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EX-31.1 - EXHIBIT 31.1 - THERMOENERGY CORPv235661_ex31-1.htm
EX-32.2 - EXHIBIT 32.2 - THERMOENERGY CORPv235661_ex32-2.htm
EX-16 - EXHIBIT 16 - THERMOENERGY CORPv235661_ex16.htm
EX-31.2 - EXHIBIT 31.2 - THERMOENERGY CORPv235661_ex31-2.htm
EX-32.1 - EXHIBIT 32.1 - THERMOENERGY CORPv235661_ex32-1.htm
 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C.  20549

FORM 10-K/A
Amendment No. 3

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

For the fiscal year ended December 31, 2010

¨     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
(Registrant’s telephone number, including area code)

SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:

Title of Each Class:
 
Name of Each Exchange on Which Registered:
Common Stock, $0.001 par value per share
 
OTC Bulletin Board

SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE 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 x No o

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

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) 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.  x

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 computed by reference to the closing price of the common stock on June 30, 2010, the last trading day of the registrant’s most recently completed second fiscal quarter, was $11,345,381.
 
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 28, 2011 – 56,681,918 shares
 
  
 
 

 
 
THERMOENERGY CORPORATION
ANNUAL REPORT ON FORM 10-K
FOR THE FISCAL YEAR ENDED DECEMBER 31, 2010
 
TABLE OF CONTENTS
 
       
Page
   
Explanatory Note
 
3
   
Forward Looking Information
 
3
         
PART  I
       
Item 1:
 
Business
 
4
Item 1A:
 
Risk Factors
 
10
Item 1B:
 
Unresolved Staff Comments
 
10
Item 2:
 
Properties
 
10
Item 3:
 
Legal Proceedings
 
10
Item 4:
 
[Removed and Reserved]
 
10
         
PART II
       
Item 5:
 
Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
 
11
Item 6:
 
Selected Financial Data
 
11
Item 7:
 
Management’s Discussion and Analysis of Financial Condition and Results of Operations
 
12
Item 7A:
 
Quantitative and Qualitative Disclosures about Market Risk
 
18
Item 8:
 
Financial Statements and Supplementary Data
 
18
Item 9:
 
Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
 
18
Item 9A:
 
Controls and Procedures
 
18
Item 9B:
 
Other Information
 
19
         
PART III
       
Item 10:
 
Directors, Executive Officers and Corporate Governance
 
23
Item 11:
 
Executive Compensation
 
29
Item 12:
 
Security Ownership by Certain Beneficial Owners and Management and Related Stockholder Matters
 
37
Item 13:
 
Certain Relationships and Related Transactions, and Director Independence
 
39
Item 14:
 
Principal Accountant Fees and Services
 
40
         
PART IV
       
Item 15:
 
Exhibits, Financial Statement Schedules
 
42
         
   
Signatures
 
43

 
2

 
 
EXPLANATORY NOTE
 
We are filing this Amendment No. 3 to our Annual Report on Form 10-K for the fiscal year ended December 31, 2010 for the following purposes:
 
(i)  
to expand our disclosure in Part I, Item 1 (“Business”) to include additional disclosure regarding the methods of competition in our industry and our patents and other intellectual property;
 
(ii)  
to amend Part II, Item 7 (Managements Discussion and Analysis of Financial Condition and Results of Operations) to explain more fully the reasons for material changes from period to period; and
 
(iii)  
to amend Part II, Item 9A (“Controls and Procedures”) (a) to provide a more accurate definition of internal control over financial reporting; (b) to disclose further details regarding the discovery and remediation of material weaknesses in our controls over financial reporting in 2010; and (c) to state Management’s conclusions as to the effectiveness of our disclosure controls and procedures as of December 31, 2010.
 
Except for the inclusion of the information described above, this Amendment does not reflect events occurring subsequent to the filing of Amendment No. 2 to our original Annual Report on Form 10-K/A on August 11, 2011 or modify or update other information or exhibits to our Annual Report on Form 10-K other than Exhibits 16, 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 ThermoEnergy Corporation (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’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://ir.stockpr.com/thermoenergy/sec-filings.  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.
 
 
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PART I

ITEM 1.  Business

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

Our wastewater treatment systems are based on our proprietary Controlled Atmosphere Separation Technology (“CAST”) platform.  Our CAST 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.  The CAST platform technology is owned by our subsidiary, CASTion Corporation (“CASTion”).

We are also the owner of a patented pressurized oxycombustion technology known as the Zero Emission Boiler System (“ZEBS”), which converts fossil fuels (including coal, oil and natural gas) and biomass into electricity without producing air emissions while removing and capturing carbon dioxide in liquid form for sequestration or beneficial reuse.  This technology can be used to build new or to retrofit old fossil fuel power plants globally with no emissions while capturing carbon dioxide as a liquid for ready sequestration far more economically than any other competing technology.  The ZEBS technology is consolidated in our 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 established a joint venture with Babcock Power, Inc. called Babcock-Thermo Carbon Capture, LLC ("BTCC") to commercialize the ZEBS process.  TEPS granted BTCC an exclusive worldwide license to commercialize 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.

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 is traded on the OTC Bulletin Board under the stock symbol TMEN.OB.

Corporate Mission

Our mission is to become a significant force within the global municipal and industrial wastewater and power generation industries.
 
Technology and Research and Development

 
We own or license all of our Technologies.  Our product engineering and research and development expenses were $466,000 and $916,000 in the fiscal years ended December 31, 2010 and 2009, respectively.
 
Water Technologies

Our management team has focused the Company on our proprietary CAST and R-CAST technologies (described below) in our intellectual property portfolio pertaining to wastewater.  The Company’s wastewater technologies offer industrial, agricultural and municipal clients superior economic and process advantages over conventional wastewater treatment methods.  The Company’s water technologies include the following:

CASTion’s CAST, R-CAST and Proprietary Water Technologies

Our proprietary 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 reduces and/or 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 disposal, 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 concentrate the contaminants; and
 
 
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·
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
 
Our patented Ammonia Recovery Process (“ARP”) captures ammonia from dilute waste streams and converts it into ammonium sulfate, a commercial grade fertilizer, which can be utilized in agricultural markets worldwide.  The ARP technology has been proven in more than 150 pilot tests.

ARP is a 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 separates ammonia out of wastewater discharge streams from municipal, industrial and agricultural waste via RCAST and converts it into standard, commercial-grade, ammonium sulfate fertilizer.  We are 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.

 On May 11, 2010 we signed a contract with the New York City Department of Environmental Protection (“NYCDEP”) relating to the ThermoEnergy Ammonia Removal Process System at the 26th Ward waste water pollution control plant (the “Contract”).  The value of the Contract is estimated to be $27.1 million.

Under the Contract, we have been engaged by NYCDEP to (a) provide engineering and design services with respect to the rehabilitation of the Cake Storage Building, process equipment, and miscellaneous systems at the 26th Ward wastewater pollution control plant, (b) supply and install our proprietary ARP equipment (the “System”) at the 26th Ward wastewater pollution control plant, and (c) operate and maintain the System at the 26th Ward wastewater pollution control plant for a period of twelve months.  We are presently obligated to complete our services under the Contract on or before December 24, 2013; however, the completion date is subject to change.

The first phase of the Contract is for engineering and design services related to the rehabilitation of the Cake Storage Building and miscellaneous systems.  We will be paid $5.8 million for this phase of the Contract, payable in installments upon achieving certain milestones.  The second phase of the Contract is for the supply and installation of the System.  We will be paid $13.4 million for this phase of the Contract, payable in installments relating to the progress of the project.  The last phase is for operation and maintenance of the System.  We will be paid $2.3 million for this phase of the Contract, payable in twelve equal monthly installments.  In addition, we will be reimbursed, on a monthly basis, for our costs related to chemicals and reagents used in the System and the handling, storage and transportation of byproducts of the System (including internal costs and overhead), estimated to be $5.6 million.

As of this filing, we have met all 60% design milestones and some 90% design milestones as defined in the first phase of the Contract.  We expect to substantially complete the first phase of the Contract by the end of the second quarter of 2011 and begin the second phase of the Contract at that time.  We believe that, based upon the terms of the ARP contract, we will be able to meet the operational requirements of the Contract.  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 need 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 forth in the Consent Decree.

 
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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 shellfish 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.
 
We recently developed a new, high-efficiency process for recovering nutrients from wastewater called Thermo ARP™.  Thermo ARP™ is specifically designed for use with industrial, agricultural and municipal anaerobic digesters where the wastewater stream requires a simpler treatment strategy.  Based on our proprietary CAST technology platform, Thermo ARP™ uniquely combines heat and flash vacuum distillation to deliver the lowest cost per pound of nitrogen removed when compared with any digestate treatment technology on the market today.  For industrial, agricultural and municipal high rate anaerobic digesters, Thermo ARP™ has a treatment cost per pound of nitrogen removed that is materially less than that of the most efficient competing technologies.  Both ARP and Thermo ARP™ have the economic and environmental advantage of recovering nitrogen as a fertilizer.  Users of this technology can generate revenue from the sale of fertilizer and combine that revenue with nutrient credits now offered in several states to reduce the cost of operating the system and can accelerate payback on the equipment investment.
 
Other water 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.  TFP provides a cost-effective solution for biosolids disposal for municipal wastewater treatment.  TFP 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 United States Environmental Protection Agency. (“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 the event of 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.  TFP is covered in the same license as Enhanced Biogas.

TFP 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.  In the lower temperature phase, (around 90-100ºF) waste solids already reduced in the first phase are more completely broken down to generate additional biogas at lower energy costs.
 
 
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The Enhanced Biogas Production process is currently protected by patents that we license exclusively.  Under the terms of the license agreement, (the “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.
 
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 Nos. 6,196,000 and 6,918,253 for the ZEBS process.  We also received patents relating to the ZEBS process in Australia, China, India, Mexico, Poland, Romania, the Russian Federation and South Africa.  Foreign patent applications have also been filed in Canada and the European Patent Office.

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 sale 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 believe many of these markets represent suitable opportunities for us to implement our business model of design, build, own and operate ("DBOO") wastewater facilities over a contracted period (anticipated to be a 5-20 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.)

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.
 
Customers

We have approximately 70 CAST wastewater treatment systems deployed worldwide, mostly in the United States.  We sell our systems to both small and large businesses, as well as to municipalities.  Historically, customers in the Fortune 1000 rankings have accounted for approximately 28% of units sold; these customers include Valero, Proctor & Gamble, General Electric and Caterpillar.  Historically, municipalities, including the New York City Department of Environmental Protection, have accounted for approximately 2% of units sold.  The remaining 70% of units were sold to mid- and smaller-sized companies.

All of our revenues in 2010 and 2009 came from the U.S. and the majority of revenues in each year were generated by a single customer.  URS Corporation was our largest customer during the fiscal year ended December 31, 2009, representing approximately 85% of our total revenues.  The City of New York Department of Environmental Protection was our largest customer during the fiscal year ended December 31, 2010, representing approximately 48% of our total revenues.
 
 
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Recent Developments
 
Over the past year, we have made significant progress in resolving our legal and financial challenges that have hindered our growth.  The following details the progress we have made in the fourth quarter of 2010 and first quarter of 2011:

On October 20, 2010, we converted notes held by the former minority shareholders of CASTion Corporation (“CASTion”), plus accrued interest, in conjunction with the settlement reached between former minority shareholders of CASTion and former majority shareholders of CASTion as discussed in Item 3 – Legal Proceedings.  As a result, notes and interest totaling $433,000 were converted into 1,802,445 shares of our Common Stock at a price of $0.24 per share.

In October 2010, the Financial Industry Regulatory Authority (“FINRA”) restored our eligibility for quotation on the over-the-counter bulletin board (“OTCBB”).   Our Common Stock had been quoted on the Pink Sheets since June 2009, when we lost our eligibility due to delinquencies in filing our quarterly and annual reports with the Securities and Exchange Commission.

We hired a new sales executive in the fourth quarter of 2010 to improve our sales function and a new project management executive to manage our New York City contract and future projects.  In addition, we have established a Board of Advisors in early 2011 and have hired a new executive to run our joint venture, BTCC.

On January 7, 2011 we entered into Note Amendment and Forbearance Agreements with the holders of our Convertible Promissory Notes (the “Old Notes”) due May 31, 2010.  Per the Agreements, we made significant payments against the Old Notes, converted a portion of the Old Notes to Series B Convertible Preferred Stock, issued warrants to the Noteholders and issued new Convertible Promissory Notes to the Noteholders (the “Restated Notes”) with a maturity date of February 29, 2012.

On February 25, 2011 we entered into Note Extension and Amendment Agreements with the holders of our Bridge Notes.  The Noteholders agreed to extend the maturity date of these Notes until February 29, 2012.  The Notes, as amended (the “Amended Notes”) bear interest at the rate of 10% per annum.  The Amended Notes are convertible into shares of the Company’s Series B Convertible Preferred Stock at the rate of $2.40 per share at any time at the election of the Noteholders.  In the event, prior to the maturity date of the Amended Notes, we pay in full the Restated Notes as detailed above, then the Amended Notes shall automatically convert into shares of the Company’s Series B Convertible Preferred Stock at the rate of $2.40 per share.

In March 2011 we introduced a new, high-efficiency process for recovering nutrients from wastewater called Thermo ARP™.  Based on our proprietary CAST technology platform, Thermo ARP™ uniquely combines heat and flash vacuum distillation to deliver the lowest cost per pound of nitrogen removed when compared with any digestate treatment technology on the market today.  For industrial, agricultural and municipal high rate anaerobic digesters, Thermo ARP™ has a treatment cost per pound of nitrogen removed that is materially less than that of the most efficient competing technologies.

On March 25, 2011, we were notified by the U.S. Internal Revenue Service that it had accepted our Offer in Compromise with respect to our tax liabilities relating to (i) employee tax withholding for all periods commencing with the quarter ended September 30, 2005 and continuing through September 30, 2009 and (ii) federal unemployment taxes (FUTA) for the years 2005 through 2008.  Pursuant to our Offer in Compromise, we have agreed to satisfy our delinquent tax liabilities by paying a total of $2,134,636 (representing the aggregate amount of tax due, without interest or penalties).  During the pendency of the IRS review of our Offer in Compromise we have made interim payments totaling $1,335,000; a balance of $799,636 remains to be paid in monthly installments of $89,000 each through December 2011.  In connection with our Offer in Compromise, we have agreed that any net operating losses sustained for the years ending December 31, 2010 through December 31, 2012 will not be claimed as deductions under the provisions of Section 172 of the Internal Revenue Code except to the extent that such net operating losses exceed the amount of interest and penalties abated.  The IRS acceptance of our Offer in Compromise is conditioned, among other things, on our filing and paying all required taxes for five tax years commencing on the date of the IRS acceptance.

In April 2010 Alexander G. Fassbender, the Company’s former Executive Vice President and Chief Technology Officer, filed a Complaint in the Fairfax County, Virginia Circuit Court alleging that his employment had been terminated in breach of his employment agreement and claiming damages in the aggregate amount of approximately $1 million, including unpaid salary, reimbursement of expenses, and other payments under his employment agreement.  The two parties are currently negotiating a settlement agreement. We have made provisions for all expected losses from litigation-related contigencies.

Patents and Other Intellectual Property Rights
 
We own or license all of our Technologies, including the Technologies discussed previously in this document.
  
We rely on patent, trademark, copyright and trade secret laws and internal controls and procedures to protect our technology. We believe that a robust technology portfolio that is assessed and refreshed periodically is an essential element of our business strategy. We believe that our success will depend in part on our ability to:
 
 
·
Obtain patent and other proprietary protection for the technology and processes that we develop;
 
 
·
Enforce and defend patents and other rights in technology, once obtained;
 
 
·
Operate without infringing the patent and proprietary rights of third parties; and
 
 
·
Preserve our company's trade secrets.
 
We presently have been issued approximately twelve patents and have eight patent applications are pending. Patents have been issued in various countries with the main concentration in the United States. Our existing significant U.S. patents will expire between 2021 and 2027.
 
We take extensive measures to protect our intellectual property rights and information. For example, every employee enters into a confidential information, non-competition and invention assignment agreement with us when they join and are reminded of their responsibilities when they leave. We also enter into and enforce a confidential information and invention assignment agreement with contractors.
 
We own or license patents and pending patents covering technologies relating to:
 
 
·
ARP - Ammonia removal from a stream
 
 
·
ZEBS - Thermodynamic efficiency and pollution control
 
 
·
Enhanced biogas recovery and production
 
Although we believe our patent portfolio is a valuable asset, the discoveries or technologies covered by the patents, patent applications or licenses may not have commercial value. Issued patents may not provide commercially meaningful protection against competitors. Other parties may be able to design around our issued patents or independently develop technology having effects similar or identical to our patented technology.
 
We periodically evaluate our patent portfolio based on our assessment of the value of the patents and the cost of maintaining such patents, and may choose from time to time to let various patents lapse, terminate or be sold.
 
8

 
Employees
 
As of December 31, 2010, we had 25 employees, all of whom were 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.
 
Manufacturing

We design, manufacture and service our products from our 20,000 square foot facility at 10 New Bond Street, Worcester, Massachusetts.  We have expansion options available at our present location in the future.

We primarily utilize commercially available or off-the-shelf parts such as pumps, heat exchangers, vacuum vessels and other balance of plant materials to produce our proprietary solutions for our customers.  No single vendor holds a sole source contract nor represents a significant portion of our standard supply chain.  We believe we could find alternative suppliers at competitive cost should any of our current suppliers be unable to fulfill our needs.
 
Competition
 
Our Technologies enable the wastewater treatment and power generation industries to comply with state and federal clean water and clean air regulatory requirements while reducing their cost of operations.  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 a 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.
 
We believe the principal competitive factors impacting our solutions are:
 
 
·
product performance;
 
 
·
price to performance characteristics;
 
 
·
delivery performance and lead times;
 
 
·
time to market;
 
 
·
breadth of product solutions;
 
 
·
sales, technical and post-sales service and support;
 
 
·
technical partnerships in early stages of product development;
 
 
·
sales channels; and
 
 
·
ability to drive standards and comply with new industry regulations.
  
Environmental

Our operations involve the use, generation and disposal of hazardous substances and are regulated under federal, state and local laws governing health and safety and the environment.  Our compliance costs were less than $100,000 in the years ended December 31, 2010 and 2009.  We believe that our products and operations at our facilities comply in all material respects with applicable environmental laws and worker health and safety laws; however, the risk of environmental liabilities cannot be completely eliminated.
 
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 programs are intended to improve existing water quality programs.  In order to comply with these regulations, industrial, agricultural and municipal wastewater treatment facilities are seeking more cost-effective methods of wastewater treatment.

Notwithstanding the uncertainty created by these regulatory and administrative initiatives, we believe that ZEBS can provide an economical and environmentally friendly solution for building new power plants or retrofitting existing power plants without any new government legislation.

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 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.
 
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ITEM 1A.  Risk Factors

Disclosures required under this item are not provided, as the Company has elected to follow the scaled disclosure requirements as a smaller reporting company.
 
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.  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 we currently pay.  We do not own any real property.
 
ITEM 3.  Legal Proceedings

In April 2010, a group representing former minority shareholders of  CASTion Corporation (“CASTion”) (“the Plaintiffs”) filed a Complaint in the Suffolk County, Massachusetts Superior Court against CASTion’s former majority shareholders (the “Defendants”) alleging claims arising out of the Defendants’ sale to the Company of their shares of capital stock and other securities of CASTion.  The Defendants threatened to file a third party complaint against the Company (and others) alleging, among other things, that the Company breached an obligation to the Defendants in not extending to the Plaintiffs an offer to purchase the CASTion securities held by them in a timely manner.

On October 20, 2010 the Company, the Plaintiffs and the Defendants entered into a settlement agreement (the “Settlement”) resolving all matters related to the Complaint.  As part of the Settlement, we agreed to pay $67,000 to the Defendants; issue 55,554 shares of our Series B Convertible Preferred Stock to the Defendants; amend the terms of our Convertible Notes with the Plaintiffs to reduce the conversion price of the Notes from $0.50 per share to $0.24 per share, modify the exercise price of certain warrants held by the Plaintiffs from $0.50 per share to $0.24 per share, and issue to the Defendants additional warrants to purchase our common stock.

On April 21, 2010, Alexander G. Fassbender, the Company’s former Executive Vice President and Chief Technology Officer, filed a Complaint in the Fairfax County, Virginia Circuit Court alleging that his employment had been terminated in breach of his employment agreement and claiming damages in the aggregate amount of approximately $1 million, including unpaid salary, reimbursement of expenses, and other payments under his employment agreement.  The two parties are currently negotiating a settlement agreement. We have made provisions for all expected losses from litigation-related contigencies.
 
ITEM 4.  [Removed and Reserved]
 
 
10

 
 
PART II
 
Item 5.  Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

Market Information

Our Common Stock was traded on the OTC Bulletin Board under the stock symbol TMEN.OB until June 2, 2009.  On that date we received a Notice of Decision from the Financial Industry Regulatory Authority (“FINRA”) 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.  At that time, our common stock continued to trade on “pink sheets” under the symbol “TMEN.PK”.  We have filed timely annual and quarterly reports since the filing of our Quarterly Report on Form 10-Q for the quarter ended September 30, 2009, and on October 28, 2010 FINRA restored our eligibility for quotation on the OTC Bulletin Board.  Our transfer agent is Registrar & Transfer Company, Cranford, New Jersey 07016. 

The ranges of the high and low bid prices for the Common Stock for the four quarters of 2009 and 2010 are shown below.
 
   
High
   
Low
 
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  
                 
Year Ended December 31, 2010
               
First Quarter
  $ 0.55     $ 0.26  
Second Quarter
  $ 0.50     $ 0.31  
Third Quarter
  $ 0.44     $ 0.29  
Fourth Quarter
  $ 0.40     $ 0.23  
 
Holders

At March 28, 2011, the number of holders of record of the issued and outstanding common stock of the Company was 1,192.

Dividends

We have never paid any cash dividends 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 6.  Selected Financial Data

Disclosures required under this item are not provided, as the Company has elected to follow the scaled disclosure requirements as a smaller reporting company.
 
 
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ITEM 7.  Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following discussion should be read in conjunction with the financial statements and notes thereto appearing elsewhere in this report.
 
Overview
 
We are a diversified technologies company engaged in the worldwide commercialization of advanced municipal and industrial wastewater treatment systems and carbon reducing power generation technologies.
 
Our wastewater treatment systems not only meet local, state and federal environmental regulations, but typically provide a rapid rate of return on investment by recovering and reusing expensive feedstocks, reducing contaminated wastewater discharge and recovering and reusing wastewater used in process operations.

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

We currently generate revenues from the sale and development of wastewater treatment systems. We enter into contracts with our customers to provide a wastewater treatment solution that meets the customer’s present and future needs.  Our revenues are tied to the size and scale of the wastewater treatment system required by the customer, as well as the progress made on each customer contract.
 
Historically, we marketed and sold our products primarily in North America.  In 2011, we began marketing and selling our products in Asia and Europe.  These sales and marketing activities were performed by our direct sales force and by authorized independent sales representatives.
We own or license all of the Technologies that we use in our business.
 
We have made significant progress over the past year in resolving outstanding legal and financial issues, strengthening our balance sheet, hiring key management personnel and building our business for future growth.  However, we have continued to incur negative cash flows from operations.  For the years ended December 31, 2010 and 2009, we incurred net losses of $9.9 million and $13.0 million, respectively, and had cash outflows from operations of $5.6 million and $3.8 million, respectively.  As of December 31, 2010 and 2009, we had an accumulated deficit of $91.1 million and $81.3 million, respectively.  As a result, we will require additional capital to continue to fund our operations.
 
Research and Development

We conduct research and development of water/wastewater treatment products and services 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 Ammonia Recovery Process (“ARP”) 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 made significant progress over the past year in resolving our past legal and financial issues, strengthening our balance sheet, hiring key management personnel and building our business for future growth.  In the past year, we have:
 
 
·
Improved our business prospects by expanding our product solutions with the introduction of Thermo ARPTM and signing a strategic alliance with Contego Systems to recover and recycle airport deicing fluid;
 
·
Attracted and retained several key executives and started a Board of Advisors;
 
·
Raised over $9 million in additional funding in 2010 and restructured $8.1 million of senior debt in early 2011;
 
·
Achieved relisting of our Common Stock on the OTC bulletin board; and
 
·
Settled IRS payroll tax issues, resulting in a $2.3 million gain in the fourth quarter of 2010, and reached a settlement with former CASTion shareholders who had threatened litigation.
 
However, we have historically lacked the financial and other resources necessary to market the Technologies or to build demonstration projects without the financial backing of government or industrial partners.  During 2010 and 2009, we funded our operations primarily from the sale of convertible debt, short-term borrowings, and preferred stock, generally from stockholders and other parties who are sophisticated investors. Although we will require substantial additional funding to continue existing operations, we believe that we will be able to obtain additional equity or debt financing on reasonable terms.
 
 
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Cash used in operations amounted to $5,628,000 and $3,816,000 for the years ended December 31, 2010 and 2009, respectively.  The increase in cash used in operations in 2010 is primarily due to deferring payments on operating expenses from 2009 to 2010 as we sought additional funding from our investors and payments against our outstanding payroll tax obligations in 2010.  Cash used in investing activities included purchases of property and equipment of $371,000 for the year ended December 31, 2010 and investments in our joint venture with Babcock Power of $61,000 and $50,000 for the years ended December 31, 2010 and 2009, respectively.

At December 31, 2010, we did not have sufficient working capital to satisfy our anticipated operating expenses for the next 12 months. As of December 31, 2010, the Company had a cash balance of approximately $4.3 million and current liabilities of approximately $6.1 million, which consisted primarily of accrued payroll taxes of $1.5 million and other current liabilities of $2 million. Current liabilities at December 31, 2010 is approximately $5.9 million lower than at December 31, 2009, as we have (i) extended the maturity date of certain convertible debt and cured defaults under such debt and (ii) eliminated liabilities related to penalties and interest on payroll tax liabilities to the IRS, as detailed below.

In January 2011 we paid $1.2 million in cash and issued approximately $900,000 of Series B Convertible Preferred Stock in partial payment of outstanding principal and interest as part of the terms of our Note Amendment and Forbearance Agreements with the holders of our convertible debt to cure a default.  In February 2011, we amended our Note Agreements with the holders of our short term borrowings to extend the maturity dates of these borrowings until February 29, 2012.

On March 25, 2011, we were notified by the U.S. Internal Revenue Service that it had accepted our Offer in Compromise with respect to our tax liabilities relating to (i) employee tax withholding for all periods commencing with the quarter ended September 30, 2005 and continuing through September 30, 2009 and (ii) federal unemployment taxes (FUTA) for the years 2005 through 2008.  Pursuant to our Offer in Compromise, we have agreed to satisfy our delinquent tax liabilities by paying a total of $2,134,636 (representing the aggregate amount of tax due, without interest or penalties).  During the pendency of the IRS review of our Offer in Compromise we have made interim payments totaling $1,335,000; a balance of $799,636 remains to be paid in monthly installments of $89,000 each through December 2011.  In connection with our Offer in Compromise, we have agreed that any net operating losses sustained for the years ending December 31, 2010 through December 31, 2012 will not be claimed as deductions under the provisions of Section 172 of the Internal Revenue Code except to the extent that such net operating losses exceed the amount of interest and penalties abated.  The IRS acceptance of our Offer in Compromise is conditioned, among other things, on our filing and paying all required taxes for five tax years commencing on the date of the IRS acceptance.

The following financing transactions describe our sources of funding for 2010:

On March 10, 2010, we entered into a Bridge Loan Agreement, effective March 1, 2010, with six investors who are parties to a financing transaction entered into in September 2009 (the “2009 Financing”) pursuant to which the investors agreed to make bridge loans totaling $2.6 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 were originally 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. We amended the Bridge Loan Agreement in June 2010 to increase the amount of bridge loans by $2 million. The new loans made under the amended Bridge Loan Agreement have been made on terms identical to the original loans under the Bridge Loan Agreement. We have received $4.6 million in proceeds under the Bridge Loan Agreement.  We further amended the Bridge Note Agreement in February 2011 to extend the maturity date of the Bridge Notes until February 29, 2012 and increased the interest rate to 10% per annum.

The Bridge Loan Agreement amends the 2009 Financing such that the investors shall surrender the Bridge Notes as payment for the Third Tranche Closing and/or the Fourth Tranche Closing, as defined, 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 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).

On June 24, 2010 we received from the NYCDEP an Order to Commence under the Contract between us and the NYCDEP dated May 11, 2010 (the “Contract”) related to our Ammonia Removal Process System at the 26th Ward wastewater pollution control plant. Total billings under this contract are estimated to be $27.1 million through December 2013.  Under the Contract, we have been engaged by the NYCDEP to provide engineering and design services for the rehabilitation of the Cake Storage Building, process equipment and other systems at the 26th Ward wastewater pollution plant; supply and install our proprietary ARP equipment (the “System”) and operate and maintain the System at the plant for twelve months. We started engineering and design work relative to this Contract in the third quarter of 2010.

Pursuant to the terms of the 2009 Financing, the Third Tranche became effective five business days after the filing of our Current Report on Form 8-K announcing the commencement of the Contract. The Current Report on Form 8-K was filed on June 30, 2010, and the Third Tranche of the 2009 Financing became effective on July 8, 2010. We converted $1.9 million from the Bridge Loan and accrued interest into shares of Series B Convertible Preferred Stock and issued warrants to purchase 8.3 million shares of stock at $0.24 per share.
 
 
13

 
 
Through December 31, 2010 we have received proceeds totaling $7.7 million from the 2009 Financing and the Bridge Loan Agreement, as amended. Of this amount, we received $3.0 million in 2009 and $4.6 million in 2010.
 
On August 9, 2010 we issued to certain investors a total of 2,083,334 shares of our Series B Convertible Preferred Stock at a purchase price of $2.40 per share and warrants to purchase up to 33,333,344 shares of our Common Stock. The total proceeds to us was $5 million before expenses of $375,000. Each share of Series B Convertible Preferred Stock is convertible into ten shares of our Common Stock at any time at the option of the investor. The Warrants entitle the holders to purchase shares of our Common Stock at a price of $0.30 per share (subject to adjustment for certain extraordinary corporate events as set forth in the Warrant Agreements). The Warrants may be exercised at any time on or before August 10, 2015, subject to certain acceleration rights, and contain other conventional terms, including provisions for cashless exercise and for adjustment in the Exercise Price and/or the securities issuable upon exercise in the event of certain specified extraordinary corporate events, such as stock splits, combinations, and stock dividends. As part of the Securities Purchase Agreement, we agreed to prepare and file with the Securities and Exchange Commission a registration statement to register the shares of our Common Stock issuable upon conversion of the Preferred Shares and exercise of the Warrants for resale by the investors. The registration rights provisions of the Securities Purchase Agreement contain conventional terms including indemnification and contribution undertakings.

On January 7, 2011 we entered into Note Amendment and Forbearance Agreements with the holders of our Convertible Promissory Notes (the “Old Notes”) due May 31, 2010.  Per the Agreements, (i) we made an aggregate of $1,144,335.52 in payments against the outstanding balances of the Old Notes; (ii) the Noteholders converted an aggregate of $902,709.60 in principal and accrued interest under the Old Notes into shares of our Series B Convertible Preferred Stock; (iii) we issued to the Noteholders warrants for the purchase of an aggregate of 17,585,127 shares of our Common Stock at an exercise price of $0.40 per share and an aggregate of 6,018,065 shares of our Common Stock at an exercise price of $0.30 per share; (iv) we amended and restated the Old Notes to read in the form of Amended and Restated Promissory Notes due February 29, 2012 (the “Restated Notes” and, with the Old Notes, the “Notes”); (v) we made additional cash payments to the Noteholders in the aggregate amount of $37,914; and (vi) the Noteholders agreed, subject to certain conditions set forth in the Note Amendment and Forbearance Agreements, to forbear until February 29, 2012, from exercising their rights and remedies under the Restated Notes.

The Restated Notes bear interest at the rate of 10% per annum (with penalty interest at the rate of 18% per annum following maturity or an event of default).  Installment payments (based on a 10-year amortization schedule) are due on the last day of each month beginning January 31, 2011 and continue through February 29, 2012, at which time the entire unpaid principal amount of, and accrued interest on, the Restated Notes shall be due and payable.  The Restated Notes are convertible, in whole or in part, at any time at the election of the Noteholders, into shares of our Series B Convertible Preferred Stock at the rate of $2.40 per share.  In the event we make any payments of principal or accrued interest on the Restated Notes on or before July 5, 2011, then simultaneously with the making of such payment a portion of the remaining principal and accrued and unpaid interest on the Restated Notes in an amount equal to the amount of such payment shall automatically convert into shares of our Series B Convertible Preferred Stock at the rate of $2.40 per share.

Although our financial condition has greatly improved, there can be no assurance that we will be able to obtain the funding necessary to continue our operations and development activities.  Given our achievements over the last year, we believe that we will be able to obtain additional equity or debt financing on reasonable terms.  
 
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. 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 consolidated 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.

 
 
14

 
 
Principles of consolidation and basis of presentation

The consolidated financial statements include the accounts of ThermoEnergy and our subsidiaries. All significant intercompany accounts and transactions have been eliminated in consolidation.

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period.  Actual results could differ from those estimates.

The 15% third party ownership interest in TEPS is recorded as a noncontrolling interest in the consolidated financial statements.  As of December 31, 2010, the noncontrolling interest in TEPS was immaterial to the consolidated financial statements taken as a whole.

Revenue recognition

Revenues from fixed-price contracts are recognized on the percentage of completion method, measured by the percentage of costs incurred to total estimated costs.  Contract costs include all direct material and labor costs and indirect costs related to contract performance, such as indirect labor, supplies, tools, repairs and depreciation.  Selling 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 are 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 years ended December 31, 2010 and 2009, we have recorded one industrial contract which represented approximately 35% and 80% of our revenues, respectively, utilizing the percentage-of-completion method based on a zero profit margin.

Billings in excess of costs and estimated earnings on uncompleted contracts, which amounted to $0 and $398,000 at December 31, 2010 and 2009, respectively, represent amounts billed in excess of revenues earned and are included in deferred revenue.

Cash and cash equivalents

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

Accounts receivable, net

Accounts receivable are recorded at their estimated net realizable value.  Receivables related to our contracts have realization and liquidation periods of less than one year and are therefore classified as current. The method for estimating our allowance for doubtful accounts is based on judgmental factors, including known and inherent risks in the underlying balances, adverse situations that may affect the customer’s ability to pay and current economic conditions.  Amounts considered uncollectible are written off based on the specific customer balance outstanding. The Company recorded bad debt expense of $0 and $9,000 for the years ended December 31, 2010 and 2009, respectively. The allowance for doubtful accounts totaled $9,000 at December 31, 2010 and 2009.

Inventories

Inventories are stated at the lower of cost or market using the first-in, first-out method and consist primarily of raw materials and supplies.
 
 
15

 
 
We evaluate our inventory for excess quantities 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.  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. The Company recorded provisions for inventory reserves of $9,000 and $74,000 for the years ended December 31, 2010 and 2009, respectively.  Inventory reserves totaled $83,000 and $74,000 at December 31, 2010 and 2009, 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 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 undiscounted cash flows or fair values of the asset, whichever is more readily determinable.

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 payroll tax and other accrued expenses 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 liability 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, “Compensation – Stock Compensation”.  These topics require that the cost of all share-based payments to employees, including grants of employee stock options, be recognized in the 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 “plain vanilla” 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 the 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.

We estimate contingent income tax liabilities based on the guidance for accounting for uncertain tax positions as prescribed in ASC Topic 740, "Income Taxes."  We use a two-step process to assess each income tax position.  We first determine whether it is more likely than not that the income tax position will be sustained, based on technical merits, upon examination by the taxing authorities.  If the income tax position is expected to meet the more likely than not criteria, we then record the benefit in the financial statements that equals the largest amount that is greater than 50% likely to be realized upon its ultimate settlement.  At December 31, 2010 and 2009, there are no uncertain tax positions that require accrual.

Series B Convertible Preferred Stock

We account for our Series B Convertible Preferred Stock by first allocating the proceeds based on the relative fair value of the Series B Convertible Preferred Stock and the warrants issued to the investors, and then to any beneficial conversion features contained in the Preferred Stock.  We determined the initial value of the Series B Convertible Preferred Stock and investor warrants using valuation models we consider to be appropriate.  Because the Series B Convertible Preferred Stock has an indefinite life, it is classified within the stockholders’ deficiency section of our consolidated balance sheets.  The value of the warrants and beneficial conversion features are considered a “deemed dividend” and are added as a component of net loss attributable to common stockholders on our consolidated statements of operations.
 
 
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Effect of New Accounting Pronouncements
 
In January 2010, the FASB issued Accounting Standards Update (“ASU”) No. 2010-06, "Fair Value Measurements and Disclosures (Topic 820): Improving Disclosures about Fair Value Measurements" (“ASU 2010-06”).  ASU 2010-06 amended certain provisions of ASC 820-10 by requiring additional disclosures for transfers in and out of Level 1 and Level 2 fair value measurements, as well as requiring fair value measurement disclosures for each class of assets and liabilities in addition to disclosures about the valuation techniques and inputs used to measure fair value for both recurring and nonrecurring fair value measurements that fall in either Level 2 or Level 3.  The adoption did not have a material impact on our financial statements or disclosures, as we did not have any financial instruments valued using Level 1 and Level 2 fair value measurements and did not have material classes of assets and liabilities that required additional disclosure.  Certain provisions of ASU 2010-06 are effective for the fiscal year beginning January 1, 2012.  These provisions will require us to present separately information on all purchases, sales, issuances, and settlements of financial instruments valued using significant unobservable inputs (Level 3) in the reconciliation for fair value measurements.  We do not believe the adoption of the provisions of ASU 2010-06 in our fiscal year beginning January 1, 2012 will have a material impact on our financial statements or disclosures.

In February 2010, the FASB issued ASU 2010-09, "Subsequent Events (Topic 855): Amendments to Certain Recognition and Disclosure Requirements" (“ASU 2010-09”).  ASU 2010-09 removes the requirement for a SEC registrant to disclose a date, in both issued and revised financial statements, through which that filer had evaluated subsequent events.  Consistent with past practice, we have evaluated subsequent events through the issuance date of our financial statements.  The adoption did not have a material impact on our financial statements.

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

Results of Operations
  
Comparison of Years Ended December 31, 2010 and December 31, 2009
 
Revenues for 2010 were $2,874,000 compared to $4,016,000 in 2009.  In 2009, we were in the middle stages of production on two large industrial contracts which comprised most of our revenues in 2009.  One of these contracts was substantially completed in the first quarter of 2010 while the other was substantially completed in the second quarter of 2010.  We started engineering and design work on our $27.1 million contract with NYCDEP in the third quarter of 2010.  This contract, along with other new contracts, are expected to significantly increase revenues in 2011.
 
Gross profit increased to $99,000 (3.4% of revenues) in 2010 compared to gross profit of $3,000 (0.1% of revenues) in 2009.  The 2010 increase is due to profit recognized on our New York City municipal contract and on two industrial contracts, offset by $226,000 of underutilized production costs due to excess capacity.  In 2009, our project profits were offset by $326,000 of underutilized production costs due to excess capacity.  In each year, we maintained excess capacity in anticipation of higher levels of business.
 
General and administrative expenses totaled $4,048,000 in 2010, an increase of $133,000 compared to 2009.  The increase is attributable to higher legal and professional expenses related to our financing transactions and an employee lawsuit.
 
Engineering, research and development expenses totaled $466,000 in 2010, a decrease  of $450,000 compared to 2009. Our engineering group was fully utilized performing design work related to our NYCDEP contract in the second half of 2010. As a result, $324,000 of engineering costs were charged to cost of revenues in 2010. Our engineering group did not perform any such work in 2009.  The remainder of the decrease is attributable mainly to reduced headcount in 2010 compared to 2009.

Selling expenses totaled $1,168,000 in 2010, an increase of $635,000 compared to 2009. The increase is due to increased sales headcount in 2010, as we focused on building our sales force to generate new business.

Stock option expense totaled $2,066,000 in 2010, an increase of $1,403,000 compared to 2009.  Stock option expenses in 2010 relate primarily to options granted to our new Chief Executive Officer and Chief Financial Officer in the fourth quarter of 2009 and the first quarter of 2010 and to certain key employees in the first quarter of 2010.  Stock option expenses in 2009 relate primarily to options granted to our executive team in the first quarter of 2009.
  
As a result of the IRS accepting our Offer in Compromise in March 2011, we have recorded a gain on payroll tax settlement of $2.3 million in 2010.  Because of our various financing transactions, including debt issuances and the restructuring of convertible debt into preferred stock in 2010 and 2009, we recognized losses on the extinguishment of debt of $614,000 and $3,285,000 in 2010 and 2009, respectively, which is primarily related to amortization of debt discounts for beneficial conversion features and warrants issued with the various debt issuances.  Expenses related to the issuance of warrants totaled $107,000 in 2010, a decrease of $1,818,000 compared to 2009.  Warrant expense in 2010 related to the issuance of warrants to our investment advisor in partial consideration for its services in connection with our private placement of shares of our Series B Convertible Preferred Stock in August 2010. Warrant expense in 2009 related primarily to the automatic repricing of certain warrants pursuant to the anti-dilution adjustment provisions of such warrants upon the consummation of our Series B Convertible Preferred Stock financing in September 2009.  In 2010, we recorded an expense of $293,000 related to the net change in fair value of our derivative instruments. We recorded income of $937,000 on these derivative instruments totaling $937,000 in 2009.  Interest expense in 2010 totaled $3,376,000 in 2010, an increase of $689,000 compared to 2009, due to higher amortization of debt discounts and higher interest rates paid on our convertible notes in default in 2010.
 

 
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Comparison of Years Ended December 31, 2009 and 2008
 
Revenues 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 revenues increased by $1,613,000 to $4,013,000 in 2009 compared to $2,400,000 in 2008.

General and administrative expenses and engineering, research and development expenses 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.

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.

ITEM 7A.  Quantitative and Qualitative Disclosures About Market Risk

Disclosures required under this item are not provided, as the Company has elected to follow the scaled disclosure requirements as a smaller reporting company.

ITEM 8.  Financial Statements and Supplementary Data

See the Company’s consolidated financial statements as of and for the years ended December 31, 2010 and 2009 beginning on page A-1.

ITEM 9.  Changes in and Disagreements With Accountants on Accounting and Financial Disclosure

On April 12, 2010, we engaged CCR LLP ("CCR") as our principal independent accountants to audit our financial statements, replacing Kemp & Company, a Professional Association ("Kemp"), who were dismissed as our principal independent accountants on the same day.  We are making this change primarily because we have relocated our financial operations from Little Rock, Arkansas to Worcester, Massachusetts. CCR is a regional firm with headquarters in Westborough, Massachusetts which can provide local support on a timely basis, while Kemp does not maintain offices outside of Little Rock, Arkansas.

The change was approved by the Audit Committee of our Board of Directors.

During our two most recent fiscal years and during the subsequent interim period, we did not consult with CCR regarding any matter, including without limitation (i) the application of accounting principles to a specified transaction, either completed or proposed, (ii) the type of audit opinion that might be rendered on our consolidated financial statements or (iii) any matter that was either the subject of a disagreement (as defined in Item 304, paragraph (a)(1)(iv) of Regulation S-K and the instructions related to such Item 304) with Kemp or a reportable event (as defined in paragraph (a)(1)(v) of such Item 304).

Kemp's reports on our financial statements for the fiscal years ended December 31, 2008 and 2009 did not contain any adverse opinion or disclaimer of opinion and were not qualified as to uncertainty, audit scope or accounting principles, except that Kemp’s reports on our financial statements for both fiscal years contained explanatory paragraphs describing conditions that raised substantial doubt about our ability to continue as a going concern.

During our two most recent fiscal years and during the subsequent interim period, there were no disagreements between us and Kemp on any matter 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, except that, with respect to the fiscal year ended December 31, 2008, the following disagreements arose:

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

(iii)        Failure to provide requested audit information:  Our prior Chief Financial Officer refused to provide critical audit documentation to Kemp.  Following termination of our prior Chief Financial Officer’s employment, our interim Chief Financial Officer and the Audit Committee of our Board of Directors 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.
 
We have authorized Kemp to respond fully to CCR concerning all of the foregoing disagreements.

In connection with its audits of our financial statements for the fiscal years ended December 31, 2009 and 2008, Kemp advised us of certain matters involving our internal controls over financial reporting that Kemp considered to be material weaknesses.  Our Audit Committee discussed such matters with Kemp and we have undertaken efforts to correct the deficiencies in internal controls identified by Kemp.  We have authorized Kemp to respond fully to CCR concerning such matters.

We have requested Kemp to provide us with a letter addressed to the Commission stating whether it agrees or disagrees with the statements contained herein and that letter is filed as Exhibit 16 hereto.
  
ITEM 9A.  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 is a process designed by, or under the supervision of, our principal executive and principal financial officers, and effected by Management and other personnel, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles and includes those policies and procedures that (i) pertain to the maintenance of records that in reasonable detail accurately and fairly reflect the transactions and dispositions of our assets, (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the Company are being made only in accordance with authorizations of our Management and Directors, and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of our assets that could have a material effect on the financial statements.  Our internal control over financial reporting is 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.

 
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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.

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 registered public accountants the scope and results of the audit effort.  The Audit Committee also meets periodically with the independent registered public accountants without management present to ensure that the independent registered public accountants have free access to the Audit Committee.
 
Our Chief Executive Officer and our Chief Financial Officer have assessed the effectiveness of our internal control over financial reporting as of December 31, 2010.  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 this assessment, Management believes that the Company did not maintain effective internal control over financial reporting as of December 31, 2010.  Specifically, Management has determined that our internal controls as of December 31, 2010 were deficient in that (i) we had not adequately allocated resources to ensure that necessary internal controls were implemented and followed and (ii) there was a lack of segregation of duties in our significant accounting functions.  The material weakness relating to our failure to allocate adequate resources to the implementation of internal controls was discovered and brought to the attention of our Audit Committee by Kemp & Company (“Kemp”), at the time our independent registered public accountants, during their audit for the year ended December 31, 2007.  The deficiency relating to the lack of segregation of duties in accounting functions was brought to our attention by Kemp during their audit for the year ended December 31, 2008.
  
Management has discussed its conclusions regarding the inadequacy of internal controls with the Audit Committee and with our independent registered public accounting firm and expects to hire additional qualified personnel in the financial and accounting area in order to remediate these material weaknesses by December 31, 2012.
 
In the Report on Internal Control over Financial Reporting included in our Annual Report on Form 10-K for the year ended December 31, 2009, Management determined that we did not maintain effective internal control over financial reporting as of December 31, 2009, citing five specific areas where internal controls were found to be deficient.  We developed and implemented policies and procedures in 2010 to cure these deficiencies.

This annual report does not include an attestation report of the Company’s independent registered public accounting firm regarding internal control over financial reporting, as permitted by the rules of the Securities and Exchange Commission.

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
    
Our Chief Executive Officer and our Chief Financial Officer carried out an evaluation of the effectiveness of disclosure controls and procedures as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended, as of December 31, 2010.  Based on this evaluation, our Management has concluded that the Company’s disclosure controls and procedures were effective as of December 31, 2010.
 
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.
 
ITEM 9B. Other Information
 
Special Meeting in lieu of 2010 Annual Meeting

We held a Special Meeting in lieu of our 2010 Annual Meeting of Stockholders on November 18, 2010.  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 of Directors:
 
Director
 
For
 
Withheld
Cary G. Bullock
 
35,201,649
 
230,277
Dennis C. Cossey
 
34,528,972
 
902,954
Arthur S. Reynolds
  
35,122,196
  
309,730

 
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2.
To amend the Company’s 2008 Incentive Stock Plan:

For
 
Against
66,121,028
 
467,789

3,
To ratify the appointment of CCR LLP as independent registered public accountants for the Company for 2010:

For
 
Against
82,997,976
 
234,239

Unregistered Sales of Equity Securities

On October 20, 2010, we issued to certain holders (the “2009 Noteholders”) of our Convertible Promissory Notes dated January 5, 2009 (the “2009 Notes”) an aggregate of 1,802,445 shares of our Common Stock upon conversion of the 2009 Notes in accordance with their terms.  The total outstanding principal amount of, and the accrued and unpaid interest on, the converted 2009 Notes was $432,587.  The conversion was effected at the rate of $0.24 per share.  Set forth below are the names of the 2009 Noteholders and the number of shares of our Common Stock issued to each upon conversion of the 2009 Notes:
 
Noteholder
 
Number of Shares
     
Estate of Homer G. Perkins
 
860,430 shares
     
Roderick L. Oxford
 
55,689 shares
     
Northern Water Resources, Inc.
 
397,915 shares
     
Peter Laird
 
56,994 shares
     
Equity Securities Partners, LLC
 
89,878 shares
     
Posternak Blankstein & Lund LLP
  
341,539 shares

The 2009 Notes had been issued in partial consideration for the sale to us by the 2009 Noteholders of shares of the Common Stock and Preferred Stock of CASTion Corporation, an entity which we now operate as a majority-owned subsidiary (“CASTion”).  Upon his or its acquisition of a 2009 Note, each 2009 Noteholder represented to us that he or it was an “accredited investor” (as such term is defined in Rule 501 of Regulation D promulgated under the Securities Act of 1933) and that he or it was acquiring the such 2009 Note for his or its own account, for investment purposes, and without a view toward distribution or resale of such securities.  The 2009 Notes and the shares of our Common Stock issued upon conversion of the 2009 Notes were issued to the 2009 Noteholders in transactions not involving a public offering and without registration under the Securities Act of 1933 in reliance on the exemption from registration provided by Section 4(2) of such Act.

Also on October 20, 2010, we issued to each of (i) Massachusetts Technology Development Corporation (“MTDC”), (ii) BCLF Ventures I, LLC (“BCLF”) and (iii) Donald F. Farley (“Farley”) shares of our Series B Convertible Preferred Stock (the “Preferred Shares”) and Common Stock Purchase Warrants (the “Warrants”) as follows:

Shareholder
 
Number of Shares
 
Number of Warrant Shares
         
Massachusetts Technology Development Corporation
 
18,518 shares
 
296,293 shares
         
BCLF Ventures I, LLC
 
18,518 shares
 
296,293 shares
         
Donald F. Farley
 
18,518 shares
 
296,293 shares
 
The issuance of the Preferred Shares and Warrants to MTDC, BCLF and Farley was made pursuant to a Settlement Agreement and Mutual Release between us and certain former shareholders and directors of CASTion (the “Settling Defendants”) who were defendants in litigation initiated by the 2009 Noteholders.  The 2009 Noteholders had alleged, among other things, that the Settling Defendants had breached their fiduciary duty to the 2009 Noteholders in connection with the sale to us by certain of the Settling Defendants of a majority of the outstanding shares of CASTion in 2007 and the Settling Defendants had threatened to assert third party claims against us in connection therewith.
 
 
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Each Preferred Share is convertible, at any time at the option of the holder thereof, into ten shares of our Common Stock.  The Warrants entitle the holders thereof to purchase shares of our Common Stock, at a purchase price of $0.30 per share.  The Warrants have a term of 5 years, subject to our right to accelerate the expiration date under certain circumstances.  The Warrants contain other conventional terms, including provisions for cashless exercise and for adjustment in the Exercise Price and/or the securities issuable upon exercise in the event of certain specified extraordinary corporate events, such as stock splits, combinations, and stock dividends.

The Preferred Shares and Warrants were issued to MTDC, BCLF and Farley without cash payment, in partial consideration for the release of claims against us by the Settling Defendants.  In the Settlement Agreement and Mutual Release, each of MTDC, BCLF and Farley represented to us that he or it was an “accredited investor” (as such term is defined in Rule 501 of Regulation D promulgated under the Securities Act of 1933) and that he or it was acquiring the Preferred Shares and the Warrants for his or its own account, for investment purposes, and without a view toward distribution or resale of such securities.  The Preferred Shares and the Warrants were issued to MTDC, BCLF and Farley in transactions not involving a public offering and without registration under the Securities Act of 1933 in reliance on the exemption from registration provided by Section 4(2) of such Act.

On December 1, 2010, we issued 200,000 shares of our Common Stock to Alliance Advisors LLC (“Alliance”) without cash payment in partial consideration for investor relations and other consulting services performed by Alliance pursuant to an Investor Relations Consulting Agreement dated as of August 1, 2010 between us and Alliance.  The shares of our Common Stock issued to Alliance are, pursuant to the Investor Relations Consulting Agreement, subject to forfeiture in the event Alliance fails to perform certain services on or before July 31, 2011.  In the Investor Relations Consulting Agreement, Alliance represented to us that it was an “accredited investor” (as such term is defined in Rule 501 of Regulation D promulgated under the Securities Act of 1933) and that it was acquiring the shares of our Common Stock for its own account, for investment purposes, and without a view toward distribution or resale of such securities.  The shares of our Common Stock were issued to Alliance in a transaction not involving a public offering and without registration under the Securities Act of 1933 in reliance on the exemption from registration provided by Section 4(2) of such Act.

On each of January 31, 2011 and February 28, 2011, we issued to the holders of our Amended and Restated Promissory Notes due February 29, 2012 (the “Restated Notes”), upon the automatic conversion, in accordance with the terms of the Restated Notes, of portions of the principal of, and accrued and unpaid interest under, such Restated Notes, the following Preferred Shares and Warrants:

 
Note Holder
 
Payment
   
Conversion
Amount
 
 
Series B Shares 
 
 
Warrants
                   
Spencer Trask Specialty Group LLC
  $ 26,853.93     $ 26,853.60  
11,189 shares
 
179,024 shares
                       
Massachusetts Technology Development Corporation
  $ 11,560.44     $ 11,558.40  
4,816 shares
 
77,056 shares
                       
BCLF Ventures I, LLC
  $ 6,303.45     $ 6,302.40  
2,626 shares
 
42,016 shares
                       
Essex Regional Retirement Board
  $ 190.57     $ 189.60  
79 shares
 
1,264 shares
                       
BancBoston Ventures Inc.
  $ 381.12     $ 379.20  
158 shares
 
2,528 shares

The automatic conversions were triggered by our making scheduled payments under the Restated Notes.  The Restated Notes provide for such automatic conversions in connection with all payments that we make on or before July 5, 2011.

In the Note Amendment and Forbearance Agreements (each, a “Forbearance Agreement”) pursuant to which the Restated Notes were issued, each noteholder represented to us that it is an “accredited investor” (as such term is defined in Rule 501 of Regulation D promulgated under the Securities Act of 1933) and that it would acquire the Preferred Shares and the Warrants for its own account, for investment purposes, and without a view toward distribution or resale of such securities.  The Preferred Shares and the Warrants were issued to the holders of the Restated Notes in a transaction not involving a public offering and without registration under the Securities Act of 1933 in reliance on the exemption from registration provided by Section 4(2) of such Act.
 
 
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On March 14, 2011, we issued to Spencer Trask Specialty Group, LLC (“Spencer Trask”) 1,000,000 shares of our Common Stock upon the conversion of 100,000 Preferred Shares which had been issued to Spencer Trask on January 4, 2011, pursuant to the Forbearance Agreement between us and Spencer Trask, upon conversion of a portion of the principal of, and accrued and unpaid interest on, our Convertible Promissory Note due May 31, 2010.  In such Forbearance Agreement, Spencer Trask represented to us that it is an “accredited investor” (as such term is defined in Rule 501 of Regulation D promulgated under the Securities Act of 1933) that it was acquiring the Preferred Shares, and would acquire the shares of our Common Stock issuable upon conversion of the Preferred Shares, for its own account, for investment purposes, and without a view toward distribution or resale of such securities.  The shares of our Common Stock issued upon conversion of the Preferred Shares were issued to Spencer Trask in a transaction not involving a public offering and without registration under the Securities Act of 1933 in reliance on the exemption from registration provided by Section 4(2) of such Act.
 
 
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PART III

ITEM 10.  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

Dennis C. Cossey, age 65, 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 65, 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 President and 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.
 
 
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David Anthony, age 50, 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 52, 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 50, 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.
 
 
24

 

Arthur S. Reynolds, age 67, 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.  From July 30 to November 30, 2011, Mr. Reynolds was the Chief Executive Officer of Clean Power Technologies.  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 42, 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.

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.
 
 
25

 

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 the following members of the Compensation and Benefits Committee are independent: Mr. Anthony and Mr. Winder Hughes.

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 all of the members of the Audit Committee are “independent directors” and “audit committee financial experts” (as defined in Item 407(d)(5)(ii) of Regulation S-K).

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.
 
 
26

 

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.
 
On April 12, 2010, the Audit Committee engaged CCR LLP ("CCR") as the Company’s principal independent accountants to audit the Company’s financial statements, replacing Kemp & Company, a Professional Association ("Kemp"), who were dismissed as the Company’s principal independent accountants on the same day.  We made this change primarily because the Company relocated its financial operations from Little Rock, Arkansas to Worcester, Massachusetts. CCR is a regional firm with headquarters in Westborough, Massachusetts which can provide local support on a timely basis, while Kemp does not maintain offices outside of Little Rock, Arkansas.
 
During our two most recent fiscal years and during the subsequent interim period, neither management nor the Audit Committee consulted with CCR regarding any matter, including without limitation (i) the application of accounting principles to a specified transaction, either completed or proposed, (ii) the type of audit opinion that might be rendered on the Company’s consolidated financial statements or (iii) any matter that was either the subject of a disagreement (as defined in Item 304, paragraph (a)(1)(iv) of Regulation S-K and the instructions related to such Item 304) with Kemp or a reportable event (as defined in paragraph (a)(1)(v) of such Item 304).
 
Kemp's reports on the Company’s financial statements for the fiscal years ended December 31, 2008 and 2009 did not contain any adverse opinion or disclaimer of opinion and were not qualified as to uncertainty, audit scope or accounting principles, except that Kemp’s reports for both fiscal years contained explanatory paragraphs describing conditions that raised substantial doubt about the Company’s ability to continue as a going concern.  During the fiscal years ended December 31, 2008 and 2009, there were no disagreements between management and Kemp on any matter 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, except as reported by the Company in its Current Report on Form 8-K filed with the Securities and Exchange Commission on April 15, 2010.
 
In connection with its audits of the Company’s financial statements for the fiscal years ended December 31, 2008 and 2009, Kemp advised the Audit Committee of certain matters involving internal controls over financial reporting that Kemp considered to be material weaknesses.  We discussed such matters with Kemp and management has undertaken efforts to correct the deficiencies in internal controls identified by Kemp.  We have authorized Kemp to respond fully to CCR concerning such matters.
 
With respect to the fiscal year ended December 31, 2010, the Audit Committee met frequently and held extensive discussions with management and with representatives of CCR. 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.
 
 
27

 

In addition, the Audit Committee discussed with representatives of CCR that firm’s independence from the Company and its management, and also considered whether the non-audit services performed during fiscal year 2010 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. At the end of each fiscal quarter, the Committee met with the independent public accountants, 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, 2010, for filing with the Securities and Exchange Commission.
 
March 24, 2011
 
 
Audit Committee
 
Arthur S. Reynolds, Chairman
 
David Anthony
 
J. Winder Hughes III

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

The Company’s Code of Business Conduct and Ethics, including provisions that apply to our Chief Executive Officer and our Chief Financial Officer, is posted on our corporate website at http://ir.stockpr.com/thermoenergy.

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.  All of the directors attended the Special Meeting in lieu of our 2010 Annual Meeting of Shareholders. During the fiscal year ended December 31, 2010, the Board of Directors held 31 meetings and every director attended at least 75% of those meetings. During 2010, the Audit Committee held six meetings, the Compensation and Benefits Committee held two meetings, and the Nominating Committee held one meeting.  All members of the Committees attended at least 75% of the meetings of their respective Committees.
 
 
28

 

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, 2010 all of our  executive officers and directors made all required Section 16(a) filings on a timely basis.

ITEM 11.  Executive Compensation

Summary Compensation Table

The table set forth below summarizes the compensation earned by our named executive officers in 2010 and 2009.

Executive Compensation (1)
 
Name and Principal Position
 
Year
 
Salary
($)
    Bonus    
Option
Awards
($)(2)
   
All Other
Compensation
($)(3)
   
Total
($)
 
                                     
Dennis C. Cossey
 
2010
  $ 154,839      75,000     $ 304,190     $ 34,276     $ 568,305  
Chairman and CEO (4)
 
2009
  $ 228,750      0     $ 0     $ 41,944     $ 270,694  
                                             
Cary G. Bullock
 
2010
  $ 207,285      0     $ 1,731,170     $ 57,008     $ 1,995,463  
President and CEO (5)
 
2009
  $ 0      0     $ 0     $ 0     $ 0  
                                             
Teodor Klowan, Jr.
 
2010
  $ 177,883      0     $ 335,168     $ 0     $ 513,051  
Executive Vice President and CFO (6)
 
2009
  $ 21,314      0     $ 662,146     $ 0     $ 683,460  
                                             
Alexander G. Fassbender
                                           
Executive Vice President and
 
2010
  $ 31,923      0     $ 0     $ 7,455     $ 37,378  
Chief Technology Officer (7)
 
2009
  $ 232,500      0     $ 0     $ 23,184     $ 255,684  
                                             
Shawn R. Hughes
 
2010
  $ 34,231      50,000     $ 0     $ 242,948     $ 327,179  
President and Chief Operating Officer (8)
 
2009
  $ 229,167      0     $ 143,000     $ 39,833     $ 412,000  
                                             
Arthur S. Reynolds
 
2010
  $ 0      53,000     $ 0     $ 65,000     $ 118,000  
Interim CFO  (9)
 
2009
  $ 60,000      30,000     $ 0     $ 153,856     $ 243,856  
                                             
Andrew T. Melton
 
2010
  $ 0      0     $ 0     $ 0     $ 0  
Executive Vice President and CFO (10)
 
2009
  $ 79,166      0     $ 0     $ 31,933     $ 111,099  

 
(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 2010 or 2009.
 
 
(2)
Amounts in the column “Option Awards” reflect the grant date fair value of stock options awarded in accordance with FASB ASC Topic 718. The fair value of options granted during 2010 and 2009 were estimated at the date of grant using a Black-Scholes option pricing model with the following assumptions:
 
   
2010
   
2009
 
             
Risk-free interest rate
   
2.5% - 3.8%
     
3.0% - 3.9%
 
Expected option life (years)
   
10.0
     
10.0
 
Expected volatility
   
80% - 97%
     
77% - 80%
 
Expected dividend rate
   
0%
     
0%
 
 
 
(3)
Amounts in the column “All Other Compensation” are comprised of the following:
 
Name and Principal Position
 
Year
 
 Severance
($)
   
 Warrant Awards
($)
   
Car
Allowances
($)
   
Medical and
Insurance
Reimbursement
($)
   
Total
($)
 
                                       
Dennis C. Cossey
 
2010
   0      0     $ 0     $ 34,276     $ 34,276  
Chairman and CEO
 
2009
   0      0     $ 18,000     $ 23,944     $ 41,944  
                                             
Cary G. Bullock
 
2010
   0      0     $ 0     $ 57,008     $ 57,008  
President and CEO
 
2009
   0      0     $ 0     $ 0     $ 0  
                                             
Teodor Klowan, Jr.
 
2010
   0      0     $ 0     $ 0     $ 0  
Executive Vice President and CFO
 
2009
   0      0     $ 0     $ 0     $ 0  
                                             
Alexander G. Fassbender
                                           
Executive Vice President and
 
2010
   0      0     $ 0     $ 7,455     $ 7,455  
Chief Technology Officer
 
2009
   0      0     $ 6,750     $ 16,434     $ 23,184  
                                             
Shawn R. Hughes
 
2010
  208,340      0     $ 0     $ 34,608     $ 242,948  
President and Chief Operating Officer
 
2009
   0      0     $ 9,000     $ 30,833     $ 39,833  
                                             
Arthur S. Reynolds
 
2010
  65,000      0     $ 0     $ 0     $ 65,000  
Interim CFO
 
2009
  15,000     138,856     $ 0     $ 0     $ 153,856  
                                             
Andrew T. Melton
 
2010
   0      0     $ 0     $ 0     $ 0  
Executive Vice President and CFO
 
2009
   0      0     $ 8,000     $ 23,933     $ 31,933  
 
  
(4)
Mr. Cossey served as Chairman and CEO until Mr. Cary Bullock was hired on January 27, 2010.  After that date, Mr. Cossey served only as Chairman. Mr. Cossey resigned as a director and his employment terminated on July 26, 2011.
 
 
(5)
Mr. Bullock was hired on January 27, 2010.
 
 
(6)
Mr. Klowan was hired on November 2, 2009 as Executive Vice President and assumed the role of Chief Financial Officer on November 16, 2009.
 
 
(7)
Mr. Fassbender’s employment as Executive Vice President and Chief Technology Officer terminated on March 3, 2010.

 
29

 
 
  
(8)
Mr. Hughes’s employment as President and Chief Operating Officer terminated upon the hiring of Mr. Bullock on January 27, 2010. Pursuant to Mr. Hughes’s Executive Employment Agreement, he received severance payments for 12 months following termination of his employment.

  
(9)
Mr. Reynolds served as interim CFO from August 3, 2009 until November 16, 2009 pursuant to a consulting agreement between the Company and Rexon Limited, a firm controlled by Mr. Reynolds.  Payments to Rexon Limited for the services of Mr. Reynolds are reported as salary, and payment of a success fee of $30,000 for the successful consummation of our Series B Convertible Preferred Stock financing is reported as a bonus. Termination payments made after the completion of Mr. Reynolds service are reported as severance.
 
Warrant awards included in “All Other Compensation” reflect the grant date fair value of warrants awarded to Mr. Reynolds in accordance with FASB ASC Topic 718. The fair value of warrants granted in 2009 were estimated at the date of grant using a Black-Scholes pricing model with the assumptions detailed in Note 2, above.
 
 
(10)
Mr. Melton’s employment as Executive Vice President and Chief Financial Officer terminated on August 3, 2009
 
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, 2010 to our directors who were not also named executive officers at the time they received compensation as directors:

Director Compensation(1)

   
Fees Earned or
 
Option Awards
       
Name
 
Paid in Cash
 
($)(2)
   
Total ($)
 
David Anthony
 
None
  $ 9,295 (3)   $ 9,295  
Shawn R. Hughes
 
None
  $ 9,295 (3)   $ 9,295  
J. Winder Hughes III
 
None
  $ 9,295 (3)   $ 9,295  
Arthur S. Reynolds
 
None
  $ 9,295 (3)   $ 9,295  

 
(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 directors required to be reported in such columns during 2010.
 
(2)
The amounts in the column “Options Award” reflect the dollar amount recognized for financial statement reporting purposes in accordance with ASC 710.  Assumptions used in the calculation of these amounts are included in Note 9 to the Company’s consolidated financial statements for the fiscal year ended December 31, 2010.  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 $0.35 per share was granted to each of Messrs. Anthony, Shawn Hughes, J. Winder Hughes III and Reynolds on November 18, 2010; these options vest on the date of our 2011 Annual Meeting of Stockholders and expire on November 18, 2020.

Outstanding Equity Awards at December 31, 2010

The following table summarizes information concerning outstanding equity awards held by the named executive officers at December 31, 2010.  No named executive officer exercised options in the fiscal year ended December 31, 2010.
 
 
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Stock Option Awards
   
Securities
   
Securities
         
   
Underlying
   
Underlying
         
   
Unexercised
   
Unexercised
   
Option
 
Option
   
Options (#)
   
Options (#)
   
Exercise
 
Expiration
Name
 
Exercisable
   
Unexercisable
   
Price ($)
 
Date
                     
Dennis C. Cossey
    150,000    
none
    $ 0.94  
01/20/2011
      350,000    
none
    $ 1.11  
01/02/2011
      797,500    
none
    $ 1.75  
06/30/2018
      250,000    
none
    $ 1.50  
02/27/2019
   
none
      1,000,000     $ 0.30  
03/01/2020
                           
Cary G. Bullock
    2,039,851       6,119,550     $ 0.30  
01/27/2020
                           
Teodor Klowan, Jr.
    781,250       1,718,750     $ 0.32  
11/02/2019
      493,660       1,086,081     $ 0.30  
01/27/2020
                           
Alexander G. Fassbender
    150,000    
none
    $ 0.94  
01/20/2011
      350,000    
none
    $ 1.11  
01/02/2011
      412,500    
none
    $ 1.75  
06/30/2018
      250,000    
none
    $ 1.50  
02/27/2019
                           
Shawn R. Hughes
    250,000    
none
    $ 1.50  
02/27/2019
      600,000    
none
    $ 0.24  
09/16/2019
   
none
      30,000     $ 0.35  
11/18/2020
                           
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
      30,000    
none
    $ 0.39  
12/15/2019
   
none
      30,000     $ 0.35  
11/18/2020
                           
Andrew T. Melton
    150,000    
none
    $ 0.94  
01/20/2011
      350,000    
none
    $ 1.11  
01/02/2011
 
 
31

 

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, 2010.

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.

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.
 
 
32

 

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. In April 2010 following the termination of his employment, Mr. Fassbender filed a Complaint in the Fairfax County, Virginia Circuit Court alleging that his employment had been terminated in breach of his employment agreement and claiming damages in the aggregate amount of approximately $1 million, including unpaid salary, reimbursement of expenses, and other payments under his employment agreement.  We have reached a settlement with Mr. Fassbender and the parties have jointly filed a motion to dismiss the complaint.

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 made 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.
 
 
33

 

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.

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.
 
 
34

 

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.

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 Stock Plan to increase the number of shares of our common stock available for grant under such Plan from 10,000,000 to 20,000,000 and to remove the limit on the number of shares with respect to which stock options may be granted to any individual.  At the Special Meeting in lieu of the 2010 Annual Meeting in November 2010, the shareholders ratified the amendments to the 2008 Incentive Stock Plan.

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.
 
 
35

 

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.
 
 
36

 

ITEM 12.  Security Ownership by Certain Beneficial Owners and Management and Related Stockholder Matters

The following table sets forth certain information as of April 26, 2011 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
    30,000 (3)     *  
                 
Cary G. Bullock
               
10 New Bond Street
               
Worcester, Massachusetts  01606
    2,549,813 (3)     4.3 %
                 
Dennis C. Cossey
               
124 West Capitol Avenue, Suite 880
               
Little Rock, Arkansas 72201
    2,753,550 (4)     4.6 %
                 
J. Winder Hughes III
               
PO Box 389
               
Ponte Vedra, Florida  32004
    11,434,556 (5)     16.8 %
                 
Shawn R. Hughes
               
717 South Edison Avenue
               
Tampa, Florida 33606
    952,500 (6)     1.7 %
                 
Teodor Klowan, Jr.
               
10 New Bond Street
               
Worcester, Massachusetts  01606
    1,529,891 (3)     2.6 %
                 
Arthur S. Reynolds
               
230 Park Avenue, Suite 1000
               
New York, New York 10169
    751,103 (7)     1.3 %
                 
All executive officers and directors as a group
(7 persons)
    20,001,413 (8)     27.8 %
                 
Other 5%  Beneficial Owners
               
                 
David Gelbaum and Monica Chavez Gelbaum
               
Quercus Trust
               
1835 Newport Blvd.
               
A109-PMC 467
               
Costa Mesa, California  92627
    53,780,887 (9)     48.7 %
                 
Security Investors, LLC
               
One Security Benefit Place
               
Topeka, Kansas 66636
    57,774,484 (10)     50.5 %
 
 
37

 

Robert S. Trump
           
89 10th Street
           
Garden City, New York 11530
    30,835,963 (11)     35.2 %
                 
Elise C. Roenigk
PO Box 230
Eureka Springs, Arkansas 72632
    5,773,112 (12)     9.2 %
                 
The Focus Fund
               
PO Box 389
               
Ponte Vedra, Florida  32004
    11,404,556 (13)     16.8 %
                 
Empire Capital Management and Affiliates
               
One Gorham Island, Suite 201
               
Westport, Connecticut 06880
    24,216,837 (14)     30.7 %
                 
Kevin B. Kimberlin
c/o Spencer Trask
               
535 Madison Avenue
               
New York, NY  10022
    25,134,954 (15)     30.7 %
                 
*   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, April 26, 2011 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 56,681,918 shares of Common Stock issued and outstanding on April 26, 2011 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, April 26, 2011.
(3)
All shares are issuable upon exercise of options.
(4)
Includes 1,360,000 shares issuable upon exercise of options.
(5)
Includes 3,357,500 shares owned by The Focus Fund and 8,047,056 shares issuable to The Focus Fund upon the exercise of warrants, conversion of shares of Series B Convertible Preferred Stock, or conversion of convertible debt.  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. 8 to the Statement on Schedule 13D filed by The Quercus Trust and Mr. and Mrs. Gelbaum as its trustees on August 13, 2010.  Includes 19,586,210 shares issuable upon conversion of shares of Series B Convertible Preferred Stock, 22,720,000 shares issuable upon the exercise of warrants, 4,083,333 shares issuable upon conversion of convertible debt and 30,000 shares upon exercise of options.
(10)
This beneficial ownership information is based on information contained in Amendment No. 3 to the Statement on  Schedule 13G filed by Security Investors, LLC on September 10, 2010.
(11)
Includes 9,366,670 shares issuable upon conversion of shares of Series B Convertible Preferred Stock, 11,711,104 shares issuable upon the exercise of warrants and 3,934,733 shares issuable upon conversion of convertible debt.
(12)
Includes 30,000 shares issuable the exercise of options, 1,500,000 shares issuable upon the exercise of warrants, and 3,573,523 shares issuable upon conversion of convertible debt.
 
 
38

 

(13)
Includes 2,977,490 shares issuable upon conversion of shares of Series B Convertible Preferred Stock, 4,958,333 shares issuable upon the exercise of warrants and 111,233 shares issuable upon conversion of convertible debt.
(14)
This beneficial ownership information is based on information contained in the Statement on Schedule 13D filed by the group consisting of Empire Capital Management LLC and its affiliates on February 15, 2011.  Includes 9,698,978 shares issuable upon conversion of  outstanding shares of Series B Convertible Preferred Stock and 11,514,288 shares of Common Stock  issuable upon the exercise of warrants.
(15)
Includes 1,604,180 shares issuable upon conversion of shares of Series B Convertible Preferred Stock, 14,364,908 shares issuable upon the exercise of warrants and 8,149,866 shares issuable upon conversion of convertible debt.

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, 2010:

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
    9,337,132     $ 0.68       10,862,868  
                         
Equity Compensation plans not approved by security holders
                       
                         
Stock options
    12,470,770     $ 0.47       0  
                         
Total
    21,807,902     $ 0.56       10,862,868  

ITEM 13.  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.
 
 
39

 

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 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.

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, three of our current Directors, Mr. Anthony, Mr. Winder Hughes and Mr. Reynolds, are “independent directors.”

ITEM 14.  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 registered public accountants. The Audit Committee has the sole authority to make these approvals.
 
 
40

 

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.

Non-Audit Services.  The Audit Committee's policy is to pre-approve all permissible non-audit services provided by the independent registered public accountants.  These services may include audit-related services, tax services and other services.  The independent registered public accountants and management are required to periodically report to the Audit Committee regarding the extent of services provided by the independent registered 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 CCR LLP and Kemp & Company Professional Association, our independent registered public accountants for fiscal years 2010 and 2009, respectively, were comprised of the following:

Audit Fees. Fees related to the 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 2010 and 2009 were $127,643 and $106,000, respectively.

Audit Related Fees. No fees were billed to us for audit related services in 2010 or 2009.

Tax Fees. Fees for tax services provided to us, including tax compliance, tax advice and planning, totaled $4,000 in each of 2010 and 2009.

All Other Fees. No other fees were billed to us in 2010 or 2009 for “other services.”

In accordance with the Audit Committee’s pre-approval policy, all audit services performed by CCR LLP and Kemp & Company during 2010 and 2009 were approved at the time such firm was engaged to serve as our independent registered 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 2010 and 2009 by Kemp & Company.
 
 
41

 
 
PART IV

ITEM 15.  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 8.
 
(2)
Financial statement schedules are not included, as the Company has provided the information, as required by Article 8 of Regulation S-X, in its consolidated financial statements as of and for the years ended December 31, 2010 and 2009.
 
(3)
Exhibits numbered in accordance with Item 601 of Regulation S-K and filed herewith.  See Index to Exhibits on Page B-1.

 
42

 

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.    
September 26, 2011
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.

/s/ Cary G. Bullock  
President and Chief Executive Officer
 
September 26, 2011
Cary G. Bullock
 
(Principal Executive Officer)
   
         
/s/ Teodor Klowan, Jr.  
Executive Vice President and Chief Financial Officer
 
September 26, 2011
Teodor Klowan, Jr.  CPA
 
(Principal Financial and Accounting Officer)
   
         
*  
Director
 
September 26, 2011
David Anthony
       
         
*  
Director
 
September 26, 2011
J. Winder Hughes III
       
         
*  
Director
 
September 26, 2011
Shawn R. Hughes
       
         
*  
Director
 
September 26, 2011
Arthur S. Reynolds
       
         
*   By:    /s/ Cary G. Bullock         
   Attorney-in-Fact        

 
43

 
 
THERMOENERGY CORPORATION

CONSOLIDATED FINANCIAL STATEMENTS

As of and For the Years ended December 31, 2010 and 2009

With

Reports of Independent Registered Public Accounting Firms
 
 
A-1

 

Report of Independent Registered Public Accounting Firm

To the Stockholders and Board of Directors of
     ThermoEnergy Corporation

We have audited the accompanying consolidated balance sheet of ThermoEnergy Corporation and subsidiaries (the Company) as of December 31, 2010 and the related consolidated statement of operations, stockholders’ deficiency and cash flows for the year then ended.  These consolidated financial statements are the responsibility of the Company’s management.  Our responsibility is to express an opinion on these consolidated financial statements based on our audit.

We conducted our audit 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 consolidated financial statements are free of material misstatement.  The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting.  Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting.  Accordingly, we express no such opinion.  An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation.  We believe that our audit provides a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of ThermoEnergy Corporation and subsidiaries as of December 31, 2010, and the results of their operations and their cash flows for the year then ended in conformity with accounting principles generally accepted in the United States of America.

The accompanying financial statements have been prepared assuming that ThermoEnergy Corporation and subsidiaries will continue as a going concern.  As reflected in the consolidated financial statements, the Company has an accumulated deficit at December 31, 2010 and has suffered significant net losses and negative cash flows from operations, which raise substantial doubt about the Company’s ability to continue as a going concern.  Management’s plans with regard to these matters are disclosed in Note 2 to the consolidated financial statements.  The consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty.
 
/s/ CCR LLP

Westborough, Massachusetts
March 30, 2011
 
 
A-2

 
 
Report of Independent Registered Public Accounting Firm

Board of Directors
ThermoEnergy Corporation

We have audited the accompanying consolidated balance sheet of ThermoEnergy Corporation and subsidiaries as of December 31, 2009, and the related consolidated statements of operations, stockholders’ deficiency and cash flows for the year 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 audit.

We conducted our audit 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 audit provides 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 the consolidated results of their operations and their cash flows for the year 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 2 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.  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 2 to the consolidated financial statements.  The consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty.
 
/s/ Kemp & Company, a Professional Association

Little Rock, Arkansas
March 30, 2010
 
 
A-3

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

   
December 31,
2010
   
December 31,
2009
 
ASSETS
           
Current Assets:
           
Cash
 
$
4,299
   
$
1,109
 
Accounts receivable, net
   
1,043
     
7
 
Inventories, net
   
65
     
74
 
Other current assets
   
289
     
205
 
Total Current Assets
   
5,696
     
1,395
 
                 
Property and equipment, net
   
560
     
241
 
Other assets
   
61
     
74
 
                 
Total Assets
 
$
6,317
   
$
1,710
 
                 
LIABILITIES AND STOCKHOLDERS' DEFICIENCY
               
Current Liabilities:
               
Accounts payable
 
$
722
   
$
812
 
Convertible debt in default
   
     
4,133
 
Accrued payroll taxes
   
1,470
     
4,972
 
Deferred revenue
   
1,880
     
398
 
Other current liabilities
   
1,995
     
1,708
 
Total Current Liabilities
   
6,067
     
12,023
 
                 
Long Term Liabilities:
               
Deferred compensation retirement plan for officers, net of current portion
   
180
     
229
 
Derivative liability
   
2,852
     
2,559
 
Convertible debt
   
8,892
     
1,370
 
Total Long Term Liabilities
   
11,924
     
4,158
 
                 
Total Liabilities
   
17,991
     
16,181
 
                 
Stockholders' Deficiency:
               
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 2010 and 2009
   
2
     
2
 
Class B Preferred Stock, liquidation preference of $2.40 per share: designated: 6,454,621 shares in 2010 and 4,371,287 shares in 2009; issued and outstanding: 5,968,510 shares in 2010 and 3,037,954 shares in 2009
   
60
     
30
 
Common Stock, $.001 par value:  authorized: 300,000,000 shares;
               
issued: 55,765,715 shares in 2010 and 53,763,270 shares in 2009;
               
outstanding: 55,681,918 shares in 2010 and 53,679,473 shares in 2009
   
55
     
54
 
Additional paid-in capital
   
79,345
     
66,711
 
Accumulated deficit
   
(91,118
)
   
(81,268
)
Treasury stock, at cost: 133,797 shares in 2010 and 83,797 shares in 2009
   
(18
)
   
 
 
               
Total Stockholders’ Deficiency
   
(11,674
)
   
(14,471
)
                 
TOTAL LIABILITIES AND STOCKHOLDERS’ DEFICIENCY
 
$
6,317
   
$
1,710
 

 
See notes to consolidated financial statements.
 
 
A-4

 

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

  
 
Year Ended December 31,
  
 
2010
   
2009
 
             
Revenues
 
$
2,874
   
$
4,016
 
Less: cost of revenues
   
2,775
     
4,013
 
Gross profit
   
99
     
3
 
                 
Operating Expenses:
               
General and administrative
   
4,048
     
3,915
 
Engineering, research and development
   
466
     
916
 
Sales and marketing
   
1,168
     
533
 
Option expense
   
2,066
     
663
 
Total operating expenses
   
7,748
     
6,027
 
                 
Loss from operations
   
(7,649
)
   
(6,024
)
                 
Other income (expense):
               
Warrant expense
   
(107
   
(1,925
Gain on payroll tax settlement
   
2,263
     
 
Loss on extinguishment of debt
   
(614
   
(3,285
Derivative liability (expense) income
   
(293
)
   
937
 
Equity in losses of joint venture
   
(74
)
   
 
Interest and other expense, net
   
(3,376
   
(2,687
Total other income (expense)
   
(2,201
)
   
(6,960
)
                 
Net loss
   
(9,850
)
   
(12,984
)
 
               
Deemed dividend on Series B Convertible Preferred Stock
   
(6,900
)
   
(2,749
)
                 
Net loss attributable to common stockholders
 
$
(16,750
)
 
$
(15,733
)
                 
Loss per share attributable to common stockholders, basic and diluted
 
$
(0.31
)
 
$
(0.30
)
                 
Weighted average shares used in computing loss per share, basic and diluted
   
54,041,586
     
52,742,611
 
 
See notes to consolidated financial statements.
 
 
A-5

 
 
THERMOENERGY CORPORATION
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' DEFICIENCY
(in thousands, except share and per share amounts)
Years Ended December 31, 2010 and 2009

   
Series A
Convertible
Preferred
Stock
   
Series B
Convertible
Preferred
Stock
   
Common
Stock