or a portion of the deferred tax assets will not be realized.

Advertising

Advertising costs are expensed as incurred and totaled $2,720 and $9,541 for the years ended December 31, 2009 and 2008, respectively.

Fair value of financial instruments and fair value measurements

The carrying amount of cash, accounts receivable, inventories, other current assets, accounts payable, short-term notes payable and other current liabilities in the consolidated financial statements approximate fair value because of the short-term nature of the instruments.  The carrying amount of the Company’s convertible debt in default and long-term convertible debt was $5,503,000 and $4,470,000 at December 31, 2009 and 2008, respectively.  The Company is unable to estimate the fair value of that debt without incurring excessive costs because a quoted market price is not available, the Company has not developed the valuation model necessary to make the estimate, and the cost of obtaining an independent valuation would be excessive.  The Company’s warrant liabilities are recorded at fair value.

The Company's financial liabilities are measured using inputs from the three levels of fair value hierarchy, as follows:
Level 1:
Quoted prices in active markets for identical assets or liabilities.
Level 2:
Inputs other than Level 1 that are observable, either directly or indirectly, such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities.
Level 3:
Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the liabilities.

Liabilities measured at fair value on a recurring basis as of December 31, 2009 are as follows: (in thousands)

  
Fair Value Measurements at Reporting Date Using
 
Description
Balance as of
December 31,
2009
 
Quoted Prices
in Active
Markets for
Identical Assets
(Level 1)
 
Significant
Other
Observable
Inputs
(Level 2)
 
Significant
Unobservable
Inputs
(Level 3)
 
                 
Liabilities
                       
Long-term warrant liability
  $ 2,559     $ -     $ -     $ 2,559  
                                 
Total Liabilities
  $ 2,559     $ -     $ -     $ 2,559  

A-9

THERMOENERGY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2009

The following table sets forth a reconciliation of changes in the fair value of derivatives classified as Level 3 (in thousands):
 
   
Long-Term
Warrant
Liability
Balance at December 31, 2008
 
$
-
 
Fair value of warrants at January 1, 2009 due to change in accounting principle
   
3,195
 
Fair value of new warrants issued in 2009
   
301
 
Change in fair value
   
(937
)
Balance at December 31, 2009
 
$
2,559
 

Series B Convertible Preferred Stock

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

Effect of new accounting pronouncements
 
In the third quarter of 2009, the Company adopted the Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) as the source of authoritative generally accepted accounting principles (“GAAP”) for nongovernmental entities.  The ASC does not change GAAP but rather takes the numerous individual pronouncements that previously constituted GAAP and reorganizes them into approximately 90 accounting topics, and displays all topics using a consistent structure.  Citing particular content in the ASC involves specifying the unique numeric path to the content.  The adoption of ASC did not have any effect on the Company’s consolidated results of operations, financial position or cash flows.

On January 1, 2009, the Company adopted FASB ASC Topic 815-40 "Determining Whether an Instrument (or Embedded Feature) is indexed to an Entity's Own Stock" (formerly EITF 07-5). ASC Topic 815-40 provides guidance on determining whether an instrument (or an embedded feature) is indexed to an entity’s own stock, which would qualify as a scope exception under prior authoritative literature FASB No. 133, “Accounting for Derivative Instruments and Hedging Activities.”  ASC 815-40 is effective for fiscal years beginning after December 15, 2008.  The Company adopted ASC topic 815-40 on January 1, 2009 and as such some of the Company’s outstanding warrants that were previously classified in equity were reclassified to liabilities as of January 1, 2009, as these warrants contain down round provisions and were no longer deemed to be indexed to the Company’s own stock.  See Note 2 for further discussion.

During the second quarter of 2009, the Company adopted ASC 855, “Subsequent Events” (formerly Statement of Financial Accounting Standards (“SFAS”) No. 165, “Subsequent Events”) which establishes general standards of accounting for and disclosure of events that occur after the balance sheet date but prior to the issuance of the financial statements.  The adoption of this standard did not have a material impact on the Company’s consolidated results of operations, financial position, cash flows or disclosures.

During the first quarter of 2009, the Company adopted ASC 805, “Business Combinations” (“ASC 805”) (formerly SFAS No. 141 (R), “Business Combinations”).  ASC 805 establishes principles and requirements for how an acquirer recognizes and measures in its financial statements the identifiable assets acquired, including goodwill, the liabilities assumed and any non-controlling interest in the acquiree.  The Statement also establishes disclosure requirements to enable users of the financial statements to evaluate the nature and financial effects of the business combination.  The impact of adopting ASC 805 did not have a material impact on the Company’s consolidated results of operations, financial position, cash flows or disclosures.
 
A-10

THERMOENERGY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2009
 
During the first quarter of 2009, the Company adopted SFAS No. 160, “Noncontrolling Interests in Consolidated Financial Statements”, which is now included in ASC 810, “Consolidations.”  This Statement requires ownership interests in subsidiaries held by others to be clearly identified, labeled and presented in the consolidated balance sheet within equity but separate from the parent company's equity.  SFAS 160 also affects the accounting requirements when the parent company either purchases a higher ownership interest or deconsolidates the equity investment.  The effects of this Statement on the Company’s statement of operations and financial position are discussed in Note 10.

Note 2:  Derivative Liabilities; Adoption of ASC Topic 815-40

 On December 18, 2007 the Company issued 6,666,667 shares of Common Stock to Quercus for $5,000,000 net of issuance cost of $667,284, and a warrant for the purchase of 10,000,000 shares of Common Stock at a purchase price of $1.50 per share.  The warrant contains anti-dilution provisions for the adjustment of the exercise price in the event the Company issues additional shares of Common Stock or securities convertible into Common Stock (subject to certain specified exclusions) at a price per share less than the then-effective exercise price.  As of December 31, 2008, the exercise price of the warrants was reduced to $1.25 per share.  The Company also issued warrants to purchase 1,333,333 shares of Common Stock to Merriman Curhan Ford & Co. (“Merriman”) as part of the placement fee paid.  These warrants have the same terms as the warrants issued to Quercus.

As further discussed in Note 6, on September 15, 2008 the Company entered into a Securities Purchase Agreement with Quercus to issue up to $7 million of 10% Convertible Promissory Notes and warrants to purchase up to 14 million shares of Common Stock.  At the initial closing on September 15, 2008, the Company issued a $2 million Note due September 30, 2013 and a warrant to purchase up to 4 million shares of Common Stock at an exercise price of $1.25 per share.  The warrants have a five year term and contain anti-dilution provisions for the adjustment of the exercise price in the event the Company issues additional shares of Common Stock or securities convertible into Common Stock (subject to certain specified exclusions) at a price per share less than $0.80 per share (the closing price of the Company’s Common Stock on September 12, 2008).  The Company also issued warrants to purchase 453,334 shares of Common Stock to Merriman as part of the placement fee paid.  These warrants have the same terms as the warrants issued to Quercus.

As discussed in Note 4, on August 12, 2008 the Company entered into a Securities Purchase Agreement with a stockholder, Robert S. Trump, through which the Company issued, at face value, a 7.5% Convertible Promissory Note due December 31, 2008 in the principal amount of $500,000.  The Company also issued a warrant to purchase one share of Common Stock for each dollar invested by Mr. Trump in the purchase of Common Stock or other convertible securities during the period from December 31, 2008 through December 31, 2011 at an exercise price of $1.50 per share.  The warrant expires on December 31, 2015, subject to acceleration provisions as provided in the Agreement.  As of December 31, 2008, the Company did not issue any warrants under this arrangement.

On January 1, 2009 the Company adopted ASC Topic 815-40.  This pronouncement provides guidance for determining whether an equity-linked financial instrument (or embedded feature) is indexed to an entity’s own stock.  Any financial instrument that is not indexed to an entity’s own stock must be recorded as a derivative instrument.  The Company evaluated whether its stock warrants and determined that warrants issued with anti-dilution provisions that protect holders from declines in the stock price and warrants issued for a variable number of shares of common stock were no longer deemed to be indexed to the Company’s own stock.  The fair value of these derivative liabilities as of January 1, 2009 was $3,195,000 and was reclassified from additional paid-in capital.  The Company used the Black-Scholes valuation model to determine the fair value of the warrants.  The significant assumptions used were: exercise prices between $0.50 and $1.25; the Company’s stock price on January 1, 2009, $0.45; expected volatility of 80%; risk free interest rate between 1.3% and 1.6%; and a remaining contract term between 4 and 4.7 years.

During 2009, the Company issued a total of 1.4 million warrants to Mr. Trump in conjunction with the August 12, 2008 Securities Purchase Agreement.  The exercise price of the warrants was reduced to $0.50 per share as of September 2009.  The Company recognized an additional warrant liability of $320,000 for these warrants.  In addition, in accordance with the anti-dilution provisions in the warrants issued to Quercus and Merriman, the exercise price was reduced to $0.36 per share in September 2009.
 
A-11

THERMOENERGY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2009

The fair value of these derivative liabilities as of December 31, 2009 was $2,559,000. The Black-Scholes stock option valuation model was used to determine the fair values. The significant assumptions used were: exercise prices between $0.36 and $0.50; the Company’s stock price on January 1, 2009, $0.28; expected volatility of 80%; risk free interest rate between 1.7% and 3.0%; and a remaining contract term between 3 and 6 years.

The decrease in fair value of the Company’s derivative liabilities resulted in a gain of $937,000 for the year ended December 31, 2009.  The gain includes an decrease in the derivative liability due to a decrease in the Company’s stock price and the passage of time, partially offset by a reduction in the exercise price of the warrants previously issued to Quercus and Merriman Curhan Ford & Co. from $1.25 to $0.36 per share.

Note 3:  Formation of Babcock-Thermo Carbon Capture LLC

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

ThermoEnergy Power Systems has entered into a license agreement with the Joint Venture and BPD, pursuant to which it has granted to the Joint Venture an exclusive, irrevocable (except as otherwise provided therein), world-wide, fully paid up and royalty-free license to ThermoEnergy Power Systems’ intellectual property related to or necessary to practice the ZEBS technology (the “ZEBS License”).   In the LLC Agreement, BPD has agreed to develop, at its own expense, intellectual property in connection with three critical subsystems relating to the ZEBS technology: a combustor subsystem, a steam generating heating surface subsystem, and a condensing heat exchangers subsystem (collectively, the “Subsystems”) and  BPD has entered into a license agreement with the Joint Venture and ThermoEnergy Power Systems pursuant to which it has granted the Joint Venture an exclusive, irrevocable (except as otherwise provided therein), world-wide, fully paid up and royalty-free license to BPD’s know-how and other proprietary intellectual property related to or necessary to practice the Subsystems.
 
Pursuant to the LLC Agreement, each of ThermoEnergy Power Systems and BPD owns a 50% membership interest in the Joint Venture.  The LLC Agreement provides that each member may be required, from time to time, to make capital contributions to the Joint Venture to fund its operations.  The Company made a $50,000 capital contribution in cash to the Joint Venture in August 2009.  This investment is included in Other Assets on the Company’s Consolidated Balance Sheet as of December 31, 2009.

The Joint Venture will be managed by a six-person Board of Managers, with three managers appointed by each member.  The Board of Managers has adopted a set of milestones by which it will measure the progress of the Joint Venture.  Pursuant to the LLC Agreement, either member may withdraw from the Joint Venture if any milestone is not met (unless the failure to meet such milestone is primarily attributable to a failure by such member to perform its obligations under the LLC Agreement or any related agreements).  If a member exercises its right to withdraw, the license that such member has granted to the Joint Venture will automatically terminate.
 
The LLC Agreement obligates the Joint Venture and each member to indemnify and hold the other member and its affiliates harmless against damages and losses resulting from such member’s fraud, gross negligence or intentional misconduct with respect to the Joint Venture.  We and Babcock Power, Inc. have entered into separate agreements to indemnify the joint venture and its members (other than our respective subsidiary-members) and their respective affiliates against damages and losses resulting from fraud, gross negligence or intentional misconduct of our respective subsidiary-members with respect to the Joint Venture.
 
The LLC Agreement contains other conventional terms, including provisions relating to governance of the entity, allocation of profits and losses, and restrictions on transfer of a member’s interest.

The Company accounts for the Joint Venture using the equity method of accounting.
 
A-12

THERMOENERGY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2009
 
Note 4:  Short-term borrowings

Short-term borrowings consisted of the following at December 31, 2009 and 2008 (in thousands):

   
2009
   
2008
           
Convertible promissory note dated December  22, 2008, 7.5%, due March 31, 2009, less discount of $194 in 2008
 
$
-
   
$
307
Convertible promissory note dated August 12, 2008, 7.5%, due March 31, 2009
   
-
     
566
     
-
     
873

On August 12, 2008, the Company entered into a Securities Purchase Agreement with a stockholder, Robert S. Trump, through which the Company issued, at face value, a 7.5% Convertible Promissory Note due December 31, 2008 in the principal amount of $500,000. The Note is convertible into shares of Common Stock at a price of $0.75 per share.  The Company may defer the maturity date of the Note to March 31, 2009 at its discretion upon payment of a deferral fee equal to 10% of the principal amount.  The full amount of principal and accrued interest will convert into shares of Common Stock at $0.75 per share.  As further consideration, the Company issued a warrant to purchase one share of Common Stock for each dollar invested by Mr. Trump in the purchase of Common Stock or other convertible securities during the period from December 31, 2008 through December 31, 2011 at an exercise price of $1.50 per share, reduced to $0.50 per share in September 2009.  The warrant expires on December 31, 2015, subject to acceleration provisions as provided in the Agreement.  As of December 31, 2009, the Company issued warrants to purchase 1.4 million shares of common stock under this arrangement.

The Company estimated the fair value of the warrants issued using a Black-Scholes option pricing model and allocated $192,000 of the proceeds received to the warrants on a relative fair value basis. In addition, the difference between the effective conversion price of the Note and the fair value of the Company’s Common Stock on the date of issuance resulted in a beneficial conversion feature amounting to $308,000, the intrinsic value of the conversion feature on that date. The total debt discount of $500,000 was amortized to interest expense over the stated term of the Note.

Pursuant to the terms of the Note, on December 31, 2008 the Company added accrued interest of $14,486 and a deferral fee of $54,449 to the principal amount of the Note and extended the maturity date of the Note to March 31, 2009.  On April 1, 2009 the Note was converted to 768,535 shares of Common Stock.

On December 22, 2008, the Company entered into a Securities Purchase Agreement with Mr. Trump through which the Company issued, at face value, a 7.5% Convertible Promissory Note due March 31, 2009 in the principal amount of $500,000.  The Note is convertible into shares of Common Stock at a price of $0.75 per share.  The Company may defer the maturity date of the Note to June 30, 2009 at its discretion upon payment of a deferral fee equal to 10% of the principal amount.  As further consideration, the Company issued a warrant to purchase 1 million shares of Common Stock at a price of $1.25 per share.  The warrant expires on December 31, 2015 subject to acceleration provisions as provided in the Agreement.

The Company estimated the fair value of the warrants issued using a Black-Scholes option pricing model and allocated $185,000 of the proceeds received to the warrants on a relative fair value basis.  In addition, the difference between the effective conversion price of the Note and the fair value of the Company’s common stock on the date of issuance resulted in a beneficial conversion feature amounting to $33,000, the intrinsic value of the conversion feature on that date. The total debt discount of $218,000 is amortized to interest expense over the stated term of the Note.

The Company extended the maturity of the Note to June 30, 2009, and added the deferral fee of $50,000 to the principal balance.  The Note remained outstanding after that date and was amended on September 28, 2009 in connection with the Series B Convertible Preferred Stock financing as discussed below.  The amended Note was converted into shares of Class B Convertible Preferred Stock in November 2009.

On February 11, 2009, the Company issued to the Quercus Trust (“Quercus”) a 10% Secured Convertible Promissory Note in the principal amount of $250,000 and entered into a Security Agreement with Quercus.  The Note matures on the earlier of the closing of an equity or convertible debt investment yielding gross proceeds of not less than $2 million to the Company (a “Financing”) or December 31, 2009.  Quercus may convert the principal amount of the Note into shares of the securities to be issued in the Financing at a price equal to 90% of the price per share to be paid by the other investors in the Financing.  Interest on the Note is payable quarterly in arrears; at the Company’s discretion, interest may be paid by the issuance of Common Stock valued at 90% of the volume weighted average trading price per share for the ten trading days immediately preceding the respective interest payment date.  The Note is secured by the Company’s intellectual property assets other than certain expressly excluded patent rights, licenses and related intellectual property identified in the Security Agreement, including, without limitation, the intellectual property rights used in or relating to our TEPS business.
 
A-13

THERMOENERGY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2009

The Note was amended on September 28, 2009 in connection with the Series B Convertible Preferred Stock financing as discussed below.  The amended Note was converted into shares of Series B Convertible Preferred Stock in November 2009.

On April 27, 2009, the Company issued to three different funds and two individual affiliates of Empire Capital Partners 10% Convertible Promissory Notes aggregating $500,000 in principal amount.  The Notes mature on the earlier of the closing of the proposed funding with Quercus as reported in the September 15, 2008 Agreement with Quercus  or October 31, 2009.   Empire Capital Partners and its affiliates may convert the Notes at any time into shares of Common Stock at a price of $0.40 per share.  The Company also issued warrants to acquire 2.5 million shares of Common Stock to the holders of these Notes.  The warrants have an exercise price of $0.55 and expire five years from the grant date.

The Company estimated the fair value of the warrants issued using a Black-Scholes option pricing model and allocated $349,000 of the proceeds received to the warrants on a relative fair value basis.  In addition, the difference between the effective conversion price of the Notes into the Company’s Common Stock on the date of issuance resulted in a beneficial conversion feature amounting to $151,000, the intrinsic value of the conversion feature on that date.  The total debt discount of $500,000 was amortized to interest expense over the stated term of the Note.

The Notes were amended and restated on September 28, 2009 in connection with the Series B Convertible Preferred Stock financing as discussed below.  As a result of the amendment and restatement of the Note, the exercise price of the warrants issued was further reduced from $0.55 per share to $0.50 per share.  The Notes were converted into shares of Series B Convertible Preferred Stock in November 2009.

On June 25, 2009, the Company issued to Quercus a 10% Secured Convertible Promissory Note.  Under the terms of the Note, Quercus agreed to make advances to the Company up to an aggregate principal amount of $150,000.  These advances may only be used to pay expenses related to the investigation by the Audit Committee of the Board of Directors of the Company’s financial affairs or other matters within the investigative authority of the Audit Committee (see Note 14).  The Note matures on the earlier of the closing of an equity or convertible debt investment yielding gross proceeds of not less than $2 million to the Company (a “Financing”) or December 31, 2009.  Quercus may participate in the Financing by converting the principal amount of the Note into shares of the securities to be issued at a price equal to 80% of the price per share to be paid by the other investors in the financing.  Interest on the Note is payable quarterly in arrears; at the Company’s discretion, interest may be paid by the issuance of Common Stock valued at 80% of the volume weighted average trading price per share for the ten trading days immediately preceding the respective interest payment date.

The Company amended its Security Agreement with Quercus dated February 11, 2009 to include this Note.  The Company also entered into an agreement with Quercus in which the Company acknowledged that certain conditions to Quercus’ obligation to invest an additional $5 million in the Company pursuant to the September 15, 2008 Securities Purchase Agreement (See Note 6) have not been and cannot be met, and the Company irrevocably released any claim on Quercus to make any further investment.

The Note was amended and restated on September 28, 2009 in connection with the Series B Convertible Preferred Stock financing as discussed below.  The Note was converted into shares of Series B Convertible Preferred Stock in November 2009.

On June 26, 2009, the Company issued to the Focus Fund, L.P. (“Focus Fund”) a 10% Convertible Promissory Note due October 15, 2009 in the principal amount of $108,000.  As further consideration, the Company issued a warrant to The Focus Fund to purchase 600,000 shares of Common Stock on or before June 17, 2014 at an exercise price of $0.54 per share.

The Company estimated the fair value of the warrant issued using a Black-Scholes option pricing model and allocated $46,000 of the proceeds received to the warrant on a relative fair value basis.  In addition, the difference between the effective conversion price of the Note into the Company’s Common Stock on the date of issuance resulted in a beneficial conversion feature amounting to $19,000, the intrinsic value of the conversion feature on that date.  The total debt discount of $65,000 was amortized to interest expense over the stated term of the Note.
 
A-14

THERMOENERGY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2009

On July 31, 2009, the outstanding principal balance of the Note was rolled into the Convertible Promissory Note described in the next paragraph.

On July 31, 2009, the Company issued an 8% Secured Convertible Promissory Note in the principal amount of $600,000 to the Focus Fund. The Note matures on the earlier of the closing of an equity or convertible debt investment yielding gross proceeds to the Company of not less than $2 million or December 31, 2011.  The Note is convertible into shares of Common Stock at the option of the holder at a price of $0.30 per share.  The Note is secured by the Company’s 85% ownership interest in TEPS.  As further consideration, the Company issued a warrant to the Focus Fund L.P. for the purchase of 2.4 million shares of Common Stock at a price of $0.50 per share. The warrant expires on July 31, 2014.

The Company estimated the fair value of the warrant issued using a Black-Scholes option pricing model and allocated $246,000 of the proceeds received to the warrant on a relative fair value basis.  In addition, the difference between the effective conversion price of the Note and the fair value of the Company’s common stock on the date of issuance resulted in a beneficial conversion feature amounting to $266,000, the intrinsic value of the conversion feature on that date. The total debt discount of $512,000 is amortized to interest expense over the stated term of the Note.

The Note was amended and restated on September 28, 2009 in connection with the Series B Convertible Preferred Stock financing as discussed below.  As a result of the amendment and restatement of the Note, the conversion price of the Note was reduced from $0.30 per share to $0.24 per share, and the exercise price of the warrants issued on June 26, 2009 was reduced from $0.54 per share to $0.50 per share.  The Note was converted into shares of Series B Convertible Preferred Stock in November 2009.

On August 21, 2009, the Company received a short-term loan in the amount of $110,000 from the Focus Fund.  This loan was repaid in September 2009.

On September 16, 2009, the Company and an investor group consisting of The Quercus Trust, Empire Capital Partners, Robert S. Trump and the Focus Fund (“the Investors”) engaged in a financing transaction, which if fully funded, would result in cash proceeds of $6.25 million to the Company.  The term sheet provides for funding in four tranches as further detailed in Note 9.  On September 28, 2009, the Company issued 8% Convertible Promissory Notes in the principal amount of $1.68 million (the “First Tranche”).  The Notes mature on the earlier of (i) the closing of the Second Tranche of the Series B Convertible Preferred Stock financing or (ii) December 31, 2010.  The Notes are convertible into shares of Common Stock at a price of $0.24 per share at any time at the Investors’ discretion.  As further consideration, the Company issued warrants to acquire 6,720,000 shares of Common Stock to the Investors of the First Tranche.  The warrants have an exercise price of $0.50 and expire five years from the grant date, subject to acceleration provisions as provided in the Agreement.  Upon the closing of the Second Tranche, the entire outstanding principal amount of the Notes plus any accrued and unpaid interest shall convert automatically into Class B Convertible Preferred Stock.  The Notes issued in the First Tranche are secured by the Company’s 85% ownership interest in TEPS.  In addition, all other Notes held by the Investors were amended and restated to be identical in form to the Convertible Promissory Note issued to the Focus Fund on July 31, 2009, as described above.

The Company estimated the fair value of the warrants issued using a Black-Scholes option pricing model and allocated $815,000 of the proceeds received to the warrants on a relative fair value basis.  In addition, the difference between the effective conversion price of the Notes and the fair value of the Company’s Common Stock on the date of issuance resulted in a beneficial conversion feature amounting to $865,000, the intrinsic value of the conversion feature on that date.  The total debt discount of $1,680,000 was recorded as a component of loss on extinguishment of debt upon the closing of the Second Tranche.

Management determined that the amended and restated note transactions discussed above, aggregating $4 million in outstanding principal amount, were exchanges of debt instruments with substantially different terms requiring debt extinguishment accounting.  A portion of the reacquisition price was allocated to the beneficial conversion options associated with the original debt based on the options’ intrinsic values at the extinguishment date, which resulted in a reduction of $762,000 in additional paid-in capital.  The intrinsic value of the amended and restated Notes was $2.5 million, which was recorded as debt discount and was recorded as a component of loss on extinguishment of debt upon the closing of the Second Tranche.
 
A-15

THERMOENERGY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2009

The principal and accrued interest on the Notes issued in the First Tranche were converted into shares of Class B Convertible Preferred Stock at a price of $2.40 per preferred share on November 19, 2009.

See Note 15 for a discussion of the Company’s Bridge Loan Agreement entered in March 2010.

Note 5:  Convertible debt in default

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

Interest on the Notes is payable semi-annually, and the Company has the option of deferring interest payments and rolling the deferred amount into the principal amount of the Notes.  At December 31, 2009 and 2008, deferred accrued interest amounts added to the principal balances of the Notes amounted to $884,000 and $438,000, respectively.

A valuation discount of $313,425 was computed on the Notes based on a fair market value interest rate of 10% compared to the stated rate of 6.5%, which was adjusted to 10% as of November 30, 2007 in accordance with the terms of the Notes.  The valuation discount resulted in a beneficial conversion feature of $313,182, the intrinsic value of the conversion feature on that date.  The total debt discount of $626,607 is amortized to interest expense over the stated term of the Notes.  The unamortized total debt discount amounted to $104,000 and $313,000 at December 31, 2009 and 2008, respectively.

The Notes are technically in default and shown in current liabilities as of December 31, 2009 and 2008, as the Company had not made the required prepayments from the Quercus Trust private placement of equity closed on December 18, 2007 (see Note 6).  Because the Notes are in default, the Company accrues interest at the default interest rate of 18%.

Note 6:  Convertible debt

Convertible debt consisted of the following at December 31, 2009 and 2008 (in thousands):

   
2009
   
2008
           
Convertible Promissory Note, 5%, due March 7, 2013, less discount of $494 in 2009 and $628 in 2008
 
$
315
   
$
141
Convertible Promissory Note, 5%, due March 21, 2013, less discounts of $180 in 2009 and $221 in 2008
   
671
     
588
Convertible Promissory Note, 7.5%, due March 31, 2009
   
-
     
263
Convertible Promissory Notes, 10%, due May 31, 2010
   
384
     
263
   
1,370
   
 $
992

On March 21, 2007 the Company issued to Mr. Martin A. Roenigk, a member of the Company’s Board of Directors as of that date, a 5% Convertible Promissory Note due March 21, 2013 in the principal amount of $750,000. The principal amount and accrued interest on the Note is convertible into shares of Common Stock at a conversion price of $0.50 per share at any time at the election of the holder.  As further consideration, the Company issued a warrant to purchase 750,000 shares of Common Stock at an exercise price equal to the daily volume weighted average price per share of the Common Stock for the 365-day period immediately preceding the date on which the warrant is exercised, subject to a minimum exercise price of $0.50 per share and a maximum exercise price of $1.00 per share.  The warrant expires on March 21, 2013.
 
A-16

THERMOENERGY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2009

The Company estimated the fair value of the warrant issued using a Black-Scholes option pricing model and allocated $193,000 of the proceeds received to the warrant on a relative fair value basis.  In addition, the difference between the effective conversion price of the Note and the fair value of the Company’s Common Stock on the date of issuance resulted in a beneficial conversion feature amounting to $88,000, the intrinsic value of the conversion feature on that date.  The total debt discount of $281,000 is amortized to interest expense over the stated term of the Note.

Interest on the Note is payable semi-annually.  The Company may, at its discretion, defer any scheduled interest payment until the maturity date of the Note upon payment of a $2,500 deferral fee.  The Company added $101,000 and $59,000 of accrued interest to the principal balance of the Note as of December 31, 2009 and 2008, respectively.
 
On March 7, 2008, Mr. Roenigk exercised his option to make an additional $750,000 investment in the Company under the terms of the Securities Purchase Agreement between the Company and Mr. Roenigk dated March 21, 2007.  The Company issued to Mr. Roenigk a 5% Convertible Promissory Note due March 7, 2013 in the principal amount of $750,000.  The principal amount and accrued interest on the Note is convertible into shares of Common Stock at a conversion price of $0.50 per share at any time at the election of the holder.  As further consideration, the Company issued a warrant to purchase 750,000 shares of Common Stock at an exercise price equal to the daily volume weighted average price per share of the Company’s Common Stock for the 365-day period immediately preceding the date on which the warrant is exercised, subject to a minimum exercise price of $0.50 per share and a maximum exercise price of $1.00 per share.  The warrant expires on March 7, 2104.
 
The Company estimated the fair value of the warrant issued using a Black-Scholes option pricing model and allocated $321,000 of the proceeds received to the warrant on a relative fair value basis.  In addition, the difference between the effective conversion price of the Note and the fair value of the Company’s common stock on the date of issuance resulted in a beneficial conversion feature amounting to $429,000, the intrinsic value of the conversion feature on that date.  The total debt discount of $750,000 is amortized to interest expense over the stated term of the Note.
 
Interest on the Note is payable semi-annually.  The Company may, at its discretion, defer any scheduled interest payment until the maturity date of the Note upon payment of a $2,500 deferral fee.  The Company added $59,000 and $19,000 of accrued interest to the principal balance of the Note as of December 31, 2009 and 2008, respectively.
 
On September 15, 2008, the Company entered into a Securities Purchase Agreement with Quercus to issue up to $7 million of 10% Convertible Promissory Notes and warrants to purchase up to 14 million shares of Common Stock.  Pursuant to the Agreement, at an initial closing on September 15, 2008, the Company issued a $2 million Note due September 30, 2013 and a warrant to purchase up to 4 million shares of Common Stock.
 
Quercus may convert the Note at any time into shares of Common Stock at a price of $0.75 per share.  Interest on the Note is payable quarterly in arrears; at the Company’s discretion, all or any portion of the interest may be paid by the issuance of Common Stock valued at 90% of the volume weighted average trading price of the Company’s Common Stock for the ten trading days immediately preceding the respective interest payment date.  The Company may not prepay the Note without the prior written consent of the holder.
 
The warrant permits the holder to purchase, at any time on or before September 30, 2013, up to 4,000,000 shares of our Common Stock at a purchase price of $1.25 per share.  The warrant contains anti-dilution provisions for the adjustment of the exercise price in the event the Company issues additional shares of Common Stock or securities convertible into Common Stock (subject to certain specified exclusions) at a price per share less than $0.80 per share (the closing price of the Company’s Common Stock on September 12, 2008).  In March 2009, the Company effected a sale of Common Stock at an exercise price of $0.35 per share. (see Note 9)  As a result, the exercise price on the warrants issued to Quercus was reduced to $0.525 per share. The warrant modification resulted in the recording of $1,030,000 of warrant expense in the first quarter of 2009.  The warrant also includes conventional provisions permitting “cashless” exercise under certain specified circumstances.

The Agreement provides that Quercus will purchase an additional Note (in form substantially identical to the Note issued at the initial closing) in the original principal amount of $5,000,000 and an additional warrant (in form substantially identical to the warrant issued at the initial closing) for the purchase of 10,000,000 shares of our Common Stock upon the satisfaction of certain conditions set forth in the Agreement.
 
A-17

THERMOENERGY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2009
 
In the Agreement, we agreed to file one or more registration statements under the Securities Act of 1933 covering the resale by Quercus of the shares of our Common Stock issuable in payment of interest on the notes, upon conversion of the Notes or upon exercise of the warrant. The registration rights provisions of the Agreement contain conventional terms including indemnification and contribution undertakings and a provision for liquidated damages in the event the required registration statements are not filed or are not declared effective prior to deadlines set forth in the Agreement.  The Agreement also grants a right of first refusal to participate in any subsequent financing we undertake prior to the earlier of (i) the date on which we first report results of operations reflecting a positive cash flow in each of two successive fiscal quarters or (ii) September 15, 2010 (subject to certain conventional exceptions) in order to permit Quercus to maintain its fully-diluted ownership interest in the Company’s Common Stock.

The Company estimated the fair value of the warrant issued using a Black-Scholes option pricing model and allocated $846,000 of the proceeds received to the warrant on a relative fair value basis.  In addition, the difference between the effective conversion price of the Note and the fair value of the Company’s Common Stock on the date of issuance resulted in a beneficial conversion feature amounting to $987,000, the intrinsic value of the conversion feature on that date.  The total debt discount of $1,833,000 is amortized to interest expense over the stated term of the Note.

For its services in connection with the sale of the Note and the warrant to Quercus, the Company paid Merriman Curhan Ford & Co. a placement fee of $160,000 and issued to that firm a warrant (in form substantially identical to the warrant issued to Quercus) for the purchase of 453,334 shares of Common Stock.  The Company estimated the fair value of the warrant using a Black-Scholes option pricing model and recorded $166,056 of general and administrative expense in connection with the issuance of the warrant.

The Note was amended and restated on September 28, 2009 in connection with the Series B Convertible Preferred Stock financing as discussed in Note 4.  As a result of the amendment and restatement of the Note, the exercise price of the warrants issued was further reduced from $0.525 per share to $0.36 per share.  The Note was converted into shares of Series B Convertible Preferred Stock in November 2009.

Note 7:  Income taxes

A valuation allowance equal to the total of the Company's deferred tax assets has been recognized for financial reporting purposes. The net changes in the valuation allowance during the years ended December 31, 2009 and 2008 were increases of approximately $3,964,000 and $4,320,000, respectively. The Company's deferred tax liabilities are not significant.

Significant components of the Company's deferred tax assets are as follows as of December 31, 2009 and 2008 (in thousands):    

   
2009
   
2008
 
             
Net operating loss carryforwards
 
$
15,506
   
$
12,920
 
Contingent liability reserves
   
1,267
     
1,425
 
Stock options and warrants
   
4,744
     
3,753
 
Valuation discount
   
1,061
     
414
 
Other
   
222
     
324
 
     
22,800
     
18,836
 
Valuation allowance – deferred tax assets
   
(22,800
)
   
(18,836
)
   
-
   
 $
-
 

A reconciliation of income tax expense (credit) at the statutory rate to income tax expense at the Company's effective rate is shown below for the years ended December 31, 2009 and 2008 (in thousands):
   
2009
   
2008
 
             
Computed at statutory rate (34%)
 
$
(5,436
)
 
$
(5,435
)
Increase in valuation allowance for deferred tax assets
   
3,964
     
4,320
 
Non-deductible items and other
   
1,472
     
1,115
 
Provision for income taxes
 
-
   
 $
-
 
 
A-18

THERMOENERGY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2009
 
The Company has net operating loss carryforwards, which expire in various amounts during 2010 through 2029, at December 31, 2009 of approximately $41,000,000.  The Internal Revenue Code provides for limitations on the use of net operating loss carryforwards for acquired entities. The Company’s annual limitation for the use of CASTion’s net operating loss carryforwards for periods prior to the date of acquisition for income tax reporting purposes is approximately $300,000.

Note 8:  Related party transactions

During 2000, the Board of Directors approved the formation of a ThermoEnergy Power Systems, LLC, a Delaware limited liability company (“TEPS”) for the purpose of transferring the Company’s rights and interests in ZEBS. The Company has an 85% ownership interest, Alexander Fassbender, former Executive Vice President and Chief Technology Officer, as the inventor of the technology, has a 7.5% ownership interest, and the remaining 7.5% is owned by an unrelated third party.  As of December 31, 2009, TEPS had not been capitalized by the Company and had no transactions.

As discussed in Note 3, On February 25, 2009, TEPS and  Babcock Power Development, LLC (“BPD”), a subsidiary of Babcock Power, Inc., entered into a joint venture establishing Babcock-Thermo Carbon Capture LLC, a Delaware limited liability company for the purpose of developing and commercializing the Company’s proprietary ZEBS technology.

During 2009, Arthur S. Reynolds, a member of the Company’s Board of Directors, performed the duties of Interim Chief Financial Officer of the Company from August 2009 through November 2009.  As compensation for his services, the Company paid Mr. Reynolds a total of $90,000 and issued warrants to purchase 681,103 shares of the Company’s Common Stock at a price between $0.31 and $0.50 per share.  The fair value of the warrants on the respective grant dates totaled $102,270, which was recorded as warrant expense in 2009.

The Company has employment agreements with each of its senior officers that specify base compensation, minimum annual increases and lump sum payment amounts in the event of a change in control of the Company.  See Notes 3, 4, 5, 6, 9 and 15 for additional related party transactions.

Note 9:  Equity

Common Stock

The Company owns 83,797 shares of its Common Stock pursuant to a settlement agreement with a former stockholder.  These treasury shares have a zero cost basis.

On March 6, 2009, the Company issued and sold 1,428,571 shares of Common Stock for cash at $0.35 per share and issued warrants to acquire 714,286 shares of Common Stock to an unrelated third party institutional investor.  The warrants have an exercise price of $0.525 and expire five years from the grant date.  Pursuant to the warrant agreements, the Company reduced the exercise price of the Quercus warrants for 14,000,000 shares of the Company’s Common Stock from $1.25 to $0.525 per share due to the March 6, 2009 sale of Common Stock at $0.35 per share.  The warrant modification resulted in the recording of $1,030,000 of warrant expense in the first quarter of 2009.

As discussed in Note 4, the Convertible Promissory Note dated August 12, 2008 maturing on March 31, 2009 was converted to 768,535 shares of the Company’s Common Stock at $.75 per share on April 1, 2009.

On April 1, 2008 the Company issued 1,146,036 shares of Common Stock at $0.50 per share for full payment of principal, accrued interest and deferral fees related to a $500,000 face value Convertible Promissory Note issued on August 23, 2007.

During 2009, the Company issued 345,000 shares of Common Stock for services and 313,005 shares of Common Stock in satisfaction of accrued interest on convertible debt.

Preferred Stock

On September 16, 2009, the Company and an investor group consisting of Quercus, Empire Capital Partners, Robert S. Trump and the Focus Fund (“the Investors”) engaged in a financing transaction, which if fully funded, would result in cash proceeds of $6.25 million to the Company.  The term sheet provides for funding in four tranches, with the first and second tranche amounts totaling $3.05 million based on specified time periods and the third and fourth tranche amounts totaling $3.2 million based on the occurrence of specified events.
 
A-19

THERMOENERGY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2009

On September 28, 2009, the Company issued 8% Convertible Promissory Notes in the principal amount of $1,680,000 for the first tranche of funding, as discussed in Note 4.

The Company received $1.4 million in the second tranche funding on November 19, 2009.  The Company issued 583,333 shares of Series B Convertible Preferred Stock at a price of $2.40 per share.  Upon the closing of the second tranche funding, the outstanding principal and accrued interest on all of the 8% Secured Convertible Promissory Notes converted into 2,454,621 shares of Series B Convertible Preferred Stock at a price of $2.40 per share.

Each share of Series B Convertible Preferred Stock is convertible, at any time at the discretion of the holder, into ten shares of the Company’s Common Stock and contains anti-dilution provisions.  Except with respect to the election of the Board of Directors, holders of Series B Convertible Preferred Stock will vote on an as-converted basis together with the Common Stock holders on all matters.  The Company’s Board of Directors consists of seven members, four of whom are elected by holders of the Company’s Series B Convertible Preferred Stock (three to be designated by Quercus and one by Robert S. Trump) and three by the holders of the Company’s Common Stock.

If the events specified in the agreement occur, in the third tranche funding of $1.8 million and the fourth tranche funding of $1.4 million, the Company will issue shares of Series B Convertible Preferred Stock.

As further consideration, the Company issued warrants to purchase 5.6 million shares of common stock.  The warrants expire in five years and provide for an exercise price of $.50 per share.  The Company estimated the fair value of the warrant issued using a Black-Scholes option pricing model and allocated $926,000 of the proceeds received to the warrant on a relative fair value basis.  In addition, the difference between the effective conversion price of the Note and the fair value of the Company’s common stock on the date of issuance resulted in a beneficial conversion feature amounting to $1,823,000, the intrinsic value of the conversion feature on that date.  Because the Series B Convertible Preferred Stock is convertible at any time at the investor’s option, the total discount of $2,749,000 is considered a “deemed dividend” to the investors of the Preferred Stock as of the date of issuance and increases the net loss attributable to common shareholders on the Company’s consolidated statement of operations.

See Note 15 for a discussion of the Company’s Bridge Loan Agreement entered in March 2010.

Stock Options

The Company’s 1997 Stock Option Plan (the “Plan”) provided for incentive and non-incentive stock options for an aggregate of 750,000 shares of Common Stock for key employees and non-employee Directors of the Company. The Plan, which expired on December 31, 2007, provided that the exercise price of each option must be at least equal to 100% of the fair market value of the Common Stock on the date of grant.  The Plan contained automatic grant provisions for non-employee Directors of the Company.

During 2008, the Company’s stockholders approved the ThermoEnergy Corporation 2008 Incentive Stock Plan (the “2008 Plan”) for officers, employees, non-employee members of the Board of Directors, consultants and other service providers.  The 2008 Plan provides for the granting of non-qualified stock options, restricted stock, stock appreciation rights (“SAR”) and incentive stock options.  Options may not be granted at an exercise price less than the fair market value of the Company’s Common Stock on the date of grant and the term of the options may not be in excess of ten years.  The maximum number of shares for stock options, restricted stock and SAR awards to any one participant under the 2008 Plan is 500,000 shares per calendar year.  The Company has reserved 10,000,000 shares of Common Stock for issuance under the 2008 Plan.

Although the granting of awards under the 2008 Plan is generally at the discretion of the Compensation Committee of the Board of Directors, the 2008 Plan provides for automatic grants of stock options to the non-employee members of the Board of Directors.  Each non-employee Director who is elected or appointed to the Board for the first time shall automatically be granted a Nonqualified Stock Option to purchase 30,000 shares of Common Stock.  Thereafter, at each subsequent annual meeting of stockholders, each non-employee Director who is re-elected to the Board of Directors or continues to serve a term that has not expired will receive a grant to purchase an additional 30,000 shares.  All options granted to non-employee Directors vest and become fully exercisable on the date of the first annual meeting of stockholders occurring after the end of the fiscal year of the Company during which such option was granted and shall have a term of ten years.
 
A-20

THERMOENERGY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2009

During 2009, the Board of Directors awarded officers, employees, and various members of the Board of Directors a total of 3,720,000 non-qualified stock options.  The options are exercisable at exercise prices ranging from $0.299 to $1.50 per share for a ten year period.  The exercise price was equal to or greater than the market price on the respective grant dates during the year.

During 2008, the Board of Directors awarded officers, employees, and various members of the Board of Directors a total of 2,031,300 non-qualified stock options.  The options are exercisable at exercise prices of $1.24 and/or $1.75 for a ten year period. The exercise price was equal to or greater than the market price on the respective grant dates during the year.

The fair value of options granted during 2009 and 2008 were estimated at the date of grant using a Black-Scholes option pricing model with the following assumptions:
 
   
2009
   
2008
 
             
Risk-free interest rate
   
3.0% - 3.9%
     
3.7% – 4.1%
 
Expected option life (years)
   
10.0
     
10.0
 
Expected volatility
   
77% - 80%
     
65%
 
Expected dividend rate
   
0%
     
0%
 

A summary of the Company’s stock option activity and related information for the years ended December 31, 2009 and 2008 follows:
 
   
2009
 
2008
 
   
Number of Shares
   
Wtd. Avg. Price per Share
 
Number of Shares
 
Wtd. Avg. Price per Share
 
Outstanding, beginning of year
 
8,213,800
   
$1.23
 
7,626,900
 
$1.61
 
Granted
 
3,720,000
   
$0.65
 
2,031,300
 
$1.56
 
Canceled and expired
 
(730,000
 
$0.83
 
(1,444,400
)
$2.84
 
                     
Outstanding, end of year
 
11,203,800
   
$1.18
 
8,213,800
 
$1.23
 
                      
Exercisable, end of year
 
8,583,800
   
$1.44
 
8,213,800
 
$1.23
 
 
The weighted average fair value of options granted were approximately $1,021,000 and $1,682,000 for the years ended December 31, 2009 and 2008, respectively.  The weighted average fair value of options vested were approximately $584,000 and $1,682,000 for the years ended December 31, 2009 and 2008, respectively.

Exercise prices for options outstanding as of December 31, 2009 ranged from $0.299 to $6.36. The weighted average remaining contractual life of those options was approximately 5.6 years at December 31, 2009.  The weighted average remaining contractual life of options vested and exercisable was approximately 3.3 years at December 31, 2009.

As of December 31, 2009, there was $615,000 of total unrecognized compensation cost related to non-vested share-based compensation arrangements granted under the Company’s stock option plans.  That cost is expected to be recognized over a weighted-average period of 1.9 years.  The Company recognizes stock-based compensation on the straight-line method.

See Note 15 for a discussion of material stock option grants issued in 2010.

Warrants

During 2009, Arthur S. Reynolds, a member of the Company’s Board of Directors, performed the duties of Interim Chief Financial Officer of the Company from August 2009 through November 2009.  The Company issued warrants to purchase 681,103 shares of the Company’s Common Stock at a price between $0.31 and $0.50 per share as part of his compensation.  The fair value of the warrants on the respective grant dates totaled $102,270, which was recorded as warrant expense in 2009.
 
A-21

THERMOENERGY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2009

On June 26, 2008 the Company issued warrants to acquire 1,250,000 shares of Common Stock to two shareholders for the final settlement of bridge loan obligations. The Company recorded an expense of $616,000 during the second quarter for the issuance of these warrants based upon the Black-Scholes options model.

The Company also issued 572,968 shares of Common Stock from the exercise of various warrants at an average price of $0.61 per share, and 1,272,351 shares of Common Stock from the cashless exercise of 2,581,164 warrants.

On June 2, 2008, a member of the Company’s Board of Directors, Mr. Martin A. Roenigk, exercised a warrant to acquire 550,000 shares of Common Stock at an exercise price of $0.60 per share.

During 2008 the Company issued 220,000 shares of Common Stock to consultants for services rendered.

The Company recorded general and administrative expense in connection with warrants issued for services amounting to $1,925,000 and $1,331,000 for the years ended December 31, 2009 and 2008, respectively.  The value of the warrants was computed using a Black-Scholes option model.

At December 31, 2009, there were outstanding warrants for the purchase of 48,419,710 shares of the Company’s Common Stock at prices ranging from $0.24 per share to $1.82 per share (weighted average exercise price was $0.55 per share) until expiration (3,000,000 shares in 2010, 13,833,333 shares in 2012, 8,479,884 shares in 2013, 19,715,389 in 2014, 2,711,104 shares in 2015 and 680,000 shares in 2019).

At December 31, 2009, approximately 105 million shares of Common Stock were reserved for future issuance under convertible debt and warrant agreements, stock option arrangements and other commitments (see Note 15 for subsequent events involving warrants).

Note 10:  Acquisition of CASTion Corporation

On July 2, 2007, the Company entered into an Agreement for the Purchase and Sale of Securities with CASTion and six investment funds, pursuant to which the Company acquired shares of the preferred stock of CASTion representing 90.31% of the total issued and outstanding shares of CASTion’s common stock on an as-converted basis and, from certain of the investment funds, $2,000,000 face amount of promissory notes and other debt obligations of CASTion.
 
As of January 1, 2009, the Company adopted SFAS No. 160, “Noncontrolling Interests in Consolidated Financial Statements”, which is now included in ASC 810, “Consolidations.”  SFAS 160 modifies the accounting and disclosure requirements for subsidiaries which are not wholly-owned.  In accordance with the provisions of SFAS 160, the Company reclassified $1,662,000 of noncontrolling interest previously reflected between long-term liabilities and stockholders’ equity and included the amount as a component of stockholders’ equity in the accompanying consolidated balance sheets and consolidated statements of stockholders’ equity as of December 31, 2008.  Additionally, the Company has presented the net income attributable to the Company and the noncontrolling ownership interests separately in the accompanying consolidated statements of operations.

On January 5, 2009, the Company acquired substantially all of the remaining outstanding shares of CASTion Corporation (“CASTion”).  The Company issued to six individuals and/or entities 435,442 shares of restricted Common Stock, $351,614 face amount of 10% convertible debt (conversion price of $.50 per share and a maturity date of May 31, 2010) and warrants to acquire 424,164 shares of restricted Common Stock.  The fair value of the total consideration was $619,955. The warrants have an exercise price of $0.50 per share and expire in approximately 4.5 years.  In addition, the Company escrowed $12,500 cash to fund the purchase of the shares held by the remaining noncontrolling stockholders that represent less than one percent of the acquired shares.  The completion of this transaction resulted in CASTion becoming a wholly-owned subsidiary of the Company.

The acquisition of the CASTion noncontrolling interest was accounted for in accordance with SFAS 160, which requires that the acquisition be recorded as an equity transaction.  This resulted in a reduction of additional paid-in capital of approximately $2,282,000.
 
A-22

THERMOENERGY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2009
 
Note 11:  Employee benefit plans

The Company has adopted an Employee Stock Ownership Plan. However, as of December 31, 2009, the Plan had not been funded nor submitted to the Internal Revenue Service for approval.  CASTion has a 401(k) Plan, but no employer contributions have been made by CASTion.

Note 12:  Segments

Operating segments are identified as components of an enterprise about which separate discrete financial information is available to the chief operating decision maker, or decision-making group, in assessing performance and allocating resources.  As stated in Note 1, the Company markets and develops advanced municipal and industrial wastewater treatment and carbon reducing clean energy technologies.  The Company currently generates a large majority of its revenues from the sale and application of its water treatment technologies.  Revenues from its clean energy technologies have been limited to grants received from governmental and other agencies for continued development.  In 2009, the Company established Babcock-Thermo Carbon Capture, LLC, a joint venture with Babcock Power Development, LLC, for the purpose of developing and commercializing the Company’s clean energy technology.  Because revenues and costs related to the Company’s clean energy technologies is immaterial to the entire Company taken as a whole, the financial information presented in these financial statements represents all the material financial information related to the Company’s water treatment technologies.

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

Note 13:  Management's consideration of going concern matters

The Company has incurred net losses since inception and will require substantial additional capital to continue commercialization of the Technologies and to fund the Company’s liabilities, which included approximately $2.6 million of payroll tax liabilities (see Note 14); approximately $4.1 million of convertible debt securities in default, net of debt discounts of $104,000 (see Note 5); and $3.05 million of contingent liability reserves at December 31, 2009 (see Note 14).  In addition, the Company may be subject to tax liens if it cannot satisfactorily settle the outstanding payroll tax liabilities and may also face criminal and/or civil action with respect to the impact of the payroll tax matters (see Note 14).  The financial statements have been prepared assuming the Company will continue as a going concern, realizing assets and liquidating liabilities in the ordinary course of business and do not reflect any adjustments that might result from the outcome of the aforementioned uncertainties. Management is considering several alternatives for mitigating these conditions.

Management has determined that obtaining substantial additional funding is essential to its continued existence.   As more fully described in Note 9, the Company and a group of investors entered into a Series B Convertible Preferred Stock financing in September 2009 that, if fully funded, would result in cash proceeds to the Company of $6.25 million.  The financing provides for funding in four tranches, with the first and second tranche amounts totaling $3.05 million completed by November 2009.  The final two tranches totaling $3.2 million in funding are based on the occurrence of specified events.  There can be no assurance that those specified events will occur in order to receive the remaining funding.  Also, see Note 15 for a discussion of the Bridge Loan Agreement entered by the Company in March 2010.

Management is also actively pursuing commercial contracts to produce fees from projects involving the Technologies.  Management has determined that the financial success of the Company may be largely dependent upon the ability and financial resources of established third parties collaborating with the Company with respect to projects involving the Technologies. As discussed in Note 3, on February 25, 2009, ThermoEnergy Power Systems and Babcock Power Development, LLC, a subsidiary of Babcock Power, Inc., entered into a Limited Liability Company Agreement forming Babcock-Thermo Carbon Capture, LLC, a Delaware limited liability company, for the purpose of developing and commercializing the Company’s ZEBS clean energy technology.

Note 14: Commitments and contingencies
 
In June 2009, the Company’s Audit Committee engaged special counsel to conduct an in-depth investigation of the federal and state employment and unemployment tax return filing and taxpaying compliance record of the Company.  Questions concerning payroll tax matters arose during the preparation of the Company’s consolidated financial statements for the year ended December 31, 2008, and the Company’s former Chief Financial Officer (“CFO”) could not produce reliable documentation supporting the Company’s status with respect to compliance with the tax return filing and taxpaying requirements.  After discovering that no payroll tax returns had been filed and that no payroll taxes had been paid to the Internal Revenue Service and state taxing authorities since the former CFO assumed his officer position in mid-2005, the special counsel’s investigation was expanded to include a forensic accounting review of the Company’s financial records by a certified public accounting firm not involved with the audit of the Company’s financial statements.
 
A-23

THERMOENERGY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2009

In July 2009, the special counsel presented a report to the Chairman of the Company’s Audit Committee which summarized the findings of the investigation, including the forensic accounting review.  The report confirmed that the Company had not filed any payroll tax returns or paid any payroll taxes since mid-2005 and that the Company’s former CFO had sole responsibility for performing those functions.  The report indicated that the former CFO’s representations regarding the status of the payroll tax matters were false and misleading and that he had made false accounting entries in the Company’s records to conceal the nonpayment of the payroll taxes.  A computation of the outstanding payroll tax liabilities and of statutory interest and penalties relating to the nonpayment of the payroll taxes and the nonfiling of the payroll tax returns as of December 31, 2008 was included in the report.

On July 31, 2009, the Company’s Board of Directors unanimously approved a resolution that the former CFO’s employment be terminated for cause.  The former CFO resigned on August 3, 2009.

During the fourth quarter of 2008, the Company accrued additional payroll taxes of approximately $1,064,000 resulting in total unpaid payroll taxes of approximately $2.6 million at December 31, 2009, and recorded a contingency accrual of $2,105,000 at December 31, 2008 for estimated interest and penalties for late filing of the payroll tax returns and nonpayment of the payroll taxes.  This accrual was increased to $2,351,000 during 2009.  Management has filed the payroll tax returns and is working with the various federal and state taxing authorities to present an offer in compromise for settlement of the payroll tax liabilities.  The Company has made payments to the various taxing authorities totaling $377,000 in the first quarter of 2010.  The Company cannot predict the outcome of the offer in compromise proceedings.

The Company may become subject to tax liens if it cannot satisfactorily settle the outstanding payroll tax liabilities.  Furthermore, due to the actions of the then-CFO summarized above, the Company may also face criminal and/or civil action with respect to the impact of the payroll tax matters.  The Company cannot predict what, if any, actions may be taken by the tax authorities, the Securities and Exchange Commission or other parties or the effect the actions may have on the Company’s results of operations, financial condition or cash flows.

During 2008, the Company exhausted the appeals process of the 2007 jury award against the Company for terminating a consulting contract with Rock Capital and was required to pay $431,762 to the plaintiff.  These amounts had already been accrued on the Company’s balance sheet, and there was no financial impact to the Company in 2008.

The Company’s contingent liability reserves total $3,053,000 and $3,334,000 at December 31, 2009 and 2008, respectively, and consist of the following: (in thousands):

   
2009
   
2008
           
Estimated penalties and interest – payroll tax liabilities
 
$
2,351
   
$
2,105
Other, including unasserted claims
   
702
     
1,229
   
3,053
   
 $
3,334

At December 31, 2009, the Company had cash in financial institutions that exceeded the limit insured by the Federal Deposit Insurance Corporation.

Note 15:  Subsequent events

On March 10, 2010, the Company entered into a Bridge Loan Agreement, effective March 1, 2010, with six of its principal investors (“the Investors”) pursuant to which the Investors agreed to make bridge loans to the Company up to $2.7 million.  The Company shall issue 3% Secured Convertible Promissory Notes in the principal amount of each Investor’s funding commitment (the “Bridge Notes”).  The Bridge Notes bear interest at the rate of 3% per annum and are due and payable on February 28, 2011.  The entire unpaid principal amount, together with all interest then accrued and unpaid under each Bridge Note, is convertible, at the election of the holder thereof, into shares of Common Stock at a conversion price of $0.24 per share.
 
A-24

 
The Bridge Loan Agreement amends the 2009 Financing (see Note 9) such that the Investors shall surrender the Bridge Notes as payment for the Third Tranche Closing and/or the Fourth Tranche Closing upon the execution of certain events.  The Agreement also makes further amendments to the Series B Convertible Preferred Stock financing to provide for additional warrant coverage based on  the amounts advances and makes changes to funding commitments among the various Investors.

The Bridge Notes contain other conventional provisions, including for the acceleration of repayment obligations upon the occurrence of certain specified Events of Default.  The Bridge Notes are secured by all of the Company’s assets except for the shares of the Company’s subsidiary, CASTion Corporation (in which no security interest has been granted).

On January 27, 2010, the Company awarded Mr. Cary G. Bullock, the Company’s President and Chief Executive Officer effective as of that date, a stock option for the purchase of 8,159,401 shares of our Common Stock (representing 5% of our fully diluted capital stock) at an exercise price of $0.30 per share (the closing price of our Common Stock in the over-the-counter market on January 26, 2010), with a provision for net surrender cashless exercise.  The option has a term of ten years, subject to Mr. Bullock’s continued employment with us, and vests with respect to the first 2,039,851 shares on December 31, 2010 and thereafter in quarterly installments of 509,962.5 shares each through December 31, 2013; provided, however, that if prior or December 31, 2010, a “Change of Control” (as such term is defined in Mr. Bullock’s Executive Employment Agreement) occurs, the option will immediately vest with respect to 2,039,851 shares; and provided, further, that if Mr. Bullock’s employment is terminated prior to December 31, 2010 for any reason other than (i) by us during the Probationary Period, (ii) by us for Cause, or (iii) voluntarily by Mr. Bullock without Good Reasons, the option will immediately vest with respect to 2,039,851 shares.

On January 27, 2010, the Company awarded Mr. Teodor Klowan, Jr., the Company’s Executive Vice President and Chief Financial Officer, a stock option for the purchase of 1,579,701 shares of our Common Stock at an exercise price of $0.30 per share (the closing price of our Common Stock in the over-the-counter market on January 26, 2010), with a provision for net surrender cashless exercise.  The option has a term of ten years, subject to Mr. Klowan’s continued employment with us, and vests with respect to the first 394,929 shares on September 30, 2010 and thereafter in quarterly installments of 98,731 shares each through September 30, 2013; provided, however, that if prior or September 30, 2010, a “Change of Control” (as such term is defined in Mr. Klowan’s Executive Employment Agreement) occurs, the option will immediately vest with respect to 394,929 shares.

On March 9, 2010, the Company entered into a new Executive Employment Agreement, effective March 1, 2010 with Dennis C. Cossey, the Chairman of our Board of Directors.  In connection with this, Agreement, the Company awarded Mr. Cossey an option for the purchase of 1,000,000 shares of our Common Stock as an exercise price of $0.30 per share (the closing price of our Common Stock in the over-the-counter market on February 19, 2010, the trading day immediately prior to the date on which the Compensation Committee of our Board of Directors approved such grant), with a provision for net surrender cashless exercise.   The option has a term of ten years, subject to Mr. Cossey’s continued service as an officer or director, and vests with respect to 250,000 shares on January 1, 2011 and with respect to an additional 62,500 shares on the first day of each April, July, October and January thereafter, commencing on April 1, 2011 and continuing through January 1, 2014 (subject to Mr. Cossey’s continued service as an officer or director); provided, however, that in the event of Mr. Cossey’s Retirement (as such term is defined in Mr. Cossey’s Executive Employment Agreement) or his death or permanent disability, such option shall immediately vest in its entirety and shall become fully exercisable.
 
A-25

 
Index of Exhibits

Exhibit No.
 
Description of Exhibit
3(i)
 
Certificate of Incorporation, as amended  —  Incorporated by reference to Exhibit 3(i) to Current Report on Form 8-K filed December 17, 2009
3(ii)
 
By-laws, as amended  —  Incorporated by reference to Exhibit 3(ii) to Current Report on Form 8-K filed November 24, 2009
4.1
 
Form of 5% Convertible Promissory Note due March 21, 2013 issued to Martin A. Roenigk — Incorporated by reference to Exhibit 4.2 to Current Report on Form 8-K filed March 22, 2007
4.2
 
Form of Common Stock Purchase Warrant issued to Martin A. Roenigk  —  Incorporated by reference to Exhibit 4.3 to Current Report on Form 8-K filed March 22, 2007
4.3
 
Form of Convertible Promissory Notes issued pursuant to the Agreement for the Purchase and Sale of Securities dated as of July 2, 2007 among ThermoEnergy Corporation, CASTion Corporation and the Sellers named therein  —  Incorporated by reference to Exhibit 4.1 to Current Report on Form 8-K filed July 10, 2007
4.4
 
Form of Common Stock Purchase Warrants issued pursuant to the Agreement for the Purchase and Sale of Securities dated as of July 2, 2007 among ThermoEnergy Corporation, CASTion Corporation and the Sellers named therein  —  Incorporated by reference to Exhibit 4.2 to Current Report on Form 8-K filed July 10, 2007
4.5 *
 
Common Stock Purchase Warrant issued to Jeffrey L. Powell  —  Incorporated by reference to Exhibit 4.3 to Current Report on Form 8-K filed July 10, 2007
4.6
 
Form of Common Stock Purchase Warrants issued to The Focus Fund and Robert S. Trump  —  Incorporated by reference to Exhibit 4.4 to Quarterly Report on Form 10-QSB for the period ended September 30, 2007
4.7
 
Form of 7.5% Convertible Promissory Notes issued to The Focus Fund and Robert S. Trump  —  Incorporated by reference to Exhibit 4.5 to Quarterly Report on Form 10-QSB for the period ended September 30, 2007
4.8
 
Warrant Agreement dated November 5, 2004 by and between ThermoEnergy Corporation and Robert S. Trump, together with Form of Warrant  —  Incorporated by reference to Exhibit 99.SS to Amendment No. 10 to Schedule 13D of Robert S. Trump filed on December 2, 2004
4.9
 
Form of Common Stock Purchase Warrant issued pursuant to Securities Purchase Agreement dated as of December 18, 2007 between ThermoEnergy Corporation and The Quercus Trust  —  Incorporated by reference to Exhibit 4.1 to Current Report on Form 8-K filed December 19, 2007
4.10
 
Amendment No. 1 to Common Stock Purchase Warrant No. 2007-12-1  —  Incorporated by reference to Exhibit 4.3 to Current Report on Form 8-K filed September 17, 2008
4.11
 
7.5% Convertible Promissory Notes due December 31, 2008 issued to Robert S. Trump  —  Incorporated by reference to Exhibit 4.1 to Current Report on Form 8-K filed August 18, 2008
4.12
 
Common Stock Purchase Warrant No. 2008-RT1 issued to Robert S. Trump  —  Incorporated by reference to Exhibit 4.2 to Current Report on Form 8-K filed August 18, 2008
4.13
 
Form of Common Stock Purchase Warrant issuable pursuant to  Securities Purchase Agreement dated as of September 15, 2008 by and between ThermoEnergy Corporation and The Quercus Trust  —  Incorporated by reference to Exhibit 4.1 to Current Report on Form 8-K filed September 17, 2008
4.14
 
10% Convertible Promissory Notes due September 30, 2013 issued to The Quercus Trust  —  Incorporated by reference to Exhibit 4.2 to Current Report on Form 8-K filed September 17, 2008
4.15
 
10% Secured Convertible Promissory Note issued to The Quercus Trust  —  Incorporated by reference to Exhibit 10.1 to Current Report on Form 8-K filed February 17, 2009
4.16
 
Form of Common Stock Purchase Warrant issued pursuant to Securities Purchase Agreement dated as of March 6, 2009  —   Incorporated by reference to Exhibit 4.1 to Current Report on Form 8-K filed April 28, 2009
4.17
 
Form of 10% Convertible Promissory Note due October 31, 2009 issued pursuant to Securities Purchase Agreement dated as of April 27, 2009  —   Incorporated by reference to Exhibit 4.2 to Current Report on Form 8-K filed April 28, 2009
4.18
 
Form of Common Stock Purchase Warrant issued pursuant to Securities Purchase Agreement dated as of April 27, 2009  —  Incorporated by reference to Exhibit 4.3 to Current Report on Form 8-K filed April 28, 2009
 
B-1

 
4.19
 
Warrant No. W09-10 for the purchase of 600,000 shares of the Common Stock of ThermoEnergy Corporation issued to The Focus Fund, LP  —   Incorporated by reference to Exhibit 4.1 to Current Report on Form 8-K filed June 30, 2009
4.20
 
10% Secured Convertible Promissory Note of ThermoEnergy Corporation dated June 25, 2009 in the principal amount of $150,000 issued to The Quercus Trust   —   Incorporated by reference to Exhibit 10.1 to Current Report on Form 8-K filed June 30, 2009
4.21
 
10% Convertible Promissory Note of ThermoEnergy Corporation dated June 17, 2009 in the principal amount of $108,000 issued to The Focus Fund, LP  —   Incorporated by reference to Exhibit 10.3 to Current Report on Form 8-K filed June 30, 2009
4.22
 
8% Secured Convertible Promissory Note in the principal amount of $600,000 issued to Focus Fund L.P.   —  Incorporated by reference to Exhibit 10.1 to Current Report on Form 8-K filed August 27, 2009
4.23
 
Common Stock Purchase Warrants issued to Focus Fund L.P.   —   Incorporated by reference to Exhibit 4.1 to Current Report on Form 8-K filed August 27, 2009
4.24
 
Form of  8% Secured Convertible Promissory Notes issued to  issued to Empire Capital Partners, LP, Empire Capital Partners, Ltd,  Empire Capital Partners Enhanced Master Fund, Ltd, Robert S. Trump and The Quercus Trust  —   Incorporated by reference to Exhibit 4.1 to Current Report on Form 8-K filed October 2, 2009
4.25
 
Form of Common Stock Purchase Warrants issued to Empire Capital Partners, LP, Empire Capital Partners, Ltd,  Empire Capital Partners Enhanced Master Fund, Ltd, Robert S. Trump and The Quercus Trust   —  Incorporated by reference to Exhibit 4.2 to Current Report on Form 8-K filed October 2, 2009
4.26
 
Form of Common Stock Purchase Warrant issued pursuant to the Securities Purchase Agreement dated as of November 19, 2009 by and among ThermoEnergy Corporation and the Investors named therein   —  Incorporated by reference to Exhibit 4.1 to Current Report on Form 8-K filed November 24, 2009
10.1
 
License Agreement, effective December 30, 1997, by and between ThermoEnergy Corporation and Battelle Memorial Institute  —  Incorporated by reference to Exhibit 10 to Quarterly Report on Form 10-QSB for the period ended March 31, 1998
10.2
 
Amendment No. 1 to License Agreement between ThermoEnergy Corporation and Battelle Memorial Institute  —  Incorporated by reference to Exhibit 10.5 to Annual Report on Form 10-KSB for the year ended December 31, 2004
10.3
 
Amendment No. 2 to License Agreement between ThermoEnergy Corporation and Battelle Memorial Institute  —  Incorporated by reference to Exhibit 10.4 to Annual Report on Form 10-KSB for the year ended December 31, 2005
10.4
 
License Agreement, effective October 1, 2003, by and between ThermoEnergy Corporation and Alexander G. Fassbender  —  Incorporated by reference to Exhibit 10.44 to Annual Report on Form 10-KSB for the year ended December 31, 2003
10.5
 
Letter Agreement from Alexander G. Fassbender dated December 17, 2007 and addressed to The Quercus Trust and ThermoEnergy Corporation  —  Incorporated by reference to Exhibit 10.2 to Current  Report on Form 8-K filed December 19, 2007
10.6 *
 
Employment Agreement of Alexander G. Fassbender, dated November 18, 1998, and Amendment No. 1 thereto  —  Incorporated by reference to Exhibit 10.6 to Annual Report on Form 10-KSB for the year ended December 31, 2004
10.7 *
 
Amendment to Employment Agreement by and between Alexander G. Fassbender and ThermoEnergy Corporation, dated as of February 25, 2009  —  Incorporated by reference to Exhibit 10.4 to Current  Report on Form 8-K filed March 2, 2009
10.8 *
 
Executive Employment Agreement dated as of March 1, 2010 by and between ThermoEnergy Corporation and Dennis C. Cossey  —  Incorporated by reference to Exhibit 10.4 to Current  Report on Form 8-K filed March 9, 2010
10.9 *
 
Executive Employment Agreement dated January 27, 2010 by and between ThermoEnergy Corporation and Cary G. Bullock  —  Incorporated by reference to Exhibit 10.1 to Current  Report on Form 8-K filed February 2, 2010
10.10 *
 
Executive Employment Agreement dated November 2, 2009 by and between ThermoEnergy Corporation and Teodor Klowan, Jr.   —  Incorporated by reference to Exhibit 10.1 to Current  Report on Form 8-K filed November 3, 2009

B-2

 
10.11 *
 
Consulting Services Agreement between Rexon Limited and ThermoEnergy Corporation dated as of August 3, 2009   —  Incorporated by reference to Exhibit 10.1 to Current Report on Form 8-K filed August 26, 2009
10.12 *
 
Form of Common Stock Purchase Warrant issued to Rexon Limited pursuant to Consulting Services Agreement between Rexon Limited and ThermoEnergy Corporation dated as of August 3, 2009   —  Incorporated by reference to Exhibit 10.2 to Quarterly Report on Form 10-Q for the period ended September 30, 2009
10.13 *
 
Executive Employment Agreement dated September 16, 2009 by and between ThermoEnergy Corporation and Shawn R. Hughes   —  Incorporated by reference to Exhibit 10.3 to Quarterly Report on Form 10-Q for the period ended September 30, 2009
10.14 *
 
Employment Agreement of Andrew T. Melton, dated May 1, 2005  —  Incorporated by reference to Exhibit 10.14 to Annual Report on Form 10-KSB for the year ended December 31, 2005
10.15 *
 
Employment Agreement of Jeffrey L. Powell, dated July 2, 2007  —  Incorporated by reference to Exhibit 10.3 to Current Report on Form 8-K filed July 10, 2007
10.16 *
 
Bonus Agreement dated July 2, 2007 among ThermoEnergy Corporation, CASTion Corporation and Donald F. Farley, as agent for certain employees of CASTion Corporation identified therein  —  Incorporated by reference to Exhibit 10.2 to Current Report on Form 8-K filed July 10, 2007
10.17 *
 
Option Agreement by and between ThermoEnergy Corporation and Dennis C. Cossey  —  Incorporated by reference to Exhibit 10.37 to Quarterly Report on Form 10-Q for the period ended September 30, 1999
10.18 *
 
Retirement Plan of P.L. Montesi  —  Incorporated by reference to Exhibit 10.43 to Annual Report on Form 10-QSB for the year ended December 31, 2003
10.19 *
 
Agreement, dated May 27, 2005, among ThermoEnergy Corporation, the Estate of P.L. Montesi and Betty Johnson Montesi  —  Incorporated by reference to Exhibit 10.1 to Current Report on Form 8-K filed June 3, 2005
10.20
 
Securities Purchase Agreement dated as of December 18, 2007 between ThermoEnergy Corporation and The Quercus Trust  —  Incorporated by reference to Exhibit 10.1 to Current Report on Form 8-K filed December 19, 2007
10.21
 
First Amendment to Securities Purchase Agreement dated as of June 25, 2008 by and between ThermoEnergy Corporation and The Quercus Trust  —  Incorporated by reference to Exhibit 10.1 to Current Report on Form 8-K filed June 30, 2008
10.22
 
Securities Purchase Agreement, dated as of March 21, 2007, between ThermoEnergy Corporation and Martin A. Roenigk  —  Incorporated by reference to Exhibit 4.1 to Current Report on Form 8-K filed March 22, 2007
10.23
 
Agreement for the Purchase and Sale of Securities dated as of July 2, 2007 among ThermoEnergy Corporation, CASTion Corporation and the Sellers named therein  —  Incorporated by reference to Exhibit 10.1 to Current Report on Form 8-K filed July 10, 2007
10.24
 
Securities Purchase Agreement, dated as of August 12, 2008, between ThermoEnergy Corporation and Robert S. Trump —  Incorporated by reference to Exhibit 4.1 to Current Report on Form 8-K filed August 18, 2008
10.25
 
Stock  Pledge Agreement dated July 2, 2007 by ThermoEnergy Corporation in favor of Spencer Trask Specialty Group, LLC (in its capacity as agent for itself and for other Secured Parties who become parties thereto  —  Incorporated by reference to Exhibit 10.4 to Current Report on Form 8-K filed July 10, 2007
10.26
 
Securities Purchase Agreement dated as of September 15, 2008 by and between ThermoEnergy Corporation and The Quercus Trust  —  Incorporated by reference to Exhibit 10.1 to Amended Current Report on Form 8-K/A filed January 13, 2009
10.27
 
Security Agreement dated as of February 11, 2009 among ThermoEnergy Corporation, CASTion Corporation and The Quercus Trust  —   Incorporated by reference to Exhibit 10.2 to Current Report on Form 8-K filed February 17, 2009
10.28
 
Limited Liability Company Agreement of Babcock-Thermo Carbon Capture LLC, dated as of February 25, 2009  —   Incorporated by reference to Exhibit 10.1 to Current Report on Form 8-K filed March 2, 2009
10.29
 
TEPS License Agreement, dated as of February 25, 2009  —  Incorporated by reference to Exhibit 10.2 to Current Report on Form 8-K filed March 2, 2009
10.30
 
Agreement to Indemnify Certain Members of Babcock-Thermo Carbon Capture LLC, dated as of February 25, 2009  —  Incorporated by reference to Exhibit 10.3 to Current Report on Form 8-K filed March 2, 2009

B-3

 
10.31
 
Form of Securities Purchase Agreement dated as of March 6, 2009 by and between ThermoEnergy Corporation and each of the Investors party thereto  —   Incorporated by reference to Exhibit 10.1 to Current Report on Form 8-K filed April 28, 2009
10.32
 
Securities Purchase Agreement dated as of April 27, 2009 by and between ThermoEnergy Corporation and the Investors party thereto  —  Incorporated by reference to Exhibit 10.2 to Current Report on Form 8-K filed April 28, 2009
10.33
 
Letter Agreement between The Quercus Trust and ThermoEnergy Corporation dated June 25, 2009  —    Incorporated by reference to Exhibit 10.2 to Current Report on Form 8-K filed June 30, 2009
10.34
 
Letter Agreement between The Focus Fund, LP and ThermoEnergy Corporation dated June 15, 2009    —   Incorporated by reference to Exhibit 10.4 to Current Report on Form 8-K filed June 30, 2009
10.35
 
Security Agreement between The Focus Fund, L.P. and ThermoEnergy Corporation dated July 31, 2009   —   Incorporated by reference to Exhibit 10.2 to Current Report on Form 8-K filed August 27, 2009
10.36
 
Promissory Note in the principal amount of $110,000 issued pursuant to Focus Fund L.P.   —  Incorporated by reference to Exhibit 10.1 to Current Report on Form 8-K filed August 31, 2009
10.37
 
Security Agreement dated as of September 28, 2009 between ThermoEnergy Corporation and Empire Capital Partners, LP, Empire Capital Partners, Ltd,  Empire Capital Partners Enhanced Master Fund, Ltd, Robert S. Trump and The Quercus Trust   —  Incorporated by reference to Exhibit 10.1 to Current Report on Form 8-K filed October 2, 2009
10.38
 
Securities Purchase Agreement dated as of November 19, 2009 by and among ThermoEnergy Corporation and the Investors named therein  —  Incorporated by reference to Exhibit 10.1 to Current Report on Form 8-K filed November 24, 2009
10.39
 
Form of Mutual Release between ThermoEnergy Corporation and the several Investors party to the Securities Purchase Agreement dated as of November 19, 2009  —  Incorporated by reference to Exhibit 10.2 to Current Report on Form 8-K filed November 24, 2009
10.40
 
Voting Agreement dated as of November 19, 2009 by and among ThermoEnergy Corporation and the Series B Preferred Stockholders named therein  —  Incorporated by reference to Exhibit 10.3 to Current Report on Form 8-K filed November 24, 2009
10.41
 
Bridge Loan Agreement dated as of March 1, 2010 by and among The Quercus Trust, Robert S. Trump, Focus Fund, L.P., Empire Capital Partners, LP, Empire Capital Partners, Ltd, and Empire Capital Partners Enhanced Master Fund Ltd  and ThermoEnergy Corporation —  Incorporated by reference to Exhibit 10.1 to Current Report on Form 8-K filed March 16, 2010
10.42
 
Form of 3% Secured Convertible Promissory Note issued pursuant to Bridge Loan Agreement dated as of March 1, 2010 by and among The Quercus Trust, Robert S. Trump, Focus Fund, L.P., Empire Capital Partners, LP, Empire Capital Partners, Ltd, and Empire Capital Partners Enhanced Master Fund Ltd  and ThermoEnergy Corporation —  Incorporated by reference to Exhibit 10.2 to Current Report on Form 8-K filed March 16, 2010
10.43
 
Security Agreement dated as of March 1, 2010 by and among ThermoEnergy Corporation, The Quercus Trust, Robert S. Trump, Focus Fund, L.P., Empire Capital Partners, LP, Empire Capital Partners, Ltd, and Empire Capital Partners Enhanced Master Fund Ltd  and The Quercus Trust (as agent for itself and the other Investors)  —  Incorporated by reference to Exhibit 10.2 to Current Report on Form 8-K filed March 16, 2010
21.1
 
Subsidiaries of the Issuer  —  Previously filed
24.1
 
Power of Attorney of Dennis C. Cossey, Cary G. Bullock, Teodor Klowan, Jr., David Anthony, J. Winder Hughes III, Shawn R. Hughes, and Arthur S. Reynolds  —  Previously filed
31.1
 
Sarbanes Oxley Act Section 302 Certificate of Principal Executive Officer  — Filed herewith
31.2
 
Sarbanes Oxley Act Section 302 Certificate of Principal Financial Officer  — Filed herewith
32.1
 
Sarbanes Oxley Act Section 906 Certificate of Principal Executive Officer  — Filed herewith
32.2
 
Sarbanes Oxley Act Section 906 Certificate of Principal Financial Officer  — Filed herewith

*  May be deemed a compensatory plan or arrangement
 
B-4