Edgar Filing: ECO2 PLASTICS INC

form10q.htm

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (D) OF THE

SECURITIES EXCHANGE ACT OF 1934

FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2008

Commission File Number: #033-31067

ECO2 PLASTICS, INC.

(Exact name of small business issuer as specified in its charter)

Delaware

(State or other jurisdiction of incorporation or organization)

31-1705310

(IRS Employer Identification Number)

680 Second Street, Suite 200

San Francisco, CA 94107

(Address of principal executive offices)(Zip Code)

(415) 829-6000

(Registrant's telephone no., including area code)

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 [ ]

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

The number of shares of the Company's common stock issued and outstanding on September 30, 2008 is 549,441,434.

Indicate by check mark whether the registrant is a large accelerated filer [ ], an accelerated filer [ ], a non-accelerated filer [ ], or a smaller reporting company [X].

ECO2 PLASTICS, INC.

FORM 10-Q

TABLE OF CONTENTS

		Page
PART I	FINANCIAL INFORMATION	3

Item 1	Financial Statements	3

Item 2	Management's Discussion and Analysis of Financial Condition and Results of Operations	17

Item 3	Quantitative and Qualitative Disclosures About Market Risk	22

Item 4	Controls and Procedures	23

PART II	OTHER INFORMATION	24

Item 1	Legal Proceedings	24

Item 1A	Risk Factors	24

Item 2	Unregistered Sales of Equity Securities and Use of Proceeds	26

Item 3	Defaults Upon Senior Securities	26

Item 4	Submission of Matters to a Vote of Security Holders	27

Item 5	Other Information	27

Item 6	Exhibits	27

	Signatures	28

PART I - FINANCIAL INFORMATION

Item 1. Financial Statements

ECO2 Plastics, Inc.
Condensed Balance Sheets
(in thousands, except share and per share data)


	September 30,			December 31,
	2008			2007
	(unaudited)
Cash and cash equivalents	$	1,091		$	101
Accounts receivable, net of allowance of $15 and $48		606			581
Inventory		330			475
Prepaid expenses and other current assets		6			2
Total current assets		2,033			1,159
Property and equipment, net		9,153			7,864
Deferred debt issue costs, net		163			445
Other assets		68			47

Total assets	$	11,417		$	9,515

Accounts payable	$	2,337		$	2,900
Accounts payable to related parties		84			692
Accrued liabilities		838			645
Accrued interest on notes payable
Due to related parties		25			846
Due to others		10			801
Notes payable, net of debt discount
Due to related parties, net of debt discount of $0 and $1,856		-			7,415
Due to others, net of debt discount of $0 and $2,558		-			5,910
Convertible notes payable, net of debt discount of $3,526		439
Current portion of note payable to California Integrated Waste Management Board		207			200
Participation Certificates obligations issued prior to 2004		354			354
Total current liabilities		4,294			19,763
Note payable to California Integrated Waste Management Board, net of current portion		1,327			1,507
Total liabilities		5,621			21,270
Commitments and contingencies (Notes 8 and 9)
Stockholders' equity (deficit)
Preferred stock, $0.001 par value, 700,000,000 shares authorized,
Series A convertible, 152,843,414 shares authorized, issued and
outstanding, preference in liquidation $4,585		153			-
Series B-1 convertible, 336,240,040 shares authorized, issued
and outstanding, preference in liquidation $6,725		336			-
Series B-2 convertible, 10,916,546 shares authorized, none issued and outstanding		-
Common stock, $0.001 par value, 1,500,000,000 shares authorized,
547,061,445 and 190,920,594 shares issued and outstanding		547			191
180,000 and 7,180,000 shares issuable		-			7
Additional paid-in capital		102,657			66,843
Deferred stock-based consulting		(11	)		(24	)
Accumulated deficit		(97,886	)		(78,772	)
Total stockholders' equity (deficit)		5,796			(11,755	)

Total liabilities and stockholders' equity (deficit)	$	11,417		$	9,515


See accompanying notes to condensed financial statements.

ECO2 Plastics, Inc.
Condensed Statements of Operations
(in thousands, except per share data)
(unaudited)


	Three months ended September 30,						Nine months ended September 30,
	2008			2007			2008			2007
							(see Note 2)
Revenue	$	2,525		$	1,449		$	5,445		$	1,966
Cost of goods sold		1,893			1,247			4,852			1,850
Gross margin		632			202			593			116
Operating expenses
Plant operations and technology development		2,764			1,708			6,588			4,264
General and administrative, including share-based
payments of $281 and $1,804 and $1,093 and $3,871		1,162			1,959			3,563			6,614
Settlement expense paid in shares of common stock		-			(60	)		-			680

Total operating expenses		3,926			3,607			10,151			11,558

Loss from operations		(3,294	)		(3,405	)		(9,558	)		(11,442	)
Other income (expense)
Interest expense, including amortization of debt discount and
debt issue costs of $474 and $4,220 and $5,474 and $10,658		(529	)		(4,686	)		(6,098	)		(11,834	)
Excess of fair value of common stock issued in exchange for
accounts payable, notes and accrued interest payable and warrants		-			-			(3,458	)		-
Total other income (expense)		(529	)		(4,686	)		(9,556	)		(11,834	)

Loss before income taxes		(3,823	)		(8,091	)		(19,114	)		(23,276	)
Income taxes		-			-			-			-

Net loss	$	(3,823	)	$	(8,091	)	$	(19,114	)	$	(23,276	)

Net loss per common share, basic and diluted	$	(0.01	)	$	(0.05	)	$	(0.04	)	$	(0.16	)

Weighted average shares used in computing
net loss per common share, basic and diluted		547,241,445			156,996,719			468,175,507			141,168,000


See accompanying notes to condensed financial statements.

ECO2 Plastics, Inc.
Condensed Statement of Changes in Stockholders' Equity (Deficit)
For the Nine Months Ended September 30, 2008
(in thousands, except share data)
(unaudited)


	Convertible Preferred Stock
	Series A				Series B-1				Common stock					Common Stock Issuable						Additional paid-in			Deferred stock-based			Accumulated
	Shares		Amount		Shares		Amount		Shares			Amount		Shares			Amount			capital			consulting			deficit			Total
																				(see Note 2)						(see Note 2)			(see Note 2)
Balance at December 31, 2007		-	$	-		-	$	-		190,920,594		$	191		7,180,000		$	7		$	66,843		$	(24	)	$	(78,772	)	$	(11,755	)
Amortization of deferred
stock-based consulting																								13						13
Value of warrants issued
with notes payable																					540									540
Stock-based compensation
expense																					939									939
Shares issued in exchange
for accounts payable										15,944,077			16								813									829
Shares vested for executive
compensation										7,700,000			7								(7	)								-
Shares issued in exchange for
notes payable, accrued
interest and warrants										325,853,917			326								17,786									18,112
Issuance of shares
previously recorded as
issuable										7,000,000			7		(7,000,000	)		(7	)											-
Preferred shares issued in
exchange for:
Notes payable and related
accrued interest		152,843,414		153		111,240,040		111													7,598									7,862
Cash						165,000,000		165													3,135									3,300
"old" Series A preferred
stock						60,000,000		60													1,140									1,200
Stock issue costs																					(242	)								(242	)
Decrease in shares issuable
previously recorded as
issued in 2006										(357,143	)		-																	-
Value of beneficial
conversion feature and
warrants issued with
convertible notes payable																					3,968									3,968
Value of warrants issued
for services																					144									144
Net loss for the nine months
ended September 30, 2008																											(19,114	)		(19,114	)
Balance at September 30, 2008		152,843,414	$	153		336,240,040	$	336		547,061,445		$	547		180,000		$	-		$	102,657		$	(11	)	$	(97,886	)	$	5,796


See accompanying notes to condensed financial statements.

ECO2 Plastics, Inc.
Condensed Statements of Cash Flows
(in thousands)
(unaudited)

	Nine months ended September 30,
	2008			2007
Cash flows from operating activities:	(see Note 2)
Net loss	$	(19,114	)	$	(23,276	)
Adjustments to reconcile net loss to net cash used by operating activities:
Depreciation and amortization		1,080			788
Excess of fair value of common stock issued and issuable in exchange
for accounts payable, notes payable, accrued interest and warrants		3,458			-
Stock-based compensation and settlement expense		1,098			4,546
Amortization of debt issue costs and discount		5,474			10,658
Expenses paid by issuance of notes payable		-			75
Changes in operating assets and liabilities:
Accounts receivable		(25	)		(539	)
Inventory		145			(73	)
Prepaid expenses and other assets		(25	)		50
Accounts payable		(417	)		1,832
Accrued liabilities		807			824
Other		10			-
Net cash used by operating activities		(7,509	)		(5,115	)
Cash flows from investing activities:
Purchase of property, plant & equipment		(2,369	)		(2,943	)
Net cash used by investing activities		(2,369	)		(2,943	)
Cash flows from financing activities:
Payments on CIWMB note payable		(174	)		(163	)
Proceeds from issuance of notes payable		7,458			8,886
Repayments of notes payable		(475	)		(300	)
Proceeds from issuance of preferred stock		4,500			-
Principal payments on capital lease obligations		-			(14	)
Proceeds from exercise of warrants		-			2
Payments of stock issue costs		(242	)		-
Payments of debt issue costs		(199	)		(169	)
Net cash provided by financing activities		10,868			8,242
Net increase in cash and cash equivalents		990			184
Cash and cash equivalents, beginning of period		101			97
Cash and cash equivalents, end of period	$	1,091		$	281
Supplemental disclosures of cash flow information:
Cash paid for interest	$	74		$	61
Cash paid for income taxes	$	-		$	-

Supplemental disclosures of non-cash investing and financing activities:
Debt discount	$	4,504		$	7,351
Deferred debt issue costs	$	-		$	82
Common stock exchanged for notes payable, accrued interest and warrants	$	13,031		$	3,054
Common stock exchanged for accounts payable and accrued liabilities	$	754		$	123
Preferred stock exchanged for notes payable and accrued interest	$	7,862		$	-

See accompanying notes to condensed financial statements.

ECO2 Plastics, Inc.

Notes to Condensed Financial Statements

September 30, 2008

(unaudited)

Note 1. Description of Business and Summary of Significant Accounting Policies

Organization and Business – ECO2 Plastics, Inc., (“ECO2”or the “Company”), was incorporated under the laws of the State of Delaware in 2000, and formed for purposes of acquiring certain patented technology and development of a worldwide market.

ECO2 has developed a unique and revolutionary patented process and system, referred to as the Eco2TM Environmental System (the “Eco2 Environmental System”). The Eco2 Environmental System cleans post-consumer plastics, without the use of water, at a substantial cost savings versus traditional methods (the “Process”). This Process is licensed from Honeywell Federal Manufacturing & Technologies, LLC (“Honeywell”) and the Department of Energy on an exclusive basis for the patent life. Since its inception, ECO2 has invested in the development of the technology and equipment comprising the Eco2 Environmental System, which includes a “Process Patent” granted in 2007. This included building several scaled up versions of the Prototype Eco2 Environmental System (the “Prototype”), testing of the Prototypes, building a pilot plant, evaluating the product produced by the Prototype and real-time testing. The Company’s first full scale production facility was constructed in Riverbank, California and is now producing saleable product and ramping up to full scale operations as it further develops the process. ECO2’s goal is to build and operate plastic recycling plants in the USA that utilize the Eco2 Environmental System and to expand the Eco2 Environmental System worldwide. ECO2’s growth strategy includes organic growth, strategic acquisitions and licensing or partnership agreements, where appropriate.

Business risks and uncertainties - The Company operates in the evolving field of plastics materials recycling and its business is reliant on its licensing of technology from Honeywell. New developments could both significantly and adversely affect existing and emerging technologies in the field. The Company's success in developing additional marketable products and processes and achieving a competitive position will depend on, among other things, its ability to attract and retain qualified management personnel and to raise sufficient capital to meet its operating and development needs. There can be no assurance that the Company will be successful in accomplishing its objectives.

Basis of presentation and Going Concern - The accompanying financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America, which contemplate the Company’s continuation as a going concern. Since inception, the Company has reported losses and operating activities have used cash, and it has a working capital deficiency that has raised substantial doubt about its ability to continue as a going concern. The Company reported a net loss of approximately $19.1 million for the nine months ended September 30, 2008, and $32.6 million for the year ended December 31, 2007, and operating activities used cash of approximately $7.5 million during the nine months ended September 30, 2008 and $7.2 million for the year ended December 31, 2007, and as of September 30, 2008, had stockholders’ equity of $5.8 million, including accumulated losses from inception of $97.9 million.

Company management intends to raise additional equity and/or debt financing to fund future capital expenditures, operations and to provide additional working capital. During the three months ended September 30, 2008, the Company received approximately $3.9 million from new and existing investors in exchange for convertible notes payable bearing interest at 15%, due in March 2009 and collateralized by a pledge of substantially all of the Company’s assets, subordinate only to CIWMB borrowings, and warrants to purchase approximately 129 million shares of Company common stock at $0.015 per share. During the three months ended June 30, 2008, the Company received $1.2 million from loans from new and existing investors, and received $4.5 million from sales of 225 million shares of its convertible preferred stock, and issued approximately 264 million shares of its convertible preferred stock in exchange for outstanding promissory notes having a principal balance of approximately $7.5 million and related accrued interest payable of $525,000. During the three months ended March 31, 2008, the Company (i) received approximately $2.2 million from loans from new and existing investors, (ii) entered into agreements with holders of certain notes payable pursuant to which the Company issued approximately 243.9 million shares of Company common stock in consideration for conversion of all convertible notes payable of $13.2 million together with related accrued interest of approximately $1.7 million and the surrender of outstanding warrants to purchase approximately 38.6 million shares of Company common stock, (iii) entered into agreements with related party and non-related party creditors providing for issuance of approximately 15.9 million shares of Company common stock as payment for accounts payable or accrued amounts owed of $754,000, and (iv) entered into agreements with holders of warrants to purchase Company common stock pursuant to which the Company issued 81.9 million shares of its common stock in exchange for the cancellation of warrants to purchase approximately 124.2 million shares. The Company’s Board of Directors and Chief Executive Officer continue to be actively involved in discussions and negotiations with investors in order to fund next generation processing and other equipment, and to provide adequate working capital for operations with a near-term goal of generating positive cash flow from operations. There is no assurance that continued financing proceeds will be obtained in sufficient amounts necessary to meet the Company's needs. In view of these matters, continuation as a going concern is dependent upon the Company's ability to meet its financing requirements, raise additional capital, and the future success of its operations.

The accompanying financial statements do not include any adjustments to reflect the possible future effects on the recoverability and classification of assets or the amounts and classifications of liabilities that may result from the possible inability of the Company to continue as a going concern.

Interim financial statements - The accompanying unaudited condensed financial statements and related notes are presented in accordance with the rules and regulations of the Securities and Exchange Commission with regard to interim financial information. Accordingly, the condensed financial statements do not include all of the information and notes to financial statements required by accounting principles generally accepted in the United States of America for complete financial statements. In the opinion of management, all adjustments, consisting of normal recurring adjustments, considered necessary for a fair presentation of the Company’s financial position, results of operations and cash flows for the interim periods presented have been included. Results of operations for the September 30, 2008 interim periods are not necessarily indicative of the results to be expected for the entire fiscal year ending December 31, 2008 or for any other future interim period. The accompanying unaudited interim condensed financial statements should be read in conjunction with the audited annual financial statements included in the Company’s December 31, 2007 Annual Report on Form 10-KSB.

Significant accounting policies used in preparation of the Company’s financial statements are disclosed in notes to its audited annual December 31, 2007 financial statements. A condensed summary of disclosures regarding certain of such policies are set forth below.

Use of estimates in the preparation of financial statements - Preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and reported amounts of revenue and expenses during the reporting periods. Actual results could differ from those estimates. The more significant accounting estimates inherent in the preparation of the Company's financial statements include estimates as to the depreciable lives of property and equipment, valuation of accounts receivable and inventories, amounts of contingent liabilities, valuation of equity related instruments and derivatives issued and issuable, and valuation allowance for deferred income tax assets.

Cash and cash equivalents - The Company considers deposits that can be redeemed on demand and investments that have original maturities of less than three months when purchased to be cash equivalents.

Contingencies - Certain conditions may exist as of the date financial statements are issued, which may result in a loss to the Company, but which will only be resolved when one or more future events occur or fail to occur. Company management and its legal counsel assess such contingent liabilities, and such assessment inherently involves an exercise of judgment. In assessing loss contingencies related to legal proceedings that are pending against the Company or unasserted claims that may result in such proceedings, the Company's legal counsel evaluates the perceived merits of any legal proceedings or unasserted claims as well as the perceived merits of the amount of relief sought or expected to be sought therein. If the assessment of a contingency indicates that it is probable that a liability has been incurred and the amount of the liability can be reasonably estimated, then the estimated liability would be accrued in the Company's financial statements. If the assessment indicates that a potentially material loss contingency is not probable, but is reasonably possible, or is probable, but cannot be reasonably estimated, then the nature of the contingent liability, together with an estimate of the range of possible loss if determinable would be disclosed.

Revenue recognition - The Company recognizes revenue when there is persuasive evidence of an arrangement, the product has been delivered to the customer, the sales price is fixed or determinable, and collectability is reasonably assured. The Company recognizes revenues from sales of recycled products upon shipment to customers. Amounts received in advance of when products are delivered are recorded as liabilities in the accompanying balance sheet. Research or other types of grants from governmental agencies or private organizations are recognized as revenues if evidence of an arrangement exists, the amounts are determinable and collectability is reasonably assured with no further obligations or contingencies remaining.

Cost of goods sold – Cost of goods sold includes costs of raw materials processed, and on occasion, write-downs for waste product.

Basic and diluted net loss per share - Basic net loss per common share is computed by dividing net loss by the weighted-average number of common shares outstanding during the period. Diluted net loss per common share is determined using the weighted-average number of common shares outstanding during the period, adjusted for the dilutive effect of common stock equivalents, consisting of shares that might be issued upon exercise of common stock options, warrants or convertible promissory notes. In periods where losses are reported, the weighted-average number of common shares outstanding excludes common stock equivalents, because their inclusion would be anti-dilutive. Computations of net loss per share for interim periods ended September 30, 2008, exclude 195,422,058 shares issuable upon exercise of outstanding warrants to purchase common stock, 264,312,856 shares issuable upon conversion of outstanding convertible notes payable and 489,083,454 shares issuable upon conversion of outstanding convertible preferred stock. Computations of net loss per share for the interim periods ended September 30, 2007, exclude 136,231,211 shares relating to common stock issuable upon conversion of convertible notes payable, and 172,914,521 shares issuable upon exercise of outstanding and issuable warrants. These common stock equivalents could have the effect of decreasing diluted net income per share in future periods.

Reclassifications – Certain amounts in 2007 financial statements have been reclassified to conform to 2008 presentation.

Recent accounting pronouncements - Effective January 1, 2008, the Company adopted SFAS No. 157, Fair Value Measurements (“SFAS 157”), for financial assets and liabilities. Adoption of SFAS 157 did not have a material impact on the Company’s results of operations, financial position or liquidity. This standard defines fair value, provides guidance for measuring fair value and requires certain disclosures. This standard does not require any new fair value measurements, but rather applies to all other accounting pronouncements that require or permit fair value measurements. This standard does not apply measurements related to share-based payments. SFAS 157 discusses valuation techniques, such as the market approach (comparable market prices), the income approach (present value of future income or cash flow), and the cost approach (cost to replace the service capacity of an asset or replacement cost). The statement utilizes a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value into three broad levels. The following is a brief description of those three levels:

Level 1: Observable inputs such as quoted prices (unadjusted) in active markets for identical assets or liabilities.

Level 2: Inputs other than quoted prices that are observable for the asset or liability, either directly or indirectly. These include quoted prices for similar assets or liabilities in active markets and quoted prices for identical or similar assets or liabilities in markets that are not active.

Level 3: Unobservable inputs that reflect the reporting entity’s own assumptions.

The Company’s financial assets subject to fair value measurements are comprised of cash and cash equivalents of $1,165,000 all of which are valued using Level 1 observable inputs.

In February 2008, the Financial Accounting Standards Board, or FASB, issued FASB Staff Position No. FAS 157-2, Effective Date of FASB Statement No. 157, which provides a one year deferral of the effective date of SFAS 157 for non-financial assets and non-financial liabilities, except those that are recognized or disclosed in the financial statements at fair value at least annually. Therefore, the Company adopted the provisions of SFAS 157 with respect to its financial assets and liabilities only.

In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities (“SFAS 159”), which is effective for fiscal years beginning after November 15, 2007. Adoption of SFAS 159 did not have a material impact on the Company’s results of operations, financial position or liquidity.

In June 2007, the Emerging Issues Task Force of the FASB issued EITF Issue No. 07-3, Accounting for Nonrefundable Advance Payments for Goods or Services to be Used in Future Research and Development Activities, (“EITF 07-3”) which is effective for fiscal years beginning after December 15, 2007. EITF 07-3 requires that nonrefundable advance payments for future research and development activities be deferred and capitalized. Such amounts will be recognized as an expense as goods are delivered or services are performed. Adoption of EITF 07-3 did not have a material impact on the Company’s results of operations or financial position.

In December 2007, the FASB issued SFAS No. 141(R), Business Combinations (“SFAS 141(R)”), which replaces SFAS No. 141. SFAS No. 141(R) establishes principles and requirements for how an acquirer recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed, any non-controlling interest in the acquiree and the goodwill acquired. The Statement also establishes disclosure requirements which will enable users to evaluate the nature and financial effects of the business combination. SFAS 141(R) is effective for fiscal years beginning after December 15, 2008. The adoption of SFAS 141(R) will have an impact on accounting for future business combinations.

In December 2007, the FASB issued SFAS No. 160, Noncontrolling Interests in Consolidated Financial Statements – an amendment of Accounting Research Bulletin No. 51 (“SFAS 160”), which establishes accounting and reporting standards for ownership interests in subsidiaries held by parties other than the parent, the amount of consolidated net income attributable to the parent and to the noncontrolling interest, changes in a parent’s ownership interest and the valuation of retained non-controlling equity investments when a subsidiary is deconsolidated. The Statement also establishes reporting requirements that provide sufficient disclosures that clearly identify and distinguish between the interests of the parent and the interests of the non-controlling owners. SFAS 160 is effective for fiscal years beginning after December 15, 2008. In the absence of possible future investments, application of SFAS 160 will have no effect on the Company’s financial statements.

In March 2008, the FASB issued SFAS No. 161, Disclosures about Derivative Instruments and Hedging Activities – an amendment of SFAS No. 133 ("SFAS 161"). This statement changes the disclosure requirements for derivative instruments and hedging activities. SFAS No. 161 requires enhanced disclosures about (a) how and why an entity uses derivative instruments, (b) how derivative instruments and related hedged items are accounted for under SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities, and its related interpretations, and (c) how derivative instruments and related hedged items affect an entity’s financial position, financial performance, and cash flows. SFAS No. 161 is effective for the Company beginning January 1, 2009. The Company does not use derivative financial instruments nor does it engage in hedging activities. The Company is currently evaluating the impact of implementation of SFAS No. 161 on its financial position, results of operations and cash flows.

In June 2008, the FASB issued SFAS No. 162, The Hierarchy of Generally Accepted Accounting Principles. This statement identifies the sources of generally accepted accounting principles and provides a framework, or hierarchy, for selecting the principles to be used in preparing U.S. GAAP financial statements for nongovernmental entities. This statement makes the GAAP hierarchy explicitly and directly applicable to preparers of financial statements. The hierarchy of authoritative accounting guidance is not expected to change current practice but is expected to facilitate the FASB‘s plan to designate as authoritative its forthcoming codification of accounting standards. This statement is effective 60 days following the SEC’s approval of the PCAOB’s related amendments to remove the GAAP hierarchy from its auditing standards.

In June 2008, the Emerging Issues Task Force of the FASB issued EITF Issue No. 08-4, Transition Guidance for Conforming Changes to Issue No. 98-05 (“EITF 08-4”), which is effective for fiscal years ending after December 15, 2008, with earlier application permitted. EITF 08-4 provides for, among other things, revisions to certain provisions of EITF 98-05, including nullification of guidance under EITF 98-05 that upon conversion, unamortized discounts for instruments with beneficial conversion features should be included in the carrying value of the convertible security that is transferred to equity at the date of conversion. This nullification was made to update guidance to acknowledge the issuance of EITF Issue No. 00-27, which revised accounting guidance to require immediate recognition of interest expense for the unamortized discount. See Note 2.

Note 2. Change in Accounting Principle

The September 30, 2008 financial statements reflect adoption of EITF 08-4. In accordance with EITF 08-4 Transition Guidance and SFAS No. 154, Accounting for Changes and Error Corrections, the Company has retrospectively applied the accounting guidance of EITF 00-27. During the three months ended March 31, 2008, certain convertible promissory notes payable were exchanged for shares of Company common stock and the remaining unamortized debt discount of approximately $2.2 million was transferred to equity. As a result of adoption of EITF 00-27 accounting guidance, the September 30, 2008 financial statements retrospectively give effect to recognition of the $2.2 million remaining unamortized debt discount as interest expense. Accordingly, interest expense and net loss for the nine months ended September 30, 2008 are approximately $2.2 million more than would have been in the absence of retrospective application and additional paid in capital is $2.2 million more. There is no effect on cash flows. There was no cumulative effect for periods prior to 2008.

Note 3. Inventories

Inventories at September 30, 2008, consist of the following (in thousands):

Raw materials	$	221
Finished goods		109
Total	$	330

Note 4. Concentrations and Major Customers

Technology License - The Company’s business is reliant on its licensing of technology from Honeywell. Pursuant to terms of a license agreement entered into by the Company and Honeywell, as amended, the Company obtained exclusive, nontransferable, worldwide license rights for the life of the underlying patent to practice the methods and to make, use, and sell the products and/or services and to certain sublicense rights, which are covered by the proprietary rights, limited to the field of use of separating and recovering motor oil from high density polyethylene plastic. Under this agreement, the Company is required to pay royalties at a rate of $0.005 per pound of recycled plastics sold, with minimum annual royalties of $100,000 for 2007, $200,000 for 2008 and $300,000 for 2009 and for years thereafter. Honeywell may terminate this agreement in the event of, among other things, the nationalization of the industry which encompasses any products or services, any suspension of payments under the terms of the agreement by government regulation, a substantial change in ownership of the Company (whether resulting from merger, acquisition, consolidation or otherwise), another company or person acquiring control of the Company, or the existence of a state of war between the United States and any country where the Company has a license to manufacture products or provide services.

Cash in excess of federally insured limits - Cash and cash equivalents are maintained at financial institutions and, at times, balances may exceed federally insured limits. The Company has never experienced any losses related to these balances. Such amounts on deposit in excess of federally insured limits at September 30, 2008 approximated $1 million.

Major Customers - During the nine months ended September 30, 2008 and 2007, the Company had revenues of over 10% of total revenue from individual customers and related accounts receivable over 10% of total accounts receivable at September 30, 2008 as follows (“*” means < 10%):

	Revenues		Accounts Receivable
	2008	2007
Customer 1	27%	29%	*
Customer 2	20%	13%	*
Customer 3	14%	*	*
Customer 4	14%	*	46%
Customer 5	10%	32%	10%
Customer 6	*	*	36%

Note 5. Notes Payable

Convertible Promissory Notes – During 2008, the Company issued approximately 243.9 million shares of its common stock in exchange for full satisfaction of all outstanding convertible notes payable, which approximated $13.2 million and related accrued interest of approximately $1.7 million, and the return of outstanding warrants to purchase approximately 38.6 million shares of Company common stock having an exercise price of $0.06 per share and expiring in April 2015, which such warrants were acquired when the notes were issued. The total number of shares issued was in excess of what would have been received had the notes been converted according to original terms. The Company has accounted for this transaction pursuant to Statement of Financial Accounting Standards No. 84 Induced Conversions of Convertible Debt—an amendment of APB Opinion No. 26 , and accordingly, the excess of fair value of consideration issued by the Company over the fair value of what was received has been recorded as a loss of approximately $2.8 million. The remaining unamortized debt discount of approximately $2.2 million was written off and recognized as interest expense and the remaining unamortized debt issue costs of $198,000 were written off with the offset decreasing additional paid-in capital.

Director Notes – During 2007, the Company received cash proceeds of approximately $2.7 million from various members of the Company’s Board of Directors (the “Director Notes”). In accordance with the Director Notes, each lender received a promissory note with an interest rate of 15% per annum (the “Note”). All or any portion of the Note, any accrued interest thereon and all other sums due under the Note, was due and payable on demand within 90 days of the Note. In connection with these notes, lenders received common stock purchase warrants to purchase 22,657,000 shares of Company common stock with an exercise price of $0.06 per share that expire in April 2015. The shares underlying the warrants are subject to piggy back registration rights. The exercise price of the warrants is subject to anti-dilution downward adjustments in the event the Company sells common stock at a price below the exercise price. Debt discount relating to the value of warrants issued of approximately $2.7 million was recorded and amortized to interest expense during the third and fourth quarters of 2007. The fair value of warrants was computed using a Black-Scholes option pricing model with the following assumptions: expected term of 7.8 years (based on the contractual term), volatility of approximately 180% (based on historical volatility), zero dividends and interest rate of approximately 4.6%.

Short-term Notes - During 2007, the Company received cash proceeds of approximately $2.2 million from new and existing investors and issued to each lender a promissory note with an interest rate of 15% per annum, due and payable on demand within 180 days (the “Short-Term Notes”), and warrants to purchase approximately 15 million shares of Company common stock with an exercise price of $0.06 per share that expire in April 2015. During the six months ended June 30, 2008, the Company received cash of approximately $3.1 million and issued to each lender Short-Term Notes, and issued to certain lenders warrants to purchase approximately 9.2 million shares of Company common stock with an exercise price of $0.06 per share that expire in April 2015. The shares underlying the warrants are subject to piggy back registration rights. The exercise price of the warrants is subject to anti-dilution downward adjustments in the event the Company sells common stock at a price below the exercise price. Debt discount relating to the value of warrants issued in 2007 and 2008 of approximately $1.1 million and $539,000 was recorded, of which approximately $1.2 million was amortized to interest expense during the six months ended June 30, 2008. The fair value of warrants was computed using a Black-Scholes option pricing model with the following assumptions: expected term of approximately 7.7 years (based on the contractual term), volatility of approximately 166% - 180% (based on historical volatility), zero dividends and interest rate of approximately 4.6%.

Exchange of Director Notes and Short-term Notes for Convertible Preferred Stock - During 2008, holders of outstanding Director Notes and Short-term notes, which had an outstanding principal amount of approximately $2.9 million and $4.6 million and related accrued interest payable of $318,000 and $206,000, respectively, exchanged all such notes and accrued interest for 152,843,413 shares of the Company’s Series A Convertible Preferred Stock and 111,240,040 shares of the Company’s Series B-1 Convertible Preferred Stock. The unamortized balance of deferred debt discount relating to a portion of the notes was $201,000 and was written off upon the transaction with the offset decreasing additional paid in-capital.

Other Notes Payable – During 2008, the Company received $300,000 cash pursuant to terms of a short-term $300,000 promissory note bearing interest at 15%, which was repaid in full.

During 2008, one of the Company’s Executive Officers loaned the Company $270,000 pursuant to terms of short-term notes payable bearing interest at 15%, and the Company repaid $175,000 of the loan, including interest thereon. The remaining $95,000 and related accrued interest of approximately $6,000 were exchanged for Convertible Notes Payable as described in the following paragraph.

Convertible Notes Payable – During the three months ended September 30, 2008, the Company received cash of approximately $3.9 million and a promissory note with related accrued interest totaling approximately $101,000 and in exchange issued convertible notes payable (the “Convertible Notes”) of approximately $4.0 million and warrants to purchase approximately 132 million shares of Company common stock. The Convertible Notes bear interest at 15%, and are due March 31, 2009. Upon written election at the discretion of holders of 60% or more of the aggregate principal amount of Convertible Notes then outstanding, the entire principal amount of such notes, together with all accrued interest, which shall be computed as if such notes were held until March 31, 2009, regardless of whether converted prior to that date, shall be converted. If the Company has raised $1 million in new equity, as defined, the conversion price would be the lesser of 80% of the new equity price or $0.015 per share. If such next equity financing has not occurred, then the conversion securities shall consist of shares of a newly created series of Series C Convertible Preferred Stock of the Company having rights, preferences and privileges substantially similar to those of the Company’s Series B Stock, except that the liquidation preference shall be senior to the Series B Stock and the Company’s Series A Convertible Preferred Stock, at a price per share equal to $0.015 (subject to appropriate adjustment for all stock splits, subdivisions, combination, recapitalizations and the like) until April 2015. The Company has pledged as collateral pursuant to terms of a Security Agreement relating to the Convertible Notes, as amended, substantially all of its assets, subject only to a security interest granted to CIWMB. Debt discount relating to these Convertible Notes approximated $4.0 million, of which approximately $438,000 was amortized to interest expense during the three months ended September 30, 2008, with the remainder to be amortized over the next six months. The fair value of warrants was computed using a Black-Scholes option pricing model with the following assumptions: expected term of 6.5 years (contractual term), volatility of 156% (based on historical volatility), zero dividends and interest rate of approximately 3.1%.

Note 6. Preferred Stock, Common Stock and Stock Warrants

Authorized Shares - Pursuant to the Definitive Schedule 14C filed by the Company on August 1, 2008, the Company amended its Certificate of Incorporation with the state of Delaware (the “Amendment”). In August 2008, the Company received notice from the state of Delaware confirming the effectiveness of the Amendment. The Articles of Incorporation, as amended, authorize a maximum of 1,500,000,000 shares of $0.001 par value common stock, and 700,000,000 shares of $0.001 par value preferred stock, of which the Company has designated and authorized 152,843,414 shares as Series A Convertible Preferred Stock (the “Series A Preferred Stock”), 336,240,040 shares as Series B-1 Convertible Preferred Stock (the “Series B-1 Preferred Stock”), and 10,916,546 shares as Series B-2 Convertible Preferred Stock (the “Series B-2 Preferred Stock”, and together with the Series B-1 Preferred Stock, the “Series B Preferred Stock”). Each share of common stock is entitled to one voting right, the right to share in earnings and the right to share in assets upon liquidation. A summary of the significant rights and privileges of the Series A Preferred Stock and Series B Preferred Stock (together, the Senior Preferred Stock”) is as follows:

Voting – Each share of Senior Preferred Stock entitles the holder thereof to vote on all matters except as required by law, voted on by holders of the Company’s common stock on an as-converted basis. For as long as any shares of Series A Preferred Stock remain outstanding, the affirmative vote of the holders of a majority of the outstanding shares of Series A Preferred Stock, voting separately as a single class, shall be necessary to amend the rights, preferences or privileges of the Series A Preferred Stock, however effected, whether by amendment, merger, consolidation, recapitalization or otherwise, provided that no such separate consent of the Series A Preferred Stock shall be required with respect to any such amendment if a similar amendment is contemporaneously effect with respect to the rights, preferences or privileges of the Series B Preferred Stock and the amendment is approved by holders of a majority of the Series B Preferred Stock then outstanding. For as long as any shares of Series B Preferred Stock remain outstanding, the affirmative vote of the holders of a majority of the outstanding shares of Series B Preferred Stock, voting separately as a single class, shall be necessary to take certain described actions, however effected, whether by amendment, merger, consolidation, recapitalization or otherwise, which include, among others, transactions with affiliates, except on an arms-length basis, authorization, creation or issuance of any class of capital stock of the Company ranking senior to or on a parity with the Series B Preferred Stock, authorizing any increase or decrease in the total authorized shares or any amendment to the rights, preferences or privileges of the Series A Preferred Stock or Series B Preferred Stock, and paying any dividend or distribution on any shares of capital stock of the Company (other than dividends paid on Preferred Stock). For so long as 134,496,016 shares of Series B Preferred Stock (as adjusted for stock dividends, splits or the like) remain outstanding, holders of Series B Preferred Stock, voting separately as a single class, shall have the right to elect three Directors (3 of 7) to the Company’s Board of Directors.

Conversion - Each share of Senior Preferred Stock is convertible at the option of the holder into fully paid and non-assessable shares of the Company’s common stock on a one-for-one basis. Upon election by holders of a majority of the then outstanding shares of Series B Preferred Stock, all issued and outstanding shares of Senior Preferred Stock shall automatically be converted into shares of common stock at the conversion rate in effect upon conversion, as potentially adjusted for any dividends or distributions, stock dividends, combinations, splits, and the like with respect to such shares. Pursuant to conversion terms, the Company shall at all times reserve and keep available out of its authorized but unissued shares of common stock, solely for the purpose of effecting the conversion of the shares of Senior Preferred Stock, such number of shares as shall be sufficient to effect the conversion of all such outstanding shares.

Dividends - Holders of Senior Preferred Stock shall be entitled to receive, on a pari passu basis, when, as and if declared by the Board of Directors, out of any assets of the Company legally available therefore, dividends at a rate of 5% of the Original Issue Price of such share of Senior Preferred Stock (in each case, as adjusted for any stock dividends, combinations, splits, recapitalizations and the like with respect to such shares) per annum prior and in preference to the holders of the Company’s common stock, and in preference to the holders of any other equity securities of the Company that may from time to time come into existence to which the Senior Preferred Stock ranks senior (such junior securities, together with the Company’s common stock, “Junior Securities”). No dividends will be paid on Junior Securities in any year unless such dividends of the Senior Preferred Stock are paid in full or declared and set apart. Additionally, whenever the Company shall pay a dividend on its common stock, each holder of a share of Senior Preferred Stock shall be entitled to receive, at the same time the dividend is paid on the common stock, a dividend equal to the amount that would have been paid in respect of the common stock issuable upon conversion of such share of Senior Preferred Stock. As of September 30, 2008, no dividends have been declared.

Liquidation - In the event of a voluntary or involuntary liquidation, dissolution, or winding up of the Company, holders of Series B Preferred Stock are entitled to be paid out first, prior and in preference to any distribution of any of the assets of the Company to holders of common stock, Series A Preferred Stock, or any other stock of the Company ranking junior to the Series B Preferred Stock, an amount per share equal to the Original Issue Price of $0.02 per share of Series B-1 Preferred Stock and of $0.025 per share of Series B-2 Preferred Stock, plus all declared and unpaid dividends on such shares. After payment of the full liquidation preference of the Series B Preferred Stock, if assets or surplus funds remain, holders of Series A Preferred Stock and common stock shall be entitled to be paid out first, prior and in preference to any distribution of any of the assets of the Company to holders of common stock, or any other stock of the Company ranking junior to the Series A Preferred Stock, an amount per share equal to the Original Issue Price of $0.03 per share, plus all declared and unpaid dividends on such shares.

Redemption – The Series A Preferred Stock and Series B Preferred Stock are not redeemable, except that, in the event of a Change of Control (as defined), holders of a majority of the then outstanding shares of Series A Preferred Stock and/or Series B Preferred Stock, separately as two groups, can require redemption of the Series A Preferred Stock and/or Series B Preferred Stock, as the case might be, at a redemption price per share equal to the amount per share to which such holder would be entitled upon a liquidation, dissolution or winding up of the Company. A “Change of Control”, as defined, means (i) the beneficial acquisition by any person or group of 45% or more of the voting power of the outstanding common stock of the Company, (ii) the occupancy of a majority of Board seats by persons other than the directors occupying such seats as of the date of the initial issuance of shares of Series B Preferred Stock (the “Current Directors”) or persons nominated by Current Directors or their nominated successors, or (iii) there shall occur a change in the Chief Executive Officer of the Company without the consent of holders of a majority of the outstanding shares of Series B Preferred Stock. A Change of Control will be treated as a liquidation, dissolution or winding up of the affairs of the Company with respect to certain matters, except as otherwise agreed by holders of a majority of the then outstanding Series B Preferred Stock.

Preferred Stock Issued for Cash and Exchange of Debt and Other Securities – In June 2008, the Company issued (i) 165,000,000 shares of its Series B-1 Preferred Stock for $3.3 million cash, (ii) 152,843,413 shares of its Series A Preferred Stock and 111,244,040 shares of its Series B-1 Preferred Stock in exchange for outstanding promissory notes having a principal balance of approximately $7.5 million and related accrued interest payable of $525,000, and (iii) 60,000,000 shares of its Series B-1 Preferred Stock in exchange for shares of the Company’s “old” Series A preferred stock, which was issued in exchange for $1.2 million cash received during April and May 2008, and which such series was eliminated upon exchange.

In connection with the acquisition of the securities, the Company entered into an Investor Rights Agreement with investors who acquired shares of Series A Preferred Stock and Series B Preferred Stock (each an “Investor” and together “Investors”). Pursuant to terms of such agreement, among other things, the Company has agreed to file with the Securities and Exchange Commission a registration statement to enable the resale of common shares issuable pursuant to conversion terms of Senior Preferred Stock and certain warrants issued concurrently, upon written notice of at least 40% of the then Registrable Securities, as defined, to use reasonable best efforts to file such registration statement, and such additional registration statements as may be necessary, at the earliest practicable date on which the Company is permitted by the SEC guidance to file such additional registration statements, and to cause such registration statement(s) to become effective and continue to be effective for such period necessary to provide for, in general, the resale of such securities with certain exceptions and limitations. The Investor Rights Agreement also provides Investors with certain piggy-back registration rights. Additionally, pursuant to terms of the Investor Rights Agreement, for a three year period, each Investor holding at least 5,000,000 shares of common stock or Senior Preferred Stock (each a “Major Holder”), shall, in general, have a pre-emptive right to receive from the Company prior notice of any proposed or intended issuance or sale of securities and to purchase such eligible purchaser’s pro rata percentage of the number of shares of common stock, as converted and defined, on such same terms and conditions.

Common Stock Issued Upon Induced Conversion of Debt and Exchange of Warrants - During the three months ended March 31, 2008, the Company issued approximately 243.9 million shares of its common stock in exchange for full satisfaction of all outstanding convertible notes payable, which approximated $13.2 million and related accrued interest of approximately $1.7 million, and the return of outstanding warrants to purchase approximately 38.6 million shares of Company common stock having an exercise price of $0.06 per share and expiring in April 2015, which such warrants were acquired when the notes were issued.

Additionally, the Company made a special offer to holders of warrants to purchase Company common stock to exchange all outstanding warrants into shares of Company common stock in a number of shares equal to 60% to 75% (depending on the warrant) of the number of warrant shares exchanged. Holders of approximately 124.2 million warrants accepted the offer and the Company issued approximately 81.9 million shares of its common stock. The shares were valued at approximately $536,000 based on the closing stock price on the exchange date, and the excess of fair value issued over the fair value of securities received has been recorded as a loss of approximately $556,000.

Common Stock Issued in Exchange for Accounts Payable and Accrued Liabilities - During the three months ended March 31, 2008, the Company entered into agreements with certain vendors that have provided services to the Company to issue shares of its common stock in satisfaction of amounts owed, and in connection with these agreements issued approximately 15.9 million shares of its common stock in satisfaction of approximately $754,000 owed, which included approximately 12.0 million shares issued in exchange for $567,000 included in accounts payable – related party at December 31, 2007. The shares were valued at $829,000 based on the quoted trading price on the agreement dates, resulting in a loss on exchange of approximately $75,000.

Common Stock Issued for Services - During 2006, the Company entered into an employment agreement with an individual to serve as its Chief Executive Officer and a Director, pursuant to which, among other things, the executive received 44,000,000 shares of Company common stock, of which 26,400,000 were fully vested, and of which 11,000,000 shares vested in 2007, and the remaining vested during the nine months ended September 2008. The total value of the shares based on the grant date quoted trading price of the Company’s common stock was approximately $5.7 million. The Company recognized stock-based compensation expense of approximately $1.4 million and $3.9 million in 2007 and 2006, respectively, and as of December 31, 2007, there was approximately $405,000 of unrecognized compensation expense related to unvested stock, which has been recognized as expense during the nine months ended September 30, 2008.

In February 2007, the Company entered into an employment agreement with an individual to serve as its Vice President of Sales & Marketing, pursuant to which, among other things, the executive received 4,400,000 shares of Company common stock, 1,100,000 of which were fully-vested and the remainder vesting evenly over the next three years, and is entitled to receive warrants to purchase 1,100,000 shares of Company common stock at $0.30 per share on the one year anniversary of the employment agreement and warrants to purchase 1,100,000 shares of Company common stock at $0.40 per share on the second year anniversary. The warrants have a four-year term and vest ratably over 3 years. The shares are valued at approximately 1,100,000 based on the quoted trading price of $0.25 on the effective date and the warrants are valued at approximately $511,000 computed using a Black-Scholes option pricing model with the following assumptions: contractual terms of 4 and 10 years, volatility of 184% (based on historical volatility over the term), zero dividends and interest rate of 4.5%. In connection with this agreement, the Company recorded compensation expense for fully-vested shares and for a portion of the unvested shares amortized on a straight-line basis over the vesting periods. The Company recorded compensation expense of approximately $792,000 during 2007. As of December 31, 2007, there was approximately $820,000 of unrecognized compensation expense related to unvested stock and warrants, which is expected to be recognized as expense of approximately $436,000 in 2008 and $230,000 in 2009, and $130,000 in 2010, and $24,000 in 2011. The Company recognized expenses of approximately $350,000 during the nine months ended September 30, 2008.

During 2007, the Company issued 5,070,411 shares of Company common stock to various non-employee service providers and has recorded the fair value of shares issued based on the closing market price of stock on the respective measurement dates of approximately $899,000 as an increase in additional paid-in capital. Stock-based compensation expense is recognized over the requisite service periods, all of which, except one relating to rent, expired in 2007. At September 30, 2008, unrecognized expense of $11,000 is recorded as deferred stock-based consulting, a component of stockholders’ deficit, which is expected to be recognized as expense in years 2008 - 2010.

Pursuant to terms of a mutual settlement and release agreement, in early 2008, among other things, the Company issued 5,000,000 shares of its common stock to a former executive, and the former executive returned to the Company for cancellation all previously issued warrants, which include vested warrants to purchase approximately 17 million shares and forfeited all rights to acquire additional shares under the employment agreement. The Company recorded the 5,000,000 shares issuable, net of the approximately $101,000 fair value of warrants surrendered, as compensation expense of approximately $249,000 during 2007, based on the $0.07 quoted trading price of the Company’s common stock and black-scholes fair value computations at year-end, when it was determined that it was more likely than not that such an arrangement would be agreed upon.

Common stock issued – During 2008, the Company issued 395,588 shares of its common stock to investors, for which the Company previously recorded 752,731 shares as issued in 2006, and obtained releases from such investors as to any additional future liability or obligations, and as a result reported a decrease in shares issuable previously recorded as issued in 2006 of 357,143 shares in the accompanying condensed statement of changes in stockholders’ equity.

Stock Warrants issued for services – During 2007, the Company issued warrants to a new employee to purchase 2,000,000 shares of its common stock at an exercise price of $0.0975 with a ten-year term and recorded compensation expense of approximately $204,000 based on the fair value as determined utilizing the Black-Scholes valuation model. The closing stock price at the issuance date was $0.19 per share. As of December 31, 2007, there was approximately $176,000 of unrecognized compensation expense related to unvested warrants. During 2008, the employee left the Company and was allowed to retain the warrants on a fully-vested basis and the Company recorded the remaining $176,000 as expense.

During 2008, the Company issued to certain of its non-employee directors warrants to purchase 750,000 shares and 1,000,000 shares of its common stock at an exercise price of $0.22 and $0.07, respectively, with a term of approximately 6.8 years and recorded compensation expense of approximately $77,000 based on the fair value as determined utilizing the Black-Scholes valuation model. The closing stock price at the issuance date was $0.04 per share.

In connection with, among other things, consummation of the June 2008 financing transactions resulting in exchanges of outstanding notes payable and receipt of cash in consideration of the issuance of shares of the Company’s Series A and Series B-1 Convertible Preferred Stock, the Company issued to each of two of the Company’s new Directors warrants to purchase 10,918,072 shares of its common stock at a per share price of $0.02 with a ten-year term. The Black-Scholes determined fair value of the warrants of approximately $1.0 million has been accounted for as stock issue costs, which results in an increase and decrease in additional paid in capital, for no net effect on stockholders’ equity.

In August 2008, the Company issued to one of its executive officers a warrant for the purchase of 7,500,000 shares of its common stock at an exercise price of $0.02, with a term of approximately 10 years. The warrants vest monthly over three years contingent upon attainment of certain specified production and other milestones relating to future periods. In September 2008, the officer ceased employment with the Company, the warrants were cancelled unvested, and no expense was recorded.

During the three months ended September 30, 2008, the Company agreed to issue to a consultant warrants for the purchase of 7,500,000 shares of its common stock at an exercise price of $0.015, with a term of approximately 6.5 years and recorded general and administrative expense of approximately $145,000 based on the fair value as determined utilizing the Black-Scholes valuation model. The closing stock price at the issuable date was $0.02 per share. In addition, during the three months ended September 30, 2008, the Company agreed to issue to a consultant warrants for the purchase of 300,000 shares of its common stock at an exercise price of $0.02, with a term of approximately 6.5 years, the estimated fair value of which approximated $11,000 as determined utilizing the Black-Scholes valuation model. The closing stock price at the issuable dates averaged approximately $0.04 per share.

Certain of the Company’s outstanding warrants have exercise prices that are subject to downward adjustments in the event the Company sells certain of its equity securities at per share prices less than originally established exercise prices. Additionally, certain of such warrants also contain provisions providing for an increase in the number of shares warrants that may be exercised. The following schedules of warrants outstanding and activity give effect to such adjustments.

The intrinsic value of stock warrants is calculated by aggregating the difference between the closing market price of the Company’s common stock at the reporting period end and the exercise price of warrants which have an exercise price less than the closing price.

The following summarizes activity for stock warrants issued to lenders for borrowings, all of which are exercisable:

	Outstanding			Weighted average exercise price		Weighted average remaining contractual life in years		Aggregate intrinsic value (in thousands)
Balance at December 31, 2007		123,406,817		$	0.09		6.2	$	962
Issued		142,997,419			0.02
Increase for price adjustment		3,833,333			0.02
Exchanged		(129,691,141	)
Balance at September 30, 2008		140,546,428		$	0.02		6.4	$	680

The following summarizes activity for stock warrants issued to consultants for services, all of which are exercisable:

	Outstanding			Weighted average exercise price		Weighted average remaining contractual life in years		Aggregate intrinsic value (in thousands)
Balance at December 31, 2007		31,715,179		$	0.08		5.6	$	220
Issued		21,836,144			0.02
Issuable		7,800,000			0.02
Exchanged		(9,325,693	)		0.10
Balance at September 30, 2008		52,025,630		$	0.03		7.4	$	37

The following summarizes activity for stock warrants issued to employees and directors, substantially all of which are exercisable:

	Outstanding			Weighted average exercise price		Weighted average remaining contractual life in years		Aggregate intrinsic value (in thousands)
Balance at December 31, 2007		27,575,000			0.09		5.6	$	151
Issued		9,250,000			0.04
Issuable		1,100,000			0.30
Exchanged		(23,825,000	)		0.08
Forfeited		(11,250,000	)		0.05
Balance at September 30, 2008		2,850,000		$	0.20		6.5	$	-

The following summarizes activity for all stock warrants, substantially all of which are exercisable:

	Outstanding			Weighted average exercise price		Weighted average remaining contractual life in years		Aggregate intrinsic value (in thousands)
Balance at December 31, 2007		182,696,996			0.09		6.1	$	1,333
Issued		174,083,563			0.02
Issuable		8,900,000			0.05
Increase for price adjustment		3,833,333			0.02
Exchanged		(162,841,834	)
Forfeited		(11,250,000	)		0.05
Balance at September 30, 2008		195,422,058		$	0.02		6.8	$	717

Additional information regarding all warrants outstanding as of September 30, 2008, is as follows:

Exercise prices			Shares		Weighted average remaining life
$	0.001			60,000	2.7 years
$	0.015			140,739,761	6.4 years
$	0.02			30,692,667	8.0 years
$	0.05			1,100,000	1.8 years
$	0.06			18,979,630	6.6 years
$	0.07			1,000,000	6.6 years
$	0.12			1,000,000	7.5 years
$	0.22			750,000	6.5 years
$	0.30			1,100,000	6.5 years
		Total		195,422,058	7.4 years

Note 7. Related Party Transactions

Pursuant to an agreement for legal services with a law firm, the managing partner of which is one of the Company’s Directors, the Company incurs legal fees for services provided. During the nine months ended September 30, 2008 and 2007, the Company incurred legal fees from the firm of approximately $261,000 and $293,000, respectively. In March 2008, the Company issued approximately 12.0 million shares of its common stock in exchange for satisfaction of accounts payable to the firm of approximately $567,000. At September 30, 2008, accounts payable due to the firm for services of $84,000 are included in accounts payable to related party.

In September 2008, the Company entered into an agreement with its former Chief Technology Officer pursuant to terms of which, among other things, the officer ceased employment with the Company and the employment agreement entered into by the Company and the officer in 2006 terminated. In connection with this agreement, the Company will pay the former officer approximately $75,000 over approximately three months, the officer will transfer to the Company 717,949 shares of Company common stock, and the Company agreed to issue 2.5 million shares of its common stock and pay $50,000 cash in three equal monthly payments starting in October 2008 to a third party. As a result, the Company recorded accrued liabilities and expense of approximately $178,000 as of September 30, 2008 and for the three and nine months then ended.

Note 8. Commitments and Contingencies

Legal proceeding – The Company is subject to various lawsuits and other claims in the normal course of business. At times, the Company establishes accruals for specific liabilities in connection with legal actions deemed to be probable and reasonably estimable. No material amounts have been accrued as of September 30, 2008 in these accompanying financial statements with respect to any legal matters. Company management does not expect that the ultimate resolution of pending legal matters in future periods will have a material effect on the Company’s financial condition or results of operations.

Leases – In August 2008, the Company entered into an amendment of its Riverbank facilities lease agreement, as amended, exercising its option to extend the expiration of the lease from May 2009 through March 2010 and to rent additional space.

Note 9. Subsequent Events through November 13, 2008

In connection with financing agreements executed by the Company and pursuant to the Preliminary Schedule 14C filed by the Company on November 6, 2008, the Company seeks to amend its Certificate of Incorporation again with the state of Delaware (the “Amendment”) to increase the amount of authorized shares of capital stock. In August 2008, ECO2’s board of directors approved an amendment of the Company’s Certificate of Incorporation, as amended, to increase the number of authorized shares to Four Billion Two Hundred Million (4,200,000,000) shares of capital stock (the “Amended Authorized Amount”). Of the Amended Authorized Amount, Two Billion Five Hundred Million (2,500,000,000) shares shall be classified as common stock and One Billion Seven Hundred Million (1,700,000,000) shares shall be classified as preferred stock.

Effective October 1, 2008, the Company and an individual agreed to terms of an offer of employment pursuant to which, among other things, the individual will serve as its Senior Vice President of Operations and in additional to cash compensation and other customary employee related benefits receive a warrant to purchase 15 million shares of Company common stock, 25% of which vest at the end of one year and the remainder vest equally on a monthly basis over the next four years. The warrants have a term of approximately 6.5 years and an exercise price of $0.015 per share and will be valued at approximately $290,000 as determined utilizing the Black-Scholes valuation model and expensed over the vesting period. The closing stock price at the issuable date was $0.02 per share.

On October 31, 2008, effective November 17, 2008, the Company and an individual agreed to terms of an offer of employment pursuant to which, among other things, the individual will serve as its Chief Financial Officer and in additional to cash compensation and other customary employee related benefits receive a warrant to purchase 20 million shares of Company common stock, 25% of which vest at the end of one year and the remainder vest equally on a monthly basis over the next four years. The warrants have a term of approximately 6.5 years and an exercise price of $0.015 per share and will be valued at approximately $385,000 as determined utilizing the Black-Scholes valuation model and expensed over the vesting period. The closing stock price at the issuable date was $0.02 per share.

As a result of our next generation proprietary CO2 system beginning to come online, which is expected to significantly reduce production bottle-necks and provide for increased throughput, and to reduce plant operating costs and use of cash during the ramp-up period, the Company decided to direct all production to the next generation technology and accordingly cease operating prior technology production lines. In the near term, specifically the quarter ending December 31, 2008, production volumes and revenues will decrease as the next generation technology comes on line and then is expected to increase as throughput increases as a percentage of capacity. In connection with ceasing prior technology production, on November 13, 2008 we terminated approximately 85 employees at our Riverbank plant, thus reducing our workforce to approximately 35 employees. As production volume increases over the next several months, similarly, our workforce is expected to increase.

Item 2. Management’s Discussion and Analysis or Plan of Operations

FORWARD LOOKING STATEMENTS CAUTIONARY

This Item 2 and the September 30, 2008 Quarterly Report on Form 10-Q may contain "forward-looking statements." In some cases, you can identify forward-looking statements by terminology such as "may," "will," "should," "could," "expects," "plans," "intends," "anticipates," "believes," "estimates," "predicts," "potential" or "continue" or the negative of such terms and other comparable terminology. These forward-looking statements include, without limitation, statements about our market opportunity, our strategies, competition, expected activities and expenditures as we pursue our business plan, and the adequacy of our available cash resources. Although we believe that the expectations reflected in any forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, performance or achievements. Actual results may differ materially from the predictions discussed in these forward-looking statements. Changes in the circumstances upon which we base our predictions and/or forward-looking statements could materially affect our actual results. Additional factors that could materially affect these forward-looking statements and/or predictions include, among other things: (1) our limited operating history; (2) the risks inherent in the investigation, involvement and acquisition of a new business opportunity; (3) unforeseen costs and expenses; (4) our ability to continue to raise funds; (5) the Company's ability to comply with federal, state and local government regulations; and (6) other factors over which we have little or no control.

We do not undertake any obligation to publicly update any forward-looking statement, whether as a result of new information, future events, or otherwise, except as required by law. Such forward-looking statements involve known and unknown risks, uncertainties and other factors which may cause our actual results or achievements to be materially different from any future results or achievements expressed or implied by such forward-looking statements. Such factors include the factors described in our audited financial statements and elsewhere in the Company’s December 31, 2007 Annual Report on Form 10-KSB.

Further, in connection with, and because we desire to take advantage of, the "safe harbor" provisions of the Private Securities Litigation Reform Act of 1995, we caution readers regarding certain forward looking statements in the following discussion and elsewhere in this report and in any other statement made by, or on our behalf, whether or not in future filings with the Securities and Exchange Commission. Forward looking statements are statements not based on historical information and which relate to future operations, strategies, financial results or other developments. Forward looking statements are necessarily based upon estimates and assumptions that are inherently subject to significant business, economic and competitive uncertainties and contingencies, many of which are beyond our control and many of which, with respect to future business decisions, are subject to change. These uncertainties and contingencies can affect actual results and could cause actual results to differ materially from those expressed in any forward looking statements made by, or on our behalf.

The following should be read in conjunction with the annual audited Company’s financial statements included in our December 31, 2007 Annual Report on Form 10-KSB (the “Annual Report”).

Business – ECO2 Plastics, Inc., “ECO2” or the “Company”, was incorporated under the laws of the State of Delaware in 2000, and formed for the purpose of acquiring certain patented technology and the development of a worldwide market for its usage. ECO2 has developed a unique and revolutionary cleaning process, referred to as the ECO2 Environmental System (the “ECO2 Environmental System”). The ECO2 Environmental System cleans post-consumer plastics, without the use of water, at a substantial cost savings versus traditional methods (the “Process”). This Process is licensed from Honeywell and the Department of Energy on an exclusive basis for the life of the patent. Since its inception, ECO2 has invested in the development of the technology and equipment comprising the ECO2 Environmental System, which includes a patent issued in 2007. This included building several scaled up versions of the Prototype ECO2 Environmental System (the “Prototype”), testing of the Prototypes, building a pilot plant, evaluating the product produced by the Prototype and real-time testing. The Company’s first full scale production facility was constructed in Riverbank, California and is now producing saleable product and ramping up to full scale operations as it further develops the process. ECO2’s goal is to build and operate plastic recycling plants in the USA that utilize the ECO2 Environmental System and to expand the ECO2 Environmental System worldwide. ECO2’s growth strategy includes organic growth, strategic acquisitions and licensing or partnership agreements, where appropriate.

The Company operates in the evolving field of plastics materials recycling. New developments could both significantly and adversely affect existing and emerging technologies in the field. The Company's success in developing additional marketable products and processes and achieving a competitive position will depend on its ability to attract and retain qualified management personnel and to raise sufficient capital to meet its operating and development needs.

Liquidity and Capital Resources - At September 30, 2008, we had cash and cash equivalents of approximately $1.1 million and a working capital deficit of approximately $2.3 million, compared to cash and cash equivalents of $101,000 and a working capital deficit of $18.6 million at December 31, 2007. At September 30, 2008, we had total stockholders’ equity of approximately $5.8 million compared with total stockholder's deficit of approximately $11.8 million at December 31, 2007. While our financial position and condition is much improved and we are well positioned for operational and financial successes in the future, at September 30, 2008, the Company does not have sufficient cash to meet its needs for the next twelve months.

The Company has incurred recurring losses from operations and has a net working capital deficit and has had net capital deficiencies that raise substantial doubt about its ability to continue as a going concern. The Report of Independent Registered Public Accounting Firm included in the Company’s December 31, 2007 Annual Report stated that these conditions, among others, raise substantial doubt about the Company’s ability to continue as a going concern. Historically, our cash needs have been met primarily through proceeds from private placements of our equity securities and debt instruments including debt instruments convertible into our equity securities. Company management intends to raise additional cash to fund future operations and to provide additional working capital. However, there is no assurance that such financing will be obtained. We expect to continue to raise capital in the future, but cannot guarantee that such financing activities will be sufficient to fund our current and future projects and our ability to meet our cash and working capital needs.

The Company’s Board of Directors and Chief Executive Officer continue to be actively involved in discussions and negotiations with investors with respect to raising additional cash. During the nine months ended September 30, 2008:

·	The Company received cash of approximately $3.4 million pursuant to issuance of short-term notes payable to new and existing investors (subsequently exchanged for equity);

Holders of convertible notes payable having a total principal amount outstanding of approximately $13.2 million, together with accrued interest of approximately $1.7 million, converted such notes and returned to the Company warrants to purchase approximately 38.6 million shares of common stock at $0.06 per share and in exchange received approximately 243.9 million shares of the Company’s common stock;

·	Pursuant to terms of a special offer made to all holders of warrants to purchase common stock, approximately 124.2 million warrants were exchanged for approximately 81.9 million shares of Company common stock;

·	The Company entered into agreements with certain service providers pursuant to which the Company issued approximately 15.9 million shares of its common stock as payment for amounts owed for services of approximately $754,000;

·	Holders of promissory notes having a principal amount of approximately $6.5 million, together with related accrued interest of $525,000, exchanged such notes for 152,000,000 shares of the Company’s Series A Preferred Stock and 111,240,040 shares of the Company’s Series B-1 Preferred Stock; and

·	The Company received cash of approximately $4.5 million relating to the sale and issuance of 225,000,000 shares of its Series B-1 Preferred Stock.

·	The Company received cash of approximately $3.9 million relating to the issuance of $3.9 million convertible notes payable and warrants to purchase shares of approximately 129 million shares of common stock at $0.015 per share.

The focus of these efforts is to sufficiently capitalize the Company in order to fund next generation processing and other equipment, and to provide adequate working capital for operations with a near-term goal of generating positive cash flow from operations.

Change in Accounting Principle - The September 30, 2008 financial statements reflect adoption of EITF 08-4. In accordance with EITF 08-4 Transition Guidance and SFAS No. 154, Accounting for Changes and Error Corrections, the Company has retrospectively applied the accounting guidance of EITF 00-27. During the three months ended March 31, 2008, certain convertible promissory notes payable were exchanged for shares of Company common stock and the remaining unamortized debt discount of approximately $2.2 million was transferred to equity. As a result of adoption of EITF 00-27 accounting guidance, the September 30, 2008 financial statements retrospectively give effect to recognition of the $2.2 million remaining unamortized debt discount as interest expense. Accordingly, interest expense and net loss for the nine months ended September 30, 2008 are approximately $2.2 million more than would have been in the absence of retrospective application and additional paid in capital is $2.2 million more. There is no effect on cash flows. There was no cumulative effect for periods prior to 2008.

Results of Operations –

Three months ended September 30, 2008 and 2007

Revenues were approximately $2.5 million during the three months ended September 30, 2008 as compared to $1.4 million during the comparative prior year period. Revenues increased due primarily to increased production volumes resulting from processing improvements and ceasing to sell recycled products at earlier stages of production.

The Company derives its revenues from certain major customers. The loss of major customers could create a significant financial hardship for the Company. During the three months ended September 30, 2008, revenues from 2 customers represented approximately 71% of total revenues.

Cost of goods sold consists of the cost of raw materials processed and was approximately $1.9 million during the three months ended September 30, 2008 as compared to $1.2 million during the comparative prior year period. There was a gross profit of $632,000 for the three months ended September 30, 2008 as compared to a gross profit of $202,000 in the comparative prior year period. As a percent of revenues, gross profit was 25% and 14% for the three months ended September 30, 2008 and 2007, respectively. The plant operated at higher levels of production during the quarter as a result of process improvements to relieve bottle-necks and increase capacity and yield. Most of the output was shipped at market prices, certain expenses were reduced and the cost of raw materials decreased slightly during the quarter.

Plant operations and technology development expenses increased to approximately $2.8 million for the three months ended September 30, 2008 as compared to $1.7 million for the comparative prior year period. As the Company ramps up the Riverbank Plant, operating expenses are increasing commensurate with the increase in operating activity, comprised primarily of payroll and related, utilities, occupancy, supplies, and repairs and maintenance expenses. Payroll and related costs approximated $877,000 in during the three months ended September 30, 2008 as compared to $737,000 during the comparative prior year period, and depreciation expense approximated $324,000 during the three months ended September 30, 2008 as compared to $266,000 in the prior year period. Other plant operating expenses approximated $1.6 million during the three months ended September 30, 2008 as compared to approximately $1.2 million during the comparative prior year period. As production increases to closer to capacity volumes, certain plant operations expenses will be included in cost of goods sold.

General and administrative expenses decreased to $1.2 million for the three months ended September 30, 2008 as compared to $2.0 million for the comparative prior year period. Payroll and related costs approximated $361,000 during the three months ended September 30, 2008 as compared to $1.4 million in the comparative prior year period. The decrease in 2008 payroll and related was primarily due to higher non-cash stock-based compensation in the comparative prior year period of $788,000 as compared to $136,000 during the comparative 2008 period relating to employment agreements equity awards with certain executive officers and related recruiter fees payable in equity securities. Consulting and legal fees expenses approximated $330,000 during the three months ended September 30, 2008 as compared to $136,000 during the comparative prior year period, the increase being attributable to $145,000 recorded as a result of issuance of 7.5 million warrants to a consultant.

As a result of the above described increase in gross profit, increase in plant operations and technology development expenses and decrease in general and administrative expenses, the Company’s loss from operations decreased from approximately $3.4 million for the three months ended September 30, 2007 to $3.3 million for the three months ended September 30, 2008.

The Company recorded interest expense of approximately $529,000 for the three months ended September 30, 2008 as compared to $4.7 million during the prior year period. Interest expense includes amortization of debt issue costs and debt discount of approximately $474,000 during the three months ended September 30, 2008 and $4.2 million during the prior year period. The decrease in interest expense for 2008 as compared to the prior year was primarily due to note conversions in 2008 and the last half of 2007.

The Company’s net loss decreased from approximately $8.1 million for the three months ended September 30, 2007, to $3.8 million for the three months ended September 30, 2008, due primarily to the $4.2 million decrease in interest expense.

Nine months ended September 30, 2008 and 2007

Revenues were approximately $5.4 million during the nine months ended September 30, 2008 as compared to $2.0 during the comparative prior year period. Revenues increased due primarily to increased production volumes resulting from processing improvements and decreasing sales of recycled products at earlier stages of production.

The Company derives its revenues from certain major customers. The loss of major customers could create a significant financial hardship for the Company. During the nine months ended September 30, 2008, revenues from 5 customers represented approximately 85% of total revenues.

Cost of goods sold consists of the cost of raw materials processed and was approximately $4.9 million during the nine months ended September 30, 2008 as compared to $1.9 million during the comparative prior year period. There was a gross profit of $593,000 for the nine months ended September 30, 2008 as compared to a gross profit of $116,000 in the comparative prior year period. As a percent of revenues, gross profit was 11% and 6% for the nine months ended September 30, 2008 and 2007, respectively. The plant operated at higher levels of production during the 2008 nine month period as compared to the prior year period as a result of process improvements to relieve bottle-necks and increase capacity and yield. Most of the output was shipped at market prices, certain expenses were reduced and the cost of raw materials decreased slightly.

Plant operations and technology development expenses increased to $6.6 million for the nine months ended September 30, 2008 as compared to $4.3 million for the comparative prior year period. As the Company ramps up the Riverbank Plant, operating expenses are increasing commensurate with the increase in operating activity, comprised primarily of payroll and related, utilities, occupancy, supplies, and repairs and maintenance expenses. Payroll and related costs approximated $2.3 million during the nine months ended September 30, 2008 as compared to $1.4 million during the comparative prior year period, and depreciation expense approximated $1.0 million during the nine months ended September 30, 2008 as compared to $788,000 in the prior year period. Other plant operating expenses approximated $3.3 million during the nine months ended September 30, 2008 as compared to $2.5 million during the comparative prior year period. As production increases to closer to capacity volumes, certain plant operations expenses will be included in cost of goods sold.

General and administrative expenses decreased to $3.6 million for the nine months ended September 30, 2008 as compared to $6.6 million for the comparative prior year period. Payroll and related costs approximated $2.0 million during the nine months ended September 30, 2008 as compared to $4.8 million in the comparative prior year period. The decrease in 2008 payroll and related was primarily due to higher non-cash stock-based compensation in the comparative prior year period of $3.0 million as compared to $972,000 during the comparative 2008 period relating to employment agreements equity awards with certain executive officers and related recruiter fees payable in equity securities. Consulting and legal fees expenses approximated $662,000 during the nine months ended September 30, 2008 as compared to $614,000 during the comparative prior year period.

As a result of the above described increase in gross profit, increase in plant operations and technology development expenses, decrease in general and administrative expenses, and the absence of settlement expense of $680,000 in 2007 the Company’s loss from operations decreased from approximately $11.4 million for the nine months ended September 30, 2007 to $9.6 million for the nine months ended September 30, 2008.

The Company recorded interest expense of approximately $6.1 million for the nine months ended September 30, 2008 as compared to $11.8 million during the prior year period. Interest expense includes amortization of debt issue costs and debt discount of approximately $5.5 million during the nine months ended September 30, 2008 and $10.7 million during the prior year period. The decrease in interest expense for 2008 as compared to 2007 was primarily due to note conversions in 2008 and last half of 2007.

The Company’s net loss decreased from approximately $23.3 million for the nine months ended September 30, 2007 to $19.1 million for the nine months ended September 30, 2008, due primarily to the $1.9 million decrease in loss from operations and $5.7 million decrease in interest expense, offset by a $3.5 million loss recorded in 2008 representing the excess of fair value of common stock issued in exchange for accounts payable, notes payable, accrued interest and warrants.

Inflation - Although our operations are influenced by general economic conditions, we do not believe that inflation had a material effect on our results of operations.

Cash Provided (Used) by Operating, Investing and Financing Activities - During the nine months ended September 30, 2008 cash used by operating activities increased to approximately $7.5 million from $5.1 million during the comparative prior year period, due primarily decreases in accounts payable in the 2008 period as compared to increases in the prior year period and to the increase in net loss before depreciation and amortization, stock-based compensation and settlement expense, amortization of debt issue costs and discount and excess of fair value of common stock issued, which is approximately $8.0 million in the 2008 period as compared to $7.3 million during the prior year period.

During the nine months ended September 30, 2008, cash used by investing activities decreased to $2.4 million relating to capital expenditures on the recycling plant as compared to $2.9 million during the prior year period.

During the nine months ended September 30, 2008, cash provided by financing activities was approximately $10.9 million as compared to $8.2 million during the comparative prior year period. During the 2008 period, the Company received cash of approximately $7.5 million pursuant to issuance of short-term notes payable to new and existing investors and $4.5 million pursuant to issuances of preferred stock. During the 2008 period, the Company repaid $475,000 of short-term notes payable and $173,000 of CIWMB obligations and incurred stock and debt issue costs of $242,000 and $199,000, respectively. During the 2007 period, the Company received proceeds of approximately $8.6 million (including approximately $1.2 million receivable for cash in escrow for securities sold in 2006) from sales of private placement units comprised of convertible promissory notes and warrants.

Critical Accounting Policies and Estimates – The preparation of financial statements included in this Quarterly Report requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. On an on-going basis, management evaluates its estimates and judgments. Management bases its estimates and judgments on historical experiences and on various other factors that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. The more significant accounting estimates inherent in the preparation of the Company's financial statements include estimates as to the depreciable lives of property and equipment, valuation of accounts receivable and inventories, amounts of contingent liabilities, valuation of equity related instruments issued, and the valuation allowance for deferred income tax assets. Our accounting policies are described in the notes to financial statements included in the Company's Annual Report on Form 10-KSB. The more critical accounting policies are as described below.

Going concern presentation - The accompanying financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America, which contemplate continuation of the Company as a going concern. Since inception, the Company has reported losses and operating activities have used cash, and has net working capital deficiencies and has had net capital deficiencies, which raises substantial doubt about its ability to continue as a going concern. The Report of Independent Registered Public Accounting Firm included in the Company’s Annual Report on Form 10-KSB stated that these conditions, among others, raise substantial doubt about the Company’s ability to continue as a going concern. Company management intends to arise additional financing to fund future operations and to provide additional working capital. However, there is no assurance that such financing will be obtained in sufficient amounts necessary to meet the Company’s needs. The accompanying financial statements do not include any adjustments to reflect the possible future effects on the recoverability and classification of assets or the amounts and classifications of liabilities that may result from the outcome of this uncertainty.

Revenue recognition - The Company recognizes revenue when there is persuasive evidence of an arrangement, the product has been delivered to the customer, the sales price is fixed or determinable, and collectability is reasonably assured. The Company recognizes revenues from sales of recycled products upon shipment to customers. Amounts received in advance of when products are delivered are recorded as liabilities until earned. Research or other types of grants from governmental agencies or private organizations are recognized as revenues if evidence of an arrangement exists, the amounts are determinable and collectability is reasonably assured with no further obligations or contingencies remaining.

In April 2007 the Company was granted $84,000 for research from a private consortium. The Company will receive payments based on achievement of milestones as defined in the grant. No payments were received and no revenues were recognized in 2007 as the milestones were not yet met. In 2008 certain milestones were met and the Company recognized approximately $161,000 of revenue.

Income taxes - The Company utilizes SFAS No. 109, “Accounting for Income Taxes,” which requires recognition of deferred tax assets and liabilities for the expected future tax consequences of events that have been included in the financial statements or tax returns. Under this method, deferred income taxes are recognized for the tax consequences in future years of differences between the tax bases of assets and liabilities and their financial reporting amounts at each period end based on enacted tax laws and statutory tax rates applicable to the periods in which the differences are expected to affect taxable income. Valuation allowances are established, when necessary, to reduce deferred tax assets to amounts expected to be realized. The Company continues to provide a full valuation allowance to reduce its net deferred tax asset to zero, inasmuch as Company management has not determined that realization of deferred tax assets is more likely than not. The provision for income taxes represents the tax payable for the period and change during the period in net deferred tax assets and liabilities.

Stock-based compensation – The Company accounts for all options and warrant grants to employees and consultants in accordance with SFAS 123R, which requires recording an expense over the requisite service period for the fair value of all options or warrants granted employees and consultants.

Recent accounting pronouncements - Effective January 1, 2008, the Company adopted SFAS No. 157, “Fair Value Measurements” (“SFAS 157”), for financial assets and liabilities. Adoption of SFAS 157 did not have a material impact on the Company’s results of operations, financial position or liquidity. This standard defines fair value, provides guidance for measuring fair value and requires certain disclosures. This standard does not require any new fair value measurements, but rather applies to all other accounting pronouncements that require or permit fair value measurements. This standard does not apply measurements related to share-based payments. SFAS 157 discusses valuation techniques, such as the market approach (comparable market prices), the income approach (present value of future income or cash flow), and the cost approach (cost to replace the service capacity of an asset or replacement cost). The statement utilizes a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value into three broad levels. The following is a brief description of those three levels:

Level 1: Observable inputs such as quoted prices (unadjusted) in active markets for identical assets or liabilities.

Level 3: Unobservable inputs that reflect the reporting entity’s own assumptions.

The Company’s financial assets subject to fair value measurements are comprised of cash and cash equivalents of $1,165,000 all of which are valued using Level 1 observable inputs.

In June 2007, the Emerging Issues Task Force of the FASB issued EITF Issue No. 07-3, Accounting for Nonrefundable Advance Payments for Goods or Services to be Used in Future Research and Development Activities, (“EITF 07-3”), which is effective for fiscal years beginning after December 15, 2007. EITF 07-3 requires that nonrefundable advance payments for future research and development activities be deferred and capitalized. Such amounts will be recognized as an expense as goods are delivered or services are performed. Adoption of EITF 07-3 did not have a material impact on the Company’s results of operations, financial position or liquidity.

In March 2008, the FASB issued SFAS No. 161, Disclosures about Derivative Instruments and Hedging Activities – an amendment of SFAS No. 133. This statement changes the disclosure requirements for derivative instruments and hedging activities. SFAS No. 161 requires enhanced disclosures about (a) how and why an entity uses derivative instruments, (b) how derivative instruments and related hedged items are accounted for under SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities, and its related interpretations, and (c) how derivative instruments and related hedged items affect an entity’s financial position, financial performance, and cash flows. SFAS No. 161 is effective for the Company beginning January 1, 2009. The Company does not use derivative financial instruments nor does it engage in hedging activities. The Company is currently evaluating the impact of implementation of SFAS No. 161 on its financial position, results of operations and cash flows.

In June 2008, the FASB issued SFAS No. 162, The Hierarchy of Generally Accepted Accounting Principles. This statement identifies the sources of generally accepted accounting principles and provides a framework, or hierarchy, for selecting the principles to be used in preparing U.S. GAAP financial statements for nongovernmental entities. This statement makes the GAAP hierarchy explicitly and directly applicable to preparers of financial statements. The hierarchy of authoritative accounting guidance is not expected to change current practice but is expected to facilitate the FASB ‘s plan to designate as authoritative its forthcoming codification of accounting standards. This statement is effective 60 days following the SEC’s approval of the PCAOB’s related amendments to remove the GAAP hierarchy from its auditing standards.

Item 3. Quantitative and Qualitative Disclosures about Market Risk.

We do not use derivative financial instruments. Our financial instruments consist of cash and cash equivalents, trade accounts receivable, accounts payable and short and long-term borrowing obligations. Investments in highly liquid instruments purchased with a remaining maturity of 90 days or less at the date of purchase are considered to be cash equivalents.

Our exposure to market risk for changes in interest rates relates primarily to our cash and cash equivalents and short and long-term obligations, all of which have fixed interest rates. Thus, fluctuations in interest rates would not have a material impact on the fair value of these securities. Based on our cash and cash equivalents balances at September 30, 2008, a 100 basis point increase or decrease in interest rates would result in an immaterial increase or decrease in interest income on an annual basis.

Cash and cash equivalents are maintained at financial institutions and, at times, balances may exceed federally insured limits. The Company has never experienced any losses related to these balances. Such amounts on deposit in excess of federally insured limits at September 30, 2008 approximated $1 million.

Item 4. Controls and Procedures

(a) Disclosure controls and procedures.

The Company maintains disclosure controls and procedures that are designed to ensure that information required to be disclosed in the Company’s Exchange Act reports is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to the Company’s management, including its Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions in accordance with the required "disclosure controls and procedures" as defined in Rule 13a-15(e). The Company’s disclosure and control procedures are designed to provide reasonable assurance of achieving their objectives, and the principal executive officer and principal financial officer of the Company concluded that the Company’s disclosure controls and procedures were effective at the reasonable assurance level.

Our management is responsible for establishing and maintaining adequate internal control over financial reporting. Internal control over financial reporting is defined in Rules 13a-15(f) and 15d-15(f) under the Securities Exchange Act, as amended, as a process designed by, or under the supervision of, a company’s principal executive and principal financial officers and effected by a company’s board of directors, 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. Our internal control over financial reporting includes those policies and procedures that:

·	pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of our assets;

provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that our receipts and expenditures are being made only in accordance with authorizations of our management and directors; and

·	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.

Internal control over financial reporting cannot provide absolute assurance of achieving financial reporting objectives because of its inherent limitations. Internal control over financial reporting is a process that involves human diligence and compliance and is subject to lapses in judgment and breakdowns resulting from human failures. Internal control over financial reporting also can be circumvented by collusion or improper management override. Because of such limitations, there is a risk that material misstatements may not be prevented or detected on a timely basis by internal control over financial reporting. However, these inherent limitations are known features of the financial reporting process. Therefore, it is possible to design into the process safeguards to reduce, though not eliminate, this risk. In addition, 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.

In order to evaluate the effectiveness of our internal control over financial reporting as of December 31, 2007, as required by Sections 404 of the Sarbanes-Oxley Act of 2002, our management commenced an assessment, based on the criteria set forth in Internal Control--Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (the "COSO Framework"). A material weakness is a control deficiency, or a combination of control deficiencies, that results in more than a remote likelihood that a material misstatement of our annual or interim financial statements will not be prevented or detected on a timely basis. In assessing the effectiveness of our internal control over financial reporting, our management, including the chief executive officer and interim chief financial officer, could not conclude that our internal controls and procedures were sufficient to ensure that we maintained appropriate internal control over financial reporting at December 31, 2007, as while we considered the criteria established in the COSO Framework, we did not perform a complete assessment as outlined in Commission Guidance Regarding Management’s Report on Internal Control Over Financial Reporting Under Section 13(a) or 15(d) of the Exchange Act. In summary, the Company did not conduct sufficient testing of internal controls in 2007 to satisfy COSO requirements. As a result, we have put an implementation plan in place whereby in 2008 sufficient testing to satisfy COSO requirements will be performed. The absence of the ability to conclude as to the sufficiency of internal controls, is a material weakness.

Despite the insufficient testing, we believe that our financial statements contained in our Annual Report on Form 10-KSB filed with the SEC fairly present our financial position, results of operations and cash flows for the fiscal year ended December 31, 2007 in all material respects. Our Annual Report does not include an attestation report of our independent registered public accounting firm regarding internal control over financial reporting. Our internal controls were not subject to attestation by our independent registered public accounting firm pursuant to temporary rules of the Securities and Exchange Commission that permit us to provide only management’s report in this annual report.

Our management, with the participation of our Chief Executive Officer and Interim Chief Financial Officer, assessed the effectiveness of the Company’s disclosure controls and procedures (as defined in the rules and regulations of the SEC under the Exchange Act) as of September 30, 2008 (the “Evaluation Date”). For those reasons noted above with respect to the assessment of control effectiveness at December 31, 2007, Management determined that its controls were ineffective, and accordingly, has concluded that the Company’s disclosure controls over financial reporting were not effective as of the Evaluation Date.

(b) Changes in internal control over financial reporting.

We are assessing the effectiveness of our internal controls over financial reporting on an account by account basis as a part of our on-going accounting and financial reporting review process in order to comply with Section 404 of the Sarbanes-Oxley Act of 2002, which requires our management to assess the effectiveness of our existing internal controls. This effort includes documenting, evaluating the design of and testing the effectiveness of our internal controls over financial reporting. We intend to continue to refine and improve our internal controls on an ongoing basis. During this process, we may identify items for review or deficiencies in our system of internal controls over financial reporting that may require strengthening or remediation.

There have been no changes in our internal controls over financial reporting during our most recent fiscal quarter that have materially affected, or are reasonably likely to materially affect, our internal controls over financial reporting.

PART II - OTHER INFORMATION

Item 1. Legal Proceedings

The Company is unaware of any threatened or pending litigation against it not in the ordinary course of business and that has not previously been disclosed.

Item 1A. Risk Factors

Risks Related to Our Business

We have had losses since our inception. We expect losses to continue in the near future and there is a risk we may never become profitable.

We have incurred losses and experienced negative operating cash flows since inception. While we cannot guarantee future results, levels of activity, performance or achievements, we expect our revenues to continue to grow in the coming quarters, which will produce gross profits in such amounts so as to more than cover our operating expenses. Actual results may differ materially from those predicted and changes in the circumstances upon which we base our predictions could materially affect our actual results.

Our independent registered public accounting firm, Salberg & Company, P.A., has expressed doubt about our ability to continue as a going concern, which may hinder our ability to obtain future financing.

Salberg & Company, P.A., in its report of independent registered public accounting firm for the years ended December 31, 2007 and 2006, has expressed “substantial doubt” as to our ability to continue as a going concern based on significant operating losses that we incurred. Our financial statements do not include any adjustments that might result from the outcome of that uncertainty. As a result of the going concern disclosure, we may find it much more difficult to obtain financing in the future, if required. Further, any financing we do obtain may be on less favorable terms.

We have few proprietary rights, the lack of which may make it easier for our competitors to compete against us.

The exclusive Patent License Agreement being granted to the Company, as amended, (the “License Agreement”) for our technology with Honeywell FM&T for the system is for the life of the patent, or until terminated by Honeywell FM&T in the event of (i) the bankruptcy of the Company; (ii) an assignment for the benefit of creditors of the Company, (iii) the nationalization of the industry which encompasses any of the products and/or services, limited only within the nationalizing country; (iv) any suspension of payments hereunder by governmental regulation, (v) the Company’s failure to commercialize the licensed technology under this License Agreement; (vi) or the existence of a state of war between the United States of America and any country where the Company has a License to manufacture products and/or services.

If we are unable to manage our growth, our growth prospects may be limited and our future profitability may be adversely affected.

We intend to expand our sales and marketing programs and our manufacturing capability. Rapid expansion may strain our managerial, financial and other resources. If we are unable to manage our growth, our business, operating results and financial condition could be adversely affected. Our systems, procedures, controls and management resources also may not be adequate to support our future operations. We will need to continually improve our operational, financial and other internal systems to manage our growth effectively, and any failure to do so may lead to inefficiencies and redundancies, and result in reduced growth prospects and profitability.

We are subject to intellectual property infringement claims, which may cause us to incur litigation costs and divert management attention from our business.

Any intellectual property infringement claims against us, with or without merit, could be costly and time-consuming to defend and divert our management’s attention from our business. If our products were found to infringe a third party’s proprietary rights, we could be required to enter into royalty or licensing agreements in order to be able to sell our products. Royalty and licensing agreements, if required, may not be available on terms acceptable to us or at all.

The success of our business is heavily dependent upon our ability to secure raw plastic.

Our ability to generate revenue depends upon our ability to secure raw plastic (PET and HDPE flake). To the extent that we are unable to secure enough raw plastic, our business, financial condition and results of operations will be materially adversely affected.

If we were to lose the services of our Chief Executive Officer our business would suffer.

We are substantially dependent upon the continued services of Rodney S. Rougelot, our Chief Executive Officer. The loss of the services of Mr. Rougelot through incapacity or otherwise would have a material adverse effect upon our business and prospects. To the extent that his services become unavailable, we will be required to retain other qualified personnel, and there can be no assurance that we will be able to recruit and hire qualified persons upon acceptable terms.

Should a change in the Chief Executive Officer occur, without the consent of holders of a majority of the outstanding shares of Series B Preferred Stock, holders of a majority of the then outstanding shares of Series B Preferred Stock could require redemption of the Series B Preferred Stock.

Penny stock regulations.

The Securities Enforcement Penny Stock Act of 1990 requires specific disclosure to be made available in connection with trades in the stock of companies defined as “penny stocks.” The Commission has adopted regulations that generally define a penny stock to be any equity security that has a market price of less than $5.00 per share, subject to certain exceptions. Such exceptions include any equity security listed on NASDAQ and any equity security issued by an issuer that has (i) net tangible assets of at least $2,000,000, if such issuer has been in continuous operation for three years; (ii) net tangible assets of at least $5,000,000, if such issuer has been in continuous operation for less than three years; or (iii) average annual revenue of at least $6,000,000, if such issuer has been in continuous operation for less than three years. Unless an exception is available, the regulations require the delivery, prior to any transaction involving a penny stock, of a disclosure schedule explaining the penny stock market and the risks associated therewith as well as the written consent of the purchaser of such security prior to engaging in a penny stock transaction. The regulations on penny stocks may limit the ability of the purchasers of our securities to sell their securities in the secondary marketplace. Our common stock is currently considered a penny stock.

We may encounter potential environmental liability which our insurance may not cover.

We may, in the future, receive citations or notices from governmental authorities that our operations are not in compliance with our permits or certain applicable regulations, including various transportation, environmental or land use laws and regulations. Should we receive such citations or notices, we would generally seek to work with the authorities to resolve the issues raised by such citations or notices. There can be no assurance, however, that we will always be successful in this regard, and the failure to resolve a significant issue could result in adverse consequences to us.

While we maintain insurance, such insurance is subject to various deductible and coverage limits and certain policies exclude coverage for damages resulting from environmental contamination. There can be no assurance that insurance will continue to be available to us on commercially reasonable terms, that the possible types of liabilities that may be incurred by us will be covered by its insurance, that our insurance carriers will be able to meet their obligations under their policies or that the dollar amount of such liabilities will not exceed our policy limits. An uninsured claim, if successful and of significant magnitude, could have a material adverse effect on our business, results of operations and financial condition.

We may need to hire additional employees as we grow.

We may need to hire additional employees to implement our business plan. In order to continue to grow effectively and efficiently, we will need to implement and improve our operational, financial and management information systems and controls and to train, motivate and manage our employees. We intend to review continually and upgrade our management information systems and to hire additional management and other personnel in order to maintain the adequacy of its operational, financial and management controls. There can be no assurance, however, that we will be able to meet these objectives.

We may be unable to obtain and maintain licenses or permits, zoning, environmental and/or other land use approvals that we need to use a landfill and operate our plants.

These licenses or permits and approvals are difficult and time-consuming to obtain and renew, and elected officials and citizens’ groups frequently oppose them. Failure to obtain and maintain the permits and approvals we need to own or operate our plants, including increasing their capacity, could materially and adversely affect our business and financial condition.

Changes in environmental regulations and enforcement policies could subject us to additional liability and adversely affect our ability to continue certain operations.

Because the environmental industry continues to develop rapidly, we cannot predict the extent to which our operations may be affected by future enforcement policies as applied to existing laws, by changes to current environmental laws and regulations, or by the enactment of new environmental laws and regulations. Any predictions regarding possible liability under such laws are complicated further by current environmental laws which provide that we could be liable, jointly and severally, for certain activities of third parties over whom we have limited or no control.

If environmental regulation enforcement is relaxed, the demand for our products may decrease.

The demand for our services is substantially dependent upon the public’s concern with, and the continuation and proliferation of, the laws and regulations governing the recycling of plastic. A decrease in the level of public concern, the repeal or modification of these laws, or any significant relaxation of regulations relating to the recycling of plastic would significantly reduce the demand for our services and could have a material adverse effect on our operations and financial condition.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.

During the period covered by this Form 10-Q, the Company sold the following securities which were not registered under the Securities Act of 1933 (the “Act”):

Convertible Notes Payable – During the three months ended September 30, 2008, the Company received cash of approximately $3.9 million and a promissory note with related accrued interest totaling approximately $101,000 and in exchange issued convertible notes payable (the “Convertible Notes”) of approximately $4.0 million and warrants to purchase approximately 132 million shares of Company common stock. The Convertible Notes bear interest at 15%, and are due March 31, 2009. Upon written election at the discretion of holders of 60% or more of the aggregate principal amount of Convertible Notes then outstanding, the entire principal amount of such notes, together with all accrued interest, which shall be computed as if such notes were held until March 31, 2009, regardless of whether converted prior to that date, shall be converted. If the Company has raised $1 million in new equity (as defined), the conversion price would be the lesser of 80% of the new equity price or $0.015 per share. If such next equity financing has not occurred, then the conversion securities shall consist of shares of a newly created series of Series C Convertible Preferred Stock of the Company having rights, preferences and privileges substantially similar to those of the Company’s Series B Stock, except that the liquidation preference shall be senior to the Series B Stock and the Company’s Series A Convertible Preferred Stock, at a price per share equal to $0.015 (subject to appropriate adjustment for all stock splits, subdivisions, combination, recapitalizations and the like) until April 2015. The Company has pledged as collateral pursuant to terms of a Security Agreement relating to the Convertible Notes, as amended, substantially all of its assets, subject only to a security interest granted to CIWMB.

Item 3. Defaults Upon Senior Securities

Not applicable.

Item 4. Submission of Matters to a Vote of Securities Holders

In July 2008, ECO2’s board of directors approved an amendment of the Company’s Certificate of Incorporation, as amended, to change the number of authorized shares to Two Billion Two Hundred Million shares of capital stock (the “Authorized Amount”). Of the Authorized Amount, One Billion Five Hundred Million (1,500,000,000) shares are classified as common stock and Seven Hundred Million Shares (700,000,000) shares are classified as preferred stock. On August 1, 2008, the Company filed a Definitive Schedule 14C (File No. 033-31067).

In connection with the financing agreements executed by the Company during August and September 2008, and pursuant to the Preliminary Schedule 14C filed by the Company on November 6, 2008, the Company seeks to amend its Certificate of Incorporation again with the state of Delaware (the “Amendment”) to increase the amount of authorized shares of capital stock. In August 2008, ECO2’s board of directors approved an amendment of the Company’s Certificate of Incorporation, as amended, to change the number of authorized shares to Four Billion Two Hundred Million (4,200,000,000) shares of capital stock (the “Amended Authorized Amount”). Of the Amended Authorized Amount, Two Billion Five Hundred Million (2,500,000,000) shares shall continue to be classified as common stock and One Billion Seven Hundred Million (1,700,000,000) shares shall be classified as preferred stock.

Item 5. Other Information

See Item 4 above. In addtion, effective November 17, 2008, the trading symbol for the Company's common stock changed to EOPI from ECOO.

Item 6. Exhibits

[See Exhibit Index below after signatures]

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, as amended, this report has been signed by the following persons on behalf of the Registrant in the capacities and on the dates indicated.

ECO2 PLASTICS, INC.

/s/ Rodney S. Rougelot

Rodney S. Rougelot

Director, Chief Executive Officer and Interim Chief Financial Officer

DATE

November 14, 2008

EXHIBIT INDEX

Exhibit No.	Description	Location

3.1(i)	Amendment to Restated Certificate of Incorporation	Incorporated by reference to Exhibit A to the DEF-14C filed by the Company on November 30, 2005.

3.2(i)	Restated Certificate of Incorporation	Incorporated by reference to Exhibit B to the DEF-14C filed by the Company on September 9, 2002.

3.3(i)	Certificate of Incorporation	Incorporated by reference to the Form S-18 Registration Statement filed by the Company File No. 33-31-67.

3.4(i)	Amendment to Restated Certificate of Incorporation	Incorporated by reference to the DEF-14C filed by the Company on February 22, 2007.

3.5(i)	Amendment to Restated Certificate of Incorporation	Incorporated by reference to the DEF-14C filed by the Company on May 15, 2008.

3.6(i)	Amendment to Restated Certificate of Incorporation	Incorporated by reference to the DEF-14C filed by the Company on August 1, 2008.

3.7(ii)	Bylaws	Incorporated by reference to Exhibit B to the DEF-14C filed by the Company on September 9, 2002.

31.1	Certification of CEO and Interim CFO pursuant to Section 302 of the Sarbanes-Oxley Act	Attached

32.1	Certification of CEO and Interim CFO pursuant to Section 906 of the Sarbanes-Oxley Act	Attached