UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

(Mark One)

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

For the quarterly period ended ~~September~~March 3031, ~~2008~~2009

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

For the transition period from to

Commission file number: 000-51991

Basin Water, Inc.

(Exact name of registrant as specified in its charter)


Delaware		20-4736881
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)

9302 Pittsburgh Avenue, Suite 210 Rancho Cucamonga, California		91730
(Address of principal executive offices)		(Zip Code)

(909) 481-6800

(Registrant’s telephone number, 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 x¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes ¨ No ¨

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

Large accelerated filer ¨ Accelerated filer x Non-accelerated filer ¨ Smaller reporting company ¨

(Do not check if a smaller reporting company)

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

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date: On ~~February 2~~May 18, 2009 there were 22,~~205~~223,~~843~~364 shares of common stock, par value $0.001, outstanding.

BASIN WATER, INC.

INDEX

			Page No.
Part I.	Financial Information:
	Item 1.	Financial Statements:
		Condensed Consolidated Balance Sheets – September 30, 2008 (unaudited) and December 31, 2007 (audited)	1
		Condensed Consolidated Balance Sheets – March 31, 2009 (unaudited) and December 31, 2008 (audited)	1
		Condensed Consolidated Statements of Operations (unaudited) – Three and nine months ended September 30, 2008 and 2007	2
		Condensed Consolidated Statements of Operations (unaudited) – Three months ended March 31, 2009 and 2008	2
		Condensed Consolidated Statement of Changes in Stockholders’ Equity (unaudited) – Nine months ended September 30, 2008	3
		Condensed Consolidated Statement of Changes in Equity (unaudited) – Three months ended March 31, 2009	3
		Condensed Consolidated Statements of Cash Flows (unaudited) – Nine months ended September 30, 2008 and 2007	4
		Condensed Consolidated Statements of Cash Flows (unaudited) – Three months ended March 31, 2009 and 2008	4
		Notes to Condensed Consolidated Financial Statements (unaudited)	5
	Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	2116
	Item 3.	Quantitative and Qualitative Disclosures About Market Risk	3022
	Item 4.	Controls and Procedures	3022
Part II.	Other Information:
	Item 1.	Legal Proceedings	3325
	Item 1A.	Risk Factors	3325
	Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	3326
	Item 3.	Defaults Upon Senior Securities	3426
	Item 4.	Submission of Matters to a Vote of Security Holders	3426
	Item 5.	Other Information	3426
	Item 6.	Exhibits	3526
Signatures			3627

PART I – FINANCIAL INFORMATION

Item 1.

Financial Statements

BASIN WATER, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

(In thousands, except share and per share data)

	September 30,2008			December 31,2007
	March 31,2009			December 31,2008
	(Unaudited)			~~Restated~~
ASSETS
Current assets
Cash and cash equivalents	$	168,~~882~~832		$	3611,~~038~~954
Accounts receivable, net of $461 and $92 allowance for doubtful accounts		3,550			3,167
Accounts receivable, net of $278 and $190 allowance for doubtful accounts		1,922			1,464
Unbilled receivables, net of $235 and $208 allowance for doubtful accounts		3,528			7,357
Accounts receivable under long-term contracts		1,242			3,776
Inventory, net of $79 and $79 reserve		1,482			975
Unbilled receivables, net of $544 and $544 allowance for doubtful accounts		2,404			2,234
Prepaid expenses and other		682			1,163
Inventory, net of $297 and $246 reserves		1,535			1,387
Total current assets		26,124			48,700
Prepaid expenses and other		917			1,030
Total current assets		16,852			21,845
Property and equipment
Property and equipment		3231,~~510~~900			2431,~~885~~894
Less: accumulated depreciation		3,~~106~~938			23,~~235~~640
Property and equipment, net		2927,~~404~~962			2228,~~650~~254
Other assets
Goodwill		2,~~773~~490			62,~~323~~490
Unbilled receivables, net of current portion		—			3,653
Intangible assets, net		2,242			2,382
Intangible assets, net		2,570			2,468
Patent costs, net		3,206			3,233
Patent costs, net		3,251			2,274
Investment in affiliate		150			1,857
Investment in affiliate		2,100			4,632
Other assets		1,160			1,115
Other assets		1,662			1,667
Total other assets		9,248			11,077
Total other assets		12,356			21,017
Total assets	$	54,062		$	61,176
Total assets	$	67,884		$	92,367
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities
Accounts payable	$	32,~~954~~320		$	32,~~553~~485
Current portion of notes payable		56202			~~239~~408
Current portion of capital lease obligations		1013			1110
Current portion of deferred revenue and advances		~~299~~1,545			~~266~~1,280
Current portion of contract loss reserve		1,~~286~~640			21,~~109~~542
Accrued expenses and other		3,~~740~~116			3,~~131~~289
Total current liabilities		98,~~345~~836			9,~~309~~014
Notes payable, net of current portion		~~111~~108			~~113~~109
Capital lease obligations, net of current portion		8—			155
Deferred revenue, net of current portion		~~327~~354			~~391~~257
Deferred revenue - affiliate		~~797~~—			~~1,456~~797
Contract loss reserve, net of current portion		75,~~043~~688			76,~~003~~428
Other long-term liabilities		—271			~~179~~337
Total liabilities		1715,~~631~~257			1816,~~466~~947
Noncontrolling interest		342			84
Commitments and contingencies
Stockholders’ equity
Equity
Common stock, $0.001 par value - 100,000,000 shares authorized, 22,205,843 and 21,948,704 shares issued and outstanding		22			22
Basin Water, Inc. stockholders’ equity
Additional paid-in capital		112,098			110,193
Common stock, $0.001 par value -100,000,000 shares authorized, 22,223,364 and 22,205,923 shares issued and outstanding		22			22
Additional paid-in capital		113,250			112,698
Treasury stock		(552	)		(552	)
Accumulated deficiency		(6174,~~657~~393	)		(3568,~~846~~371	)
Total stockholders’ equity		49,911			73,817
Total Basin Water, Inc. stockholders’ equity		38,327			43,797
Total liabilities and stockholders’ equity	$	67,884		$	92,367
Noncontrolling interest		478			432
Total equity		38,805			44,229
Total liabilities and equity	$	54,062		$	61,176

See accompanying notes to unaudited condensed consolidated financial statements.

BASIN WATER, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(In thousands, except per share data)

(Unaudited)


	Three Months Ended March 31,
	2009			2008
	(Unaudited)
Revenues
System sales	$	1,422		$	1,064
Contract revenues		2,130			1,785

Total revenues		3,552			2,849

Cost of revenues
Cost of system sales		1,072			833
Cost of contract revenues		1,879			1,487
Depreciation expense		260			199

Total cost of revenues		3,211			2,519

Gross profit		341			330

Research and development expense		43			74
Selling, general and administrative expense		5,385			5,645

Loss from operations		(5,087	)		(5,389	)

Other income (expense)
Interest expense		(7	)		(41	)
Interest income		28			358
Equity in loss of affiliate		—			(40	)
Impairment charge - investment in affiliate		(910	)		—
Other income		—			2

Total other income (expense)		(889	)		279

Loss before taxes		(5,976	)		(5,110	)
Income tax benefit		—			—

Loss before noncontrolling interest		(5,976	)		(5,110	)
Less: net income attributable to noncontrolling interest		(46	)		(74	)

Net loss	$	(6,022	)	$	(5,184	)

Net loss per share:
Basic	$	(0.27	)	$	(0.24	)
Diluted	$	(0.27	)	$	(0.24	)
Weighted average common shares outstanding:
Basic		21,920			21,737
Diluted		21,920			21,737

	Three Months EndedSeptember 30,						Nine Months EndedSeptember 30,
	2008			2007Restated			2008			2007Restated
Revenues
System sales	$	665		$	625		$	2,603		$	2,739
Contract revenues		2,182			1,781			6,202			3,631
Total revenues		2,847			2,406			8,805			6,370
Cost of revenues
Cost of system sales		878			2,471			2,708			5,303
Cost of contract revenues		2,144			8,851			5,921			10,633
Depreciation expense		205			142			603			346
Total cost of revenues		3,227			11,464			9,232			16,282
Gross loss		(380	)		(9,058	)		(427	)		(9,912	)
Research and development expense		882			152			1,101			398
Selling, general and administrative expense		11,891			3,399			22,589			8,019
Loss from operations		(13,153	)		(12,609	)		(24,117	)		(18,329	)
Other income (expense)
Interest expense		(65	)		(81	)		(210	)		(629	)
Interest income		164			683			765			2,108
Equity in loss of affiliate		(223	)		—			(703	)		—
Impairment charge - investment in affiliate		(1,277	)		—			(1,277	)		—
Other income (expense)		(8	)		100			(11	)		101
Total other income (expense)		(1,409	)		702			(1,436	)		1,580
Loss before income taxes		(14,562	)		(11,907	)		(25,553	)		(16,749	)
Income tax benefit		—			—			—			—
Loss before noncontrolling interest		(14,562	)		(11,907	)		(25,553	)		(16,749	)
Less: net income attributable to noncontrolling interest		(91	)		—			(258	)		(74	)
Net loss	$	(14,653	)	$	(11,907	)	$	(25,811	)	$	(16,823	)
Net loss per share:
Basic	$	(0.67	)	$	(0.60	)	$	(1.19	)	$	(0.85	)
Diluted	$	(0.67	)	$	(0.60	)	$	(1.19	)	$	(0.85	)
Weighted average common shares outstanding:
Basic		21,812			19,873			21,774			19,751
Diluted		21,812			19,873			21,774			19,751

See accompanying notes to unaudited condensed consolidated financial statements.

BASIN WATER, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENT OF CHANGES IN ~~STOCKHOLDERS’~~ EQUITY

(In thousands)

(Unaudited)

	Common Stock			AdditionalPaid-in		Treasury			Accumulated
	Basin Water, Inc. Stockholders’ Equity
	Shares	Amount		Capital		Stock			Deficiency			Totals
	Common Stock			AdditionalPaid-inCapital		TreasuryStock			AccumulatedDeficiency			NoncontrollingInterest			TotalEquity
Balance - December 31, 2007 (Restated)	21,949	$	22	$	110,193	$	(552	)	$	(35,846	)	$	73,817
	Shares	Amount
Stock options exercised	29		—		25		—			—			25
Balance - December 31, 2008	22,206	$	22	$	112,698	$	(552	)	$	(68,371	)	$	432		$	44,229
Stock-based compensation expense	—		—		~~1,880~~552		—			—			~~1,880~~—			552
Deferred stock compensation	~~228~~17		—		—		—			—			—			—
Net loss	—		—		—		—			(256,~~811~~022	)		~~(25,811~~46	)		(5,976	)
Balance - September 30, 2008	22,206	$	22	$	112,098	$	(552	)	$	(61,657	)	$	49,911
Balance - March 31, 2009	22,223	$	22	$	113,250	$	(552	)	$	(74,393	)	$	478		$	38,805

See accompanying notes to unaudited condensed consolidated financial statements.

BASIN WATER, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOW

(In thousands)

	Nine Months EndedSeptember 30,
	Three Months EndedMarch 31,
	2008			2007Restated
	2009			2008
	(Unaudited)
Cash flows from operating activities
Net loss	$	(256,~~811~~022	)	$	(165,~~823~~184	)
Adjustments to reconcile net loss to net cash provided by operating activities:
Depreciation and amortization		~~1,305~~544			~~700~~464
Stock-based compensation expense		~~1,880~~552			~~1,034~~607
Amortization of deferred compensation		~~119~~—			~~148~~39
Bad debt expense		562			235
Equity in loss of affiliate		—			40
Equity in loss of affiliate		703			—
Net income attributable to noncontrolling interest		46			74
Net income attributable to noncontrolling interest		258			74
Impairment of investment in affiliate		910			—
Impairment of goodwill		4,952			—
Impairment of capitalized costs due to contract terminations		685			—
Impairment of investment in affiliate		1,277			—
Changes in operating assets and liabilities:
Changes in operating assets and liabilities, net of effect of acquisitions:
Accounts receivable		2,076			1,078
Accounts receivable		(716	)		(599	)
Unbilled receivables		(170	)		(936	)
Unbilled receivables		2,755			3,778
Inventory		(148	)		(475	)
Inventory		(507	)		172
Prepaid expenses and other		113			63
Prepaid expenses and other		481			(467	)
Accounts payable		(165	)		(1,227	)
Accounts payable		401			1,718
Deferred revenues		362			9
Deferred revenues		215			(117	)
Accrued expenses and other		(173	)		(41	)
Accrued expenses and other		559			(1,203	)
Contract loss reserve		(642	)		(367	)
Contract loss reserve		(783	)		6,012
Other assets and other liabilities		(249	)		(1,604	)
Other assets and other liabilities		(560	)		(795	)
Net cash used in operating activities		(2,281	)		(7,460	)
Net cash used in operating activities		(12,910	)		(6,133	)
Cash flows from investing activities
Purchase of property, plant and equipment		(~~4,067~~632	)		(~~4,489~~587	)
Acquisition of business, net of cash acquired		(1,971	)		(6,231	)
Patent costs		—			(10	)
Patent costs		(40	)		(125	)
Net cash used in investing activities		(632	)		(597	)
Net cash used in investing activities		(6,078	)		(10,845	)
Cash flows from financing activities
Proceeds from stock option exercises		25			326
Repayments of notes payable and capital lease obligations		(209	)		(89	)
Proceeds from warrant exercises		—			3,088
Net cash used in financing activities		(209	)		(89	)
Proceeds from notes payable		—			500
Net decrease in cash and cash equivalents		(3,122	)		(8,146	)
Repayments of notes payable and capital lease obligations		(193	)		(2,296	)
Cash and cash equivalents, beginning of period		11,954			36,038
Net cash provided by (used in) financing activities		(168	)		1,618
Cash and cash equivalents, end of period	$	8,832		$	27,892
Net decrease in cash and cash equivalents		(19,156	)		(15,360	)
Supplemental disclosures of cash flow information:
Cash and cash equivalents, beginning of period		36,038			54,567
Cash paid during the period for:
Cash and cash equivalents, end of period	$	16,882		$	39,207
Interest	$	5		$	41
Income taxes	$	—		$	—

See accompanying notes to unaudited condensed consolidated financial statements.

BASIN WATER, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

(In thousands, except share and per share data)

Note 1—Business Activity and Basis of Presentation

Basin Water, Inc. and its subsidiaries (the Company) design, build and implement systems for the treatment of contaminated groundwater, municipal and industrial wastewater, industrial process water, and air streams from municipal and industrial sources. Customers can choose between purchasing the Company’s systems and entering into long-term contracting arrangements for the Company’s systems. ~~The Company also offers long-term contracts for the treatment of water produced from installed treatment systems as well as other water treatment-related services.~~

The Company markets its treatment systems and services primarily to utilities, cities, municipalities, special districts, ~~real~~industry ~~estate developers,~~ and other organizations for use in treating groundwater that does not comply with federal or state drinking water regulations due to the presence of chemical contaminants, treating wastewater, and treating air streams from municipalities and industry for the removal of odor-causing and other contaminants. The Company markets its treatment systems and services through its direct sales force, independent contractors and strategic relationships.

OnCapital ~~September 14,~~Resources 2007, the Company completed the acquisition of Mobile Process Technology Co. (MPT), a provider of technology and services to the water and wastewater treatment and industrial process markets. This acquisition extended the Company’s capabilities including expanded technological solutions, geographic presence and customer base. Additional services the Company can now provide as a result of the acquisition include: (1) central regeneration for ion-exchange, in which the Company replaces the resin vessel on a periodic basis and regenerates the resin offsite, (2) smaller ion-exchange systems permitting the servicing of low-flow wells, and (3) technologies to treat process water and to provide resource recovery from wastewater. The Company now also has the ability to service and treat smaller capacity water systems.

InThe ~~2007,~~accompanying consolidated financial statements have been prepared by the Company ~~entered~~on ~~into~~a ~~transactions~~going ~~with respect~~concern tobasis, which contemplates the ~~sale~~realization of ~~water~~amounts ~~treatment~~and ~~systems~~satisfaction toof ~~two~~obligations ~~special~~in ~~purpose~~the ~~entities~~normal course of business. As of March 31, 2009 and December 31, 2008, the Company had approximately $8,400 and $11,500 in cash and cash equivalents, respectively (excluding cash balances resulting from the consolidation of VL Capital, orwhich ~~VLC~~funds of VL Capital are not available to support the Company’s liquidity needs). The Company has experienced significant negative cash flows from operating and ~~Water~~investing ~~Services~~activities ~~Solutions~~since 2006, orincluding ~~WSS)~~during ~~that~~the ~~were~~first quarter of 2009, and expects to berequire ~~funded~~additional bycash ~~third-party~~for ~~financial~~such ~~institutions~~activities for the foreseeable future. InThe ~~accordance~~Company ~~with~~had ~~the~~a ~~provisions~~net loss of ~~Financial Accounting~~approximately ~~Standards~~$6,000 ~~Board~~for ~~Interpretation~~the ~~No.~~three months ended March 4631, ~~Consolidation~~2009 ofand ~~Variable~~incurred ~~Interest~~net ~~Entities~~losses –during ~~Deferral~~the ~~for~~fiscal ~~Certain~~years ~~Interests~~ended December 31, ~~Revised~~2008 ~~December~~and ~~2003~~2007 ~~(FIN~~of ~~46(R))~~approximately $32,500 and $18,300, respectively. Unless and until the Company ~~has~~is ~~concluded~~able ~~that~~to ~~the~~generate ~~financial~~sufficient ~~statements~~revenues offrom ~~VLC~~its system sales and ~~WSS~~ ~~should~~contract beservices, ~~consolidated~~it ~~with~~expects ~~those~~such oflosses to continue in the ~~Company~~future. ~~Accordingly~~Therefore, the Company’s ~~condensed~~ability ~~consolidated~~to continue to operate as a going concern is highly dependent on the amount of cash and cash equivalents on hand combined with its ability to raise capital to support future operations. Additional capital, whether obtained through financial ~~statements~~markets ~~for~~or collaborative or other arrangements with water providers, corporate partners or from other sources, may not be available at all, when needed, or on terms acceptable to the ~~periods~~Company. ~~presented~~This ~~herein~~raises ~~include~~substantial ~~these~~doubt ~~entities~~as to the Company’s ability to continue as a going concern.

InThe ~~September~~Company’s ~~2008,~~independent ~~the~~auditors’ ~~Company~~report ~~acquired~~for the ~~bioreactor~~year ~~and~~ended ~~biofilter business (Envirogen) of Shaw Environmental~~December ~~& Infrastructure~~31, ~~Inc.~~2008 ~~(Shaw) for~~included ~~$1,500~~an ~~cash~~explanatory ~~(subject~~paragraph tostating ~~adjustment~~that ~~for~~these recurring ~~working~~losses ~~capital)~~from ~~plus~~operations ~~the~~and ~~settlement~~negative ofcash aflows ~~previously~~raise ~~disputed~~substantial ~~claim~~doubt ~~against~~about ~~Shaw for amounts~~ the Company’s ~~claimed~~ability to becontinue ~~owed~~as bya ~~Shaw~~going concern. ~~The~~If ~~dispute involved an ion exchange unit purchase agreement executed by~~ the Company ~~and~~is ~~Shaw~~unable into ~~December~~continue ~~2005 which was structured~~ as a $5going concern,~~000~~ ~~sale~~it ofmay ~~water~~elect ~~treatment~~or ~~units~~be byrequired ~~the Company~~ to ~~Shaw~~seek inprotection from ~~two~~creditors ~~parts.~~by Infiling ~~the~~a ~~settlement,~~voluntary ~~Shaw~~petition ~~relinquished~~in ~~its~~bankruptcy ~~claims~~ or ~~rights~~may ~~under~~be ~~the~~subject ~~2005~~to ~~purchase~~an ~~agreement~~involuntary ~~generally,~~petition ~~and~~ in ~~particular~~ ~~to the ion exchange units that were the subject of the agreement~~bankruptcy. In ~~the~~such ~~transaction~~a case, the Company ~~acquired~~may ~~the~~have ~~assets~~to ofliquidate ~~Envirogen,~~its ~~which~~assets ~~includes the design~~ and ~~supply~~may ofreceive ~~fluidized~~less ~~bed,~~than ~~membrane,~~the ~~and~~value ~~suspended~~at ~~carrier~~which ~~bioreactors~~those ~~for~~assets ~~the~~are ~~treatment~~carried ofon ~~groundwater~~its ~~and~~financial ~~wastewater streams in industrial~~statements, ~~municipal~~ and ~~federal~~it ~~applications.~~is ~~The~~likely ~~business~~that ~~also~~investors ~~includes~~will ~~the~~lose ~~design~~all ~~and~~or ~~supply~~a ofpart ~~biofilters for the treatment~~ of ~~air~~their ~~streams from municipalities and industry for the removal of odor-causing and other contaminants~~investment.

~~The~~Note ~~Company~~2—Summary ~~restated~~of ~~its previously reported consolidated financial statements for the years ended~~Significant ~~December 31,~~Accounting ~~2007~~Policies and 2006 and the quarterly periods therein, as well as the quarter ended March 31, 2008. See Notes 3 and 4 to the condensed consolidated financial statements included in the Company’s Annual Report on Form 10-K/A for the fiscal year ended December 31, 2007 and Note 3 to the condensed consolidated financial statements included in the Company’s Quarterly Report on Form 10-Q/A for the fiscal quarter ended March 31, 2008.

Interim Consolidated Financial Statements

The interim consolidated financial statements for the three-month periods ended March 31, 2009 and 2008 have been prepared in accordance with Regulation S-X Rule 10-01 of the Securities Exchange Act of 1934 (the Exchange Act) as prescribed by the Securities and Exchange Commission (SEC). As such, certain disclosures which would substantially duplicate the disclosures contained in the Company’s latest audited consolidated financial statements have been omitted. This Quarterly Report on Form 10-Q for the quarter ended March 31, 2009 (the March Report) should be read in concert with the Company’s Annual Report on Form 10-K for the year ended December 31, 2008 (the 2008 Annual Report), as amended on April 30, 2009, which contains the Company’s audited consolidated financial statements for the year ended December 31, 2008.

BASIN WATER, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

(In thousands, except share and per share data)

Note 2—Summary of Significant Accounting Policies (continued)

~~Interim~~The ~~Consolidated~~interim ~~Financial~~financial ~~Statements~~information for the three-month periods ended March 31, 2009 and 2008 is unaudited and has been prepared on the same basis as the audited financial statements. However, the financial statements contained in the March Report do not include all of the information and disclosures required by accounting principles generally accepted in the United States of America (US GAAP) for audited financial statements. In the opinion of management, such unaudited information includes all adjustments (consisting of normal recurring adjustments) necessary for fair presentation of the interim financial information.

The interim consolidated financial statements for the three and nine-month periods ended September 30, 2008 and 2007 have been prepared in accordance with Regulation S-X Rule 10-01 of the Securities Exchange Act of 1934 (the Exchange Act) as prescribed by the Securities and Exchange Commission (SEC). As such, certain disclosures which would substantially duplicate the disclosures contained in the Company’s latest audited consolidated financial statements have been omitted. This Quarterly Report on Form 10-Q for the quarter ended September 30, 2008 (the September Report) should be read in concert with the Company’s Annual Report on Form 10-K/A for the year ended December 31, 2007 (the Restated 2007 Annual Report), which contains the Company’s restated audited consolidated financial statements for the year ended December 31, 2007.

The interim financial information for the three- and nine-month periods ended September 30, 2008 and 2007 is unaudited and has been prepared on the same basis as the audited financial statements. However, the financial statements contained in the September Report do not include all of the information and disclosures required by accounting principles generally accepted in the United States of America (US GAAP) for audited financial statements. In the opinion of management, such unaudited information includes all adjustments (consisting of normal recurring adjustments) necessary for fair presentation of the interim financial information.

Basis of Presentation and Use of Estimates

The preparation of financial statements in conformity with US GAAP requires management to make estimates and assumptions that affect certain reported amounts of assets, liabilities, revenues and expense, and related disclosures. Accordingly, actual results could differ from those estimates.

Certain reclassifications have been made to the prior year financial statement presentation to conform to the current year presentation.

Inventory

Inventory consists primarily of raw materials and supplies used in the fabrication of the Company’s ~~groundwater~~ground water treatment systems, as well as the reprocessing and conditioning of resins. Inventory items are stated at the lower of cost on a first-in, first-out (FIFO) basis or market. Inventory that is no longer usable as a system component is considered obsolete. A reserve for slow-moving inventory is maintained as appropriate.

Revenue Recognition and Fluctuation

As described in the Company’s ~~Restated~~2008 ~~2007~~ Annual Report, the Company recognizes revenues either from the sale of a system or as recurring revenues from the lease of a system. In addition, the Company also recognizes recurring revenues from long-term contracts for the treatment of the water produced from installed treatment systems or by providing other services for the processing of water and other water treatment-related services. These revenues are also referred to as service revenues.

The Company’s revenues vary from period to period, because customers may choose between purchasing groundwater treatment systems and entering into long-term contract arrangements for groundwater treatment systems. If a customer chooses to purchase a system, revenues are recognized over a much shorter period of time, generally within two or three quarters, than for the same system if the customer chooses a long-term contract arrangement. Revenues tend to be higher in periods in which sales rather than long-term lease and services contracts occur. In addition, service revenues tend to be higher in warmer, dryer weather when treated water is at a high demand. The results of operations for the first ~~nine~~ three months of ~~2008~~2009 are not necessarily predictive of the remaining ~~three~~ nine months of the year. The timing and amount of revenues from system sales in a given period can be unpredictable and relatively inconsistent, and are dependent on such factors as the duration of the sales cycle (which varies from customer to customer), size and number of water treatment systems included in the sale, and whether the equipment is sold or leased.

Recently Issued Accounting Pronouncements

In May 2008, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) No. 162, The Hierarchy of Generally Accepted Accounting Principles, which identifies the sources of accounting principles and the framework for selecting the principles to be used in the preparation of financial statements of nongovernmental entities that are presented in conformity with US GAAP. SFAS No. 162 becomes effective in the third quarter of 2009 and is not expected to have a material impact on the Company’s consolidated financial statements.

Other than the above, there have been no recent accounting pronouncements issued which would impact the Company’s consolidated financial statements following the filing of the Company’s 2008 Annual Report.

Impact of Recently Adopted Accounting Pronouncements

In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements. This statement establishes a single authoritative definition of fair value, sets out a framework for establishing fair value, and requires additional disclosures about fair value measurements. This statement applies only to fair value measurements that are already required or permitted by other accounting standards and is expected to increase the consistency of those measurements. The Company was required to adopt SFAS No. 157 for its fiscal year beginning on January 1, 2008, prospectively applied, except for the provisions of SFAS No. 157 relating to nonfinancial instruments, which were required to be adopted by the Company for its fiscal year beginning January 1, 2009. The adoption of SFAS No. 157 did not have a material impact on the Company’s consolidated financial statements.

BASIN WATER, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

(In thousands, except share and per share data)

Note 2—Summary of Significant Accounting Policies (continued)

Recent Accounting Pronouncements

In May 2008, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) No. 162, The Hierarchy of Generally Accepted Accounting Principles, which identifies the sources of accounting principles and the framework for selecting the principles to be used in the preparation of financial statements of nongovernmental entities that are presented in conformity with US GAAP. SFAS No. 162 becomes effective in the third quarter of 2009 and is not expected to have a material impact on the Company’s consolidated financial statements.

In March 2008, the FASB issued SFAS No. 161, Disclosures about Derivative Instruments and Hedging Activities, an amendment of SFAS No. 133, which requires enhanced disclosures for derivative and hedging activities. SFAS No. 161 becomes effective in the first quarter of 2009 and is not expected to have a material impact on the Company’s consolidated financial statements.

Impact of Recent Accounting Pronouncements

In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities—Including an amendment of FASB Statement No. 115. This statement permits companies to choose to measure many financial instruments and other specified items at fair value. The Company was required to adopt SFAS No. 159 for its fiscal year beginning on January 1, 2008, prospectively applied. The adoption of SFAS No. 159 did not have a material impact on the Company’s consolidated financial statements.

In ~~September~~December ~~2006~~2007, the FASB issued SFAS No. ~~157~~141(R), ~~Fair~~Business ~~Value~~Combinations ~~Measurements~~(SFAS 141(R)). This statement ~~establishes~~replaces aSFAS ~~single~~141 ~~authoritative~~in ~~definition~~its ofentirety and ~~fair~~retains ~~value~~the fundamental requirements in SFAS 141, ~~sets~~including ~~out~~that athe ~~framework~~purchase method be used for ~~establishing~~all ~~fair~~business ~~value,~~combinations and ~~requires~~for ~~additional~~an ~~disclosures~~acquirer ~~about~~to ~~fair~~be ~~value~~identified ~~measurements~~for each business combination. This ~~statement~~standard ~~applies~~defines ~~only~~the toacquirer ~~fair~~as ~~value~~the ~~measurements~~entity that obtains ~~are~~control ~~already~~of ~~required~~one or ~~permitted~~more bybusinesses ~~other~~in ~~accounting standards~~the business combination and isestablishes ~~expected~~the toacquisition ~~increase~~date as the ~~consistency~~date ofthat ~~those~~the ~~measurements.~~acquirer ~~The~~achieves ~~Company~~control ~~was~~instead ~~required~~of tothe ~~adopt~~date ~~SFAS~~that Nothe consideration is transferred. SFAS ~~157~~141(R) ~~for~~requires ~~its~~an acquirer ~~fiscal~~in ~~year~~a ~~beginning~~business oncombination, ~~January 1~~including business combinations achieved in steps (step acquisition), ~~2008~~to recognize the assets acquired, ~~prospectively~~liabilities ~~applied~~assumed, ~~except~~and ~~for~~any non-controlling interest in the ~~provisions~~acquiree at the acquisition date, measured at their fair values of ~~SFAS~~that date, with limited exceptions. It also requires the recognition of assets acquired and liabilities assumed arising from certain contractual contingencies as of the acquisition date, measured at their acquisition-date fair Novalues. SFAS ~~157~~141(R) ~~relating~~applies prospectively to ~~nonfinancial~~business ~~instruments,~~combinations for which ~~will~~the beacquisition ~~required~~date tois beon ~~adopted~~or byafter the ~~Company~~beginning ~~for~~of ~~its~~the ~~fiscal~~first ~~year~~reporting period beginning ~~January~~on or after December 115, ~~2009~~2008, and could not be applied before that date. The adoption of SFAS ~~No. 157~~141(R) did not have a material impact on the Company’s consolidated financial statements.

~~Note~~In 3December 2007, the FASB issued SFAS No. 160, Noncontrolling Interests in Consolidated Financial Statements—~~Acquisitions~~an amendment of ARB No. 51 (SFAS 160) which establishes accounting and reporting standards for the noncontrolling interest in a subsidiary and for the deconsolidation of a subsidiary. This statement became effective for the fiscal year beginning January 1, 2009 to be applied prospectively. The adoption of SFAS 160 did not have a material impact on the Company’s consolidated financial statements.

~~Mobile~~In ~~Process~~March ~~Technology~~2008, the FASB issued SFAS No. 161, Disclosures about Derivative Instruments and Hedging Activities, an amendment of SFAS No. 133, which requires enhanced disclosures for derivative and hedging activities. SFAS No. 161 became effective in the first quarter of 2009 and did not have a material impact on the Company’s consolidated financial statements.

OnNote ~~September 14,~~3—Acquisition ~~2007, a newly formed subsidiary~~ of ~~the~~Envirogen Company acquired 100% of the business of Mobile Process Technology Co., an Arkansas corporation based in Memphis, Tennessee, through the means of a merger agreement, and upon completion of the merger and acquisition, the business was renamed Basin Water-MPT, Inc. (MPT). MPT is a provider of technology and services to the water treatment and industrial process markets.

~~The~~On ~~aggregate purchase price was approximately $12~~September 18,~~200,~~ ~~consisting of approximately $6~~2008,~~900~~ ~~of cash and 462,746 shares of Company common stock with a fair value of approximately $5,300. The fair value of~~ the ~~common stock issued was determined based on the average closing market price of the~~ Company’s ~~common~~acquired ~~stock over~~ the ~~period~~bioreactor ~~beginning five business days before~~ and ~~ending~~biofilter ~~five~~ business ~~days~~(Envirogen) ~~after~~of ~~the~~Shaw ~~terms~~Environmental of& ~~the~~Infrastructure, ~~acquisition~~Inc. ~~were~~(Shaw) through ~~agreed~~an ~~upon~~asset ~~and~~purchase ~~announced~~agreement.

The Company previously sold to Shaw water treatment systems for a total purchase price of approximately $4,800, including installation, of which the Company recognized revenues of approximately $3,000 and approximately $1,600 during the years ended December 31, 2006 and 2005, respectively. Under the terms of the sale, Shaw made a down payment of $227 and was to pay an additional $2,048 of the total amount due not later than December 31, 2007 and the remaining balance of approximately $2,300 not later than December 31, 2008.

The aggregate purchase price for Envirogen was approximately $4,100, consisting of cash consideration of approximately $2,000 (including adjustments and transaction costs) of cash and the satisfaction of approximately $4,700 of accounts receivable and accrued interest owed to the Company by Shaw (as described in the previous paragraph), less approximately $2,600 representing the fair value of the water treatment systems returned by Shaw to the Company. The fair value of the water treatment systems was determined by management through an evaluation of the current replacement cost of equivalent systems, less the expected costs to sell such systems.

BASIN WATER, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

(In thousands, except share and per share data)

Note 3—~~Acquisitions~~Acquisition of Envirogen (continued)

~~A valuation of MPT’s property and intangible assets was finalized during the second quarter of 2008.~~ The following table presents the estimated fair values of the assets acquired and liabilities assumed at the date of acquisition.:

Current assets	$	~~2,585~~890
Property, plant and equipment		21,~~191~~132
Goodwill		61,~~323~~140
Intangible assets		41,~~329~~524
Total assets acquired		154,~~428~~686
Current liabilities		(~~2,754~~584	)
Long-term debt		(266	)
Other liabilities		—
Other liabilities		(179	)
Total liabilities assumed		(584	)
Total liabilities assumed		(3,199	)
Net assets acquired	$	4,102
Net assets acquired	$	12,229

The net assets acquired in the table above represent cash consideration of approximately $6,200 (net of cash acquired), approximately $700 of cash acquired included in current assets above and common stock consideration of approximately $5,300. The purchase price was allocated to net tangible and intangible assets acquired based on their estimated fair values, with approximately $41,~~200~~100 allocated to intangible assets with a weighted-average useful life of approximately 11nine years and approximately $400 allocated to intangible assets with indefinite useful lives.

AsAcquired intangible assets consist of ~~September 30,~~contract ~~2008,~~backlog ~~approximately~~in the amount of $183 (one year useful life),~~250~~ ofdistribution ~~the~~network ~~cash~~in ~~portion~~the amount of ~~the~~$112 ~~purchase~~(six ~~price~~year useful ~~remained~~life), patents in anthe ~~escrow~~amount ~~account~~of as$966 a(10 ~~reserve~~year ~~for~~useful ~~unidentified~~life) ~~liabilities~~and oftrade ~~the~~name ~~acquired~~in ~~business,~~the ~~which~~amount isof ~~included~~$363 in(indefinite ~~goodwill~~useful life). ~~This~~The ~~balance~~excess ~~was subsequently~~of ~~released~~the innet ~~full~~purchase toprice over the ~~former~~estimated ~~shareholders~~fair value of ~~MPT~~assets acquired was approximately $1,100 which was recorded as tax deductible goodwill.

In addition, $750 of the cash portion of the purchase price was placed into an escrow account until the working capital of MPT at the date of acquisition was finalized. In February 2008, $326 was released from the working capital escrow account to the Company, reducing the purchase price by that amount, and the balance of the working capital escrow account was released to the former shareholders of MPT.

Acquired intangible assets consist of a covenant not to compete in the amount of $322 (three year useful life), trade name in the amount of $180 (two year useful life), service agreements and contracts in the amount of $1,355 (six year useful life), customer relationships in the amount of $569 (15 year useful life) and patents in the amount of $1,812 (17 year useful life). The excess of the net purchase price over the estimated fair value of assets acquired was approximately $6,300 which was recorded as non-tax deductible goodwill.

During the quarter ended September 30, 2008, the Company determined that the goodwill related to the MPT acquisition was impaired, and recorded a charge to earnings of $4,952 to reduce the carrying value of goodwill. See Note 6 for a further discussion of this impairment charge.

The results of MPT’s operations have been included in the Company’s consolidated financial statements included in this report since it was acquired on September 14, 2007.

Envirogen

On September 18, 2008, the Company acquired the bioreactor and biofilter businesses (Envirogen) from Shaw Environmental and Infrastructure, Inc. (Shaw) through an asset purchase agreement.

BASIN WATER, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

(In thousands, except share and per share data)

Note 3—Acquisitions (continued)

The aggregate purchase price for Envirogen was approximately $4,100, consisting of approximately $2,000 (including adjustments and transaction costs) of cash and the satisfaction of approximately $4,700 of accounts receivable and accrued interest owed to the Company by Shaw, less approximately $2,600 representing the fair value of the water treatment systems returned by Shaw to the Company. The fair value of the water treatment systems was determined by management through an evaluation of the current replacement cost of equivalent systems, less the cost to sell such systems.

A valuation of Envirogen’s property and intangible assets is in the process of being developed; accordingly, the allocation of the purchase price is subject to revision and adjustment. The following table presents the estimated fair values of the assets acquired and liabilities assumed at the date of acquisition.

Current assets	$	249
Property, plant and equipment		947
Goodwill		1,423
Intangible assets		1,534
Total assets acquired		4,153
Current liabilities		(51	)
Other liabilities		—
Total liabilities assumed		(51	)
Net assets acquired	$	4,102

The net assets acquired in the table above represent cash consideration of approximately $2,000 (including adjustments and transaction costs) and approximately $4,700 representing satisfaction of accounts receivable and accrued interest owed to the Company by Shaw, less approximately $2,600 representing the fair value of the water treatment systems returned by Shaw to the Company. The purchase price was allocated to net tangible and intangible assets acquired based on their estimated fair values, with approximately $1,100 allocated to intangible assets with a weighted-average useful life of approximately nine years and approximately $400 allocation to intangible assets with indefinite useful lives.

Acquired intangible assets consist of contract backlog in the amount of $83 (one year useful life), distribution network in the amount of $112 (six year useful life), patents in the amount of $966 (10 year useful life) and trade name in the amount of $363 (indefinite useful life). The excess of the net purchase price over the estimated fair value of assets acquired was approximately $1,400 which was recorded as non-tax deductible goodwill.

The results of Envirogen’s operations have been included in the consolidated financial statements since it was acquired on September 18, 2008.

The unaudited pro forma condensed combined statements of operations table below reflects the results of operations of the Company and Envirogen for the three- and nine-month periods ended September 30, 2008 and 2007 as if the acquisition had occurred at the inception of each of the periods presented. Unaudited pro forma condensed combined statements of operations are not necessarily indicative of the results that would have been achieved had the transaction been consummated as of the date indicated or had the entities been a single entity during these periods, and are not necessarily indicative of the results that may be achieved in the future.

	Three Months EndedSeptember 30,						Nine Months EndedSeptember 30,
	2008			2007			2008			2007
	(Unaudited pro forma)						(Unaudited pro forma)
Revenues	$	3,701		$	4,279		$	14,783		$	11,654
Net loss	$	(14,985	)	$	(12,573	)	$	(26,565	)	$	(18,740	)
Net loss per share
Basic	$	(0.68	)	$	(0.63	)	$	(1.22	)	$	(0.95	)
Diluted	$	(0.68	)	$	(0.63	)	$	(1.22	)	$	(0.95	)

BASIN WATER, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

(In thousands, except share and per share data)

Note 4—Earnings Per Share

In accordance with the provisions of SFAS No. 128, Earnings Per Share, the Company reports earnings per share (EPS) by computing both basic and diluted EPS. Basic EPS measures the Company’s performance for a reporting period by dividing net income available to common stockholders by the weighted average number of shares of common ~~shares~~stock outstanding during the period. Diluted EPS measures the Company’s performance for a reporting period by dividing net income available to common stockholders by the weighted average number of shares of common ~~shares~~stock plus common stock equivalents outstanding during the period. Common stock equivalents consist of all potentially dilutive ~~shares of~~ common ~~stock~~shares, such as stock options and warrants, which are convertible into shares of common stock.

The Company incurred net losses for ~~the~~both ~~three-~~of ~~and nine-month~~the ~~periods~~quarters ended ~~September~~March 3031, ~~2008~~2009 and ~~2007, respectively~~2008. NoAs ~~stock~~a ~~options~~result, orapproximately ~~warrants,~~0 ~~but~~and ~~388~~247,000 shares ofissuable ~~unvested~~upon ~~stock~~exercise ~~have been excluded from the computation~~ of ~~diluted~~outstanding ~~EPS~~stock ~~for~~options ~~the three months ended September 30, 2008,~~ and approximately ~~82,000~~0 ~~stock options~~and 416, ~~175,~~000 warrants ~~and 333,000 shares of unvested stock~~ have been excluded from the computation of diluted EPS for the ~~nine~~three months ended ~~September~~March 3031, 2009 and 2008, respectively, due to the antidilutive effect of such common stock equivalents. ~~Likewise~~Also, approximately ~~730~~2,061,000 ~~stock~~and ~~options~~784, ~~279,~~000 stock ~~shares~~options ofand ~~unvested~~approximately ~~stock~~419,000 and 148,~~355,~~000 warrants have been excluded from the computation of diluted EPS for the three months ended ~~September 30~~March 31, ~~2007,~~2009 and ~~approximately 528~~2008,~~000 stock~~ ~~options~~respectively, ~~245,000~~as ~~shares~~the exercise prices of ~~unvested~~such ~~stock~~options and ~~860,000~~ warrants ~~have~~were ~~been~~higher than ~~excluded~~the ~~from~~weighted ~~the~~average ~~computation~~price of ~~diluted EPS for~~ the ~~nine~~Company’s ~~months ended September 30, 2007, due to the antidilutive effect of such~~ common stock ~~equivalents~~during those periods.

In8 addition, approximately 1,413,000 stock options and 675,000 warrants have been excluded from the computation of diluted EPS for both the three- and nine-month periods ended September 30, 2008, and approximately 327,000 stock options and 33,000 warrants have been excluded from the computation of diluted EPS for the three- and nine-month periods ended September 30, 2007, as the exercise prices of such options and warrants were higher than the weighted average price of the Company’s common stock during those periods.

BASIN WATER, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

(In thousands, except share and per share data)

Note 4—Earnings Per Share (continued)

The following tables contain a reconciliation of the numerators (net loss) and denominators (weighted average shares) used in both basic and diluted EPS calculations:

	Three Months EndedSeptember 30,						Nine Months EndedSeptember 30,
	Three Months EndedMarch 31,
	2008			2007			2008			2007
	2009			2008
	(Unaudited)						~~(Unaudited)~~
Net loss per share
Numerator:
Net loss applicable to common shares	$	(146,~~653~~022	)	$	(115,~~981~~184	)	$	~~(25,811~~	)	$	~~(16,823~~	)
Denominator:
Weighted average common shares outstanding		21,~~812~~920			1921,~~873~~737			~~21,774~~			~~19,751~~
Net loss per common share	$	(0.6727	)	$	(0.6024	)	$	~~(1.19~~	)	$	~~(0.85~~	)
Net loss per share - assuming dilution
Numerator:
Net loss applicable to common shares	$	(146,~~655~~022	)	$	(115,~~981~~184	)	$	~~(25,811~~	)	$	~~(16,823~~	)
Denominator:
Weighted average common shares outstanding		21,~~812~~920			1921,~~873~~737			~~21,774~~			~~19,751~~
Net loss per common share - diluted	$	(0.6727	)	$	(0.6024	)	$	~~(1.19~~	)	$	~~(0.85~~	)

~~The~~Note ~~Company incurred net losses in the three~~5—Stock-Based ~~and~~Incentive ~~nine-month~~Compensation ~~periods~~Plans ~~ended September 30, 2008 and 2007. The impact of common stock equivalents has been excluded from the computation of diluted EPS because the effect on net loss per share is anti-dilutive.~~

Note 5—Stock-Based Compensation

2006 Equity Incentive Award Plan

In May 2006, the Company adopted the Basin Water 2006 Equity Incentive Award Plan, or 2006 Equity Plan. The 2006 Equity Plan became effective immediately prior to the completion of the initial public offering in May 2006. Under the 2006 Equity Plan, 2,500,000 shares of the Company’s common stock were initially reserved for issuance. In addition, the 2006 Plan contains an evergreen provision that allows for an annual increase in the number of shares available for issuance under the plan on January 1 of each year during the ten-year term of the 2006 Plan, beginning on January 1, 2007. Under this evergreen provision, the annual increase in the number of shares shall be equal to the least of:

• 5.0% of the Company’s outstanding ~~capital~~common stock on the first day of the relevant fiscal year;

•

1,000,000 shares; and

•

an amount determined by the Company’s board of directors.

11In no event shall the number of shares of the Company’s common stock that may be issued or transferred pursuant to awards under the 2006 Plan exceed an aggregate of 12,500,000 shares. The number of total shares of common stock that may be issued under the 2006 Plan automatically increased to 5,495,383 and 4,495,383 shares as of January 1, 2009 and 2008, respectively.

BASIN WATER, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

(In thousands, except share and per share data)

Note 5—Stock-Based Compensation (continued)

In no event shall the number of shares of the Company’s common stock that may be issued or transferred pursuant to awards under the 2006 Plan exceed an aggregate of 12,500,000 shares. The number of total shares of common stock that may be issued under the 2006 Plan automatically increased to 4,495,383 and 3,495,383 shares as of January 1, 2008 and 2007, respectively.

Options under the plan are issued with an exercise price equal to the closing price of the Company’s stock on the date of the grant. Option grants generally vest over three years, with one-third of the shares subject to the option vesting on each of the first, second and third anniversaries of the grant date and expire 10 years from the date of grant. Options granted to directors generally vest on the first anniversary of the grant date.

Cheap Stock Amortization

Prior to becoming a publicly traded company in May 2006, the Company granted stock options with exercise prices equal to the estimated fair value of its common stock. However, to the extent that the deemed fair value of the common stock exceeded the exercise price of stock options on the grant date the Company recorded deferred stock-based compensation expense and amortizes the expense over the vesting period of the options. The fair value of the Company’s common stock was determined by the Board. In the ~~absence of a public trading market for the Company’s common stock, the Board considered both objective and subjective factors~~ in determining the fair value of the Company’s common stock and related stock options. Consistent with the guidance provided by the American Institute of Certified Public Accountants in its Technical Practice Aid (TPA) entitled The Valuation of Privately Held Company Equity Securities Issued as Compensation, such considerations included, but were not limited to, the following factors:

•9 ~~The liquidation preference, anti-dilution and redemption rights of the preferred stock and the lack of such rights for the common stock;~~

• The per share price for concurrent or recent sales of common stock and redeemable convertible preferred stock;

• Historical performance and operating results at the time of the grant;

• Expected future earnings performance;

• Liquidity and future capital requirements;

• Stage of development and business strategy;

• Marketplace developments and major competition;

• Market barriers to entry;

• Strategic relationships with third parties;

• Size of workforce and related skills;

• The illiquidity of the common stock; and

• The likelihood of achieving a liquidity event for the shares of common stock, such as an initial public offering or a sale.

In connection with the Company’s initial public offering, the Company re-evaluated the historical fair value of its common stock. As a result of this re-evaluation, the Company recorded deferred stock-based compensation which represents the difference between the exercise price of stock options granted in the first quarter of 2006 and in the fourth quarter of 2005 and the revised fair value of the common stock underlying such options on the date of grant.

BASIN WATER, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

(In thousands, except share and per share data)

Note 5—Stock-Based Incentive Compensation Plans (continued)

~~Pursuant~~absence toof ~~FASB~~a ~~Interpretation~~public ~~(FIN)~~trading ~~No. 28,~~market for the Company’s iscommon ~~amortizing~~stock, ~~these~~the ~~deferred~~Board ~~compensation~~considered ~~amounts~~both ~~using~~objective ~~the~~and ~~straight-line~~subjective ~~attribution~~factors ~~method~~in ~~over~~determining the ~~vesting~~fair ~~period~~value of the ~~options,~~Company’s ~~which~~common isstock ~~generally~~and ~~three~~related ~~years.~~stock Asoptions, aconsistent ~~result~~with of the ~~amortization~~guidance ofprovided by the ~~deferred~~American ~~compensation~~Institute ~~amounts,~~of ~~the~~Certified ~~Company~~Public ~~recorded~~Accountants ~~$119~~in ~~and~~its ~~$148~~Technical ofPractice ~~non-cash~~Aid ~~stock-based compensation~~(TPA) ~~expense~~entitled ~~for~~The ~~the~~Valuation ~~nine-month~~of ~~periods~~Privately ~~ended~~Held ~~September 30,~~Company ~~2008~~Equity ~~and~~Securities ~~2007,~~Issued ~~respectively~~as Compensation.

Pursuant to FASB Interpretation (FIN) No. 28, the Company has amortized these deferred compensation amounts using both the graded attribution method and the straight-line attribution method over the vesting period of the options, which is generally three years. As a result of the amortization of these deferred compensation amounts, the Company recorded $0 and $39 of non-cash stock-based compensation expense for the three-month periods ended March 31, 2009 and 2008, respectively, all of which was included in selling, general and administrative expense.

Method of Accounting for Stock-Based Compensation

The Company accounts for stock-based compensation in accordance with the provisions set forth in SFAS No. 123(R), Share-Based Payment (SFAS ~~No.~~ 123(R)). Under the provisions of SFAS ~~No.~~123(R), stock-based compensation cost is measured at the date of grant, based on the calculated fair value of the stock-based award, and is recognized as expense over the employee’s requisite service period (generally the vesting period of the award).

The Company estimates the fair value of stock options granted using the Black-Scholes method. Key assumptions used to estimate the fair value of stock options include the exercise price of the award, the fair value of the Company’s common stock on the date of grant, the expected option term, the risk free interest rate at the date of grant, the expected volatility of the Company’s common stock over the expected option term, and the expected annual dividend yield on the Company’s common stock.

~~The~~No ~~fair~~options ~~value~~were ofgranted ~~each option grant~~ during the three- ~~and nine-~~month periods ended ~~September~~March 3031, ~~2008~~2009 and ~~2007~~2008. ~~was estimated on the date of grant using the following assumptions:~~

	Three Months EndedSeptember 30,		Nine Months EndedSeptember 30,
	2008	2007	2008	2007
Expected option term in years	—	6.5 to 7.0	5.5 to 6.5	5.0 to 7.0
Risk free interest rate	—	4.5%	4.5%	4.5% to 4.8%
Expected volatility	—	26.9%	28.4%	26.9% to 29.5%
Expected dividend yield	—	0.0%	0.0%	0.0%

The expected option term in years is calculated using an average of the vesting period and the option term, in accordance with the “simplified method” for “plain vanilla” stock options allowed under Staff Accounting Bulletin (SAB) 110.

The ~~estimated~~risk ~~forfeiture~~free ~~rates~~interest ~~for~~rate ~~stock~~is the ~~option~~rate ~~grants~~on ~~during~~a ~~the three~~zero-coupon ~~and~~U.S. ~~nine-month~~Treasury ~~periods ended~~bond ~~September~~with ~~30,~~a ~~2008~~remaining ~~and~~term ~~2007~~equal ~~were~~to ~~9.0%~~the ~~and~~expected 8option term.0% The expected volatility is derived from an industry-based index, ~~respectively.~~in accordance with the calculated value method allowed under SFAS 123(R).

NoSFAS ~~options~~123(R) ~~were~~requires ~~granted~~entities ~~during~~to estimate the ~~quarter~~number ~~ended~~of ~~September~~forfeitures ~~30,~~expected ~~2008.~~to occur and record expense based upon the number of awards expected to vest.

~~The~~10 expected option term in years was calculated using an average of the vesting period and the option term, in accordance with the “simplified method” for “plain vanilla” stock options allowed under Staff Accounting Bulletin (SAB) No. 110.

The risk free interest rate is the rate on a zero-coupon U.S. Treasury bond with a remaining term equal to the expected option term. The expected volatility was derived from an industry-based index, in accordance with the calculated value method allowed under SFAS No. 123(R).

BASIN WATER, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

(In thousands, except share and per share data)

Note 5—Stock-Based Incentive Compensation Plans (continued)

Stock Option Activity

A summary of stock option activity for the ~~nine~~three months ended ~~September~~March 3031, ~~2008~~2009 is as follows:

(In thousands, except exercise prices)	Numberof Shares		WeightedAverageExercisePrice
Options outstanding at December 31, 2007	1,710		$	5.85
Options outstanding at December 31, 2008	2,167		$	5.66
Granted	~~518~~—			~~4.71~~—
Exercised	~~(29~~—	)		~~0.83~~—
Forfeited	(2616	)		45.8119
Options outstanding at September 30, 2008	2,173		$	5.75
Options outstanding at March 31, 2009	2,151		$	5.66

The following table summarizes information about stock options outstanding and exercisable as of ~~September~~ March 3031, ~~2008~~ 2009:

(In thousands, except exercise prices and years)	Outstanding		Exercisable
Number of shares		2,~~173~~151		~~953~~1,121
Weighted average remaining contractual life in years		7.61		5.8
Weighted average exercise price per share	$	5.7566	$	4.3167
Aggregate intrinsic value (at Sept. 30, 2008 closing price of $1.84 per share)	$	178	$	178
Aggregate intrinsic value (at March 31, 2009 closing price of $0.88 per share)	$	5	$	5

The aggregate intrinsic value in the preceding table ~~above~~ represents the total pretax intrinsic value (the difference between the Company’s closing stock price as of ~~September~~March 3031, ~~2008~~2009 and the weighted average exercise price multiplied by the number of shares) that would have been received by the option holders had all ~~options~~option holders exercised their options on ~~September~~ March 3031, ~~2008~~2009. This ~~amount~~intrinsic value will vary as the Company’s stock price ~~varies~~fluctuates.

~~The~~Compensation ~~weighted~~expense arising ~~average~~from ~~grant-date~~stock ~~fair~~option ~~value~~grants ~~of options~~was ~~granted~~$218 byand ~~the~~$306 ~~Company~~for ~~during~~ the ~~nine~~three months ended ~~September~~March 3031, 2009 and 2008, respectively, all of which expense was $1included in selling, general and administrative expense for each period.81 ~~per~~No ~~share~~related income tax benefit was recorded as the Company has significant net operating loss carryforwards.

~~Compensation~~As ~~expense~~of ~~arising~~March 31, ~~from grants~~2009, approximately $1,000 of unrecognized compensation expense related to stock options ~~was~~is ~~$812~~expected ~~and~~to ~~$453~~be ~~during~~recognized ~~the~~over ~~nine~~a ~~months~~weighted ~~ended~~average ~~September~~period ~~30,~~of ~~2008~~1.0 ~~and~~years. ~~2007,~~The ~~respectively.~~total ~~Such~~fair ~~expense~~value ~~was~~of ~~classified~~options asvested ~~selling~~during the three months ended March 31, ~~general~~2009 and ~~administrative~~2008 ~~expense~~was $55 and $74, respectively.

AsStock ~~of September 30, 2008, approximately $1,700 of unrecognized compensation expense related to stock~~ options isoutstanding ~~expected~~and toexercisable beat ~~recognized over a weighted average period of 1.1 years. The total fair value of options vested during the nine months ended September~~March 3031, ~~2008~~2009, and ~~2007~~the ~~was~~related ~~$398~~exercise price and ~~$152,~~remaining ~~respectively,~~contractual life ~~which~~are ~~was~~as ~~included~~follows: ~~in selling, general and administrative expense.~~


	Options Outstanding				Options Exercisable
Exercise Price	Number of Options Outstanding	Weighted Average Exercise Price		Weighted Average Remaining Contractual Life of Options Outstanding	Number of Options Exercisable	Weighted Average Exercise Price
$0.83 - $1.33	217	$	1.03	2.4 yrs	217	$	1.03
$4.00 - $4.29	450	$	4.04	6.5 yrs	303	$	4.00
$5.00	665	$	5.00	7.8 yrs	340	$	5.00
$6.79 - $9.00	714	$	7.88	8.0 yrs	227	$	7.56
$9.87 - $12.29	105	$	11.33	8.4 yrs	34	$	11.34

	2,151	$	5.66		1,121	$	4.67

BASIN WATER, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

(In thousands, except share and per share data)

Note 5—Stock-Based Incentive Compensation Plans (continued)

~~Stock~~The ~~options~~total ~~outstanding~~intrinsic ~~and~~value ~~exercisable~~of atstock ~~September 30,~~options ~~2008,~~exercised ~~and~~during the ~~related~~three ~~exercise~~months ~~price~~ended March 31, 2009 and ~~remaining contractual~~2008 ~~life~~was ~~are~~$0 asand ~~follows:~~$38, respectively.

	Options Outstanding				Options Exercisable
Exercise Price	Number ofOptionsOutstanding	WeightedAverageExercisePrice		WeightedAverageRemainingContractualLife of OptionsOutstanding	Number ofOptionsExercisable	WeightedAverageExercisePrice
$0.83 - $1.33	218	$	1.03	2.9 yrs	218	$	1.03
$4.00 - $4.29	455	$	4.04	7.0 yrs	308	$	4.00
$5.00	677	$	5.00	8.3 yrs	286	$	5.00
$6.79 - $9.00	718	$	7.88	8.5 yrs	107	$	7.82
$9.87 - $12.29	105	$	11.33	8.9 yrs	34	$	11.34
	2,173	$	5.75	7.6 yrs	953	$	4.31

The total intrinsic value of stock options exercised during the nine months ended September 30, 2008 and 2007 was $99 and $541, respectively.

Non-vested Stock

Under the 2006 Equity Plan, the Company has granted non-vested common stock to management, officers and directors, which is subject only to a service condition. In general, such non-vested stock vests over three years for management and ~~officers, and~~ one year for directors. The total cumulative number of shares of non-vested stock granted under the 2006 Equity Plan through ~~September~~March 3031, ~~2008~~2009 is ~~510~~ 528,~~514~~035, of which ~~122~~232,~~123~~856 shares had vested as of ~~September~~March 3031, ~~2008~~2009.

The fair value of non-vested stock is measured at the date of grant based upon the closing price of the Company’s common stock on that date, and such fair value is recognized as stock-based compensation expense over the requisite vesting period. Compensation expense arising from grants of non-vested stock during the ~~nine~~three months ended ~~September~~March 3031, ~~2008~~2009 and ~~2007~~2008 was $~~1,016~~334 and $~~624~~301, respectively, all of which expense was included in selling, general and administrative expense for each year. As of ~~September~~March 3031, ~~2008~~2009, approximately $~~1,600~~900 of unrecognized compensation expense related to non-vested stock grants is expected to be recognized over a weighted average period of 10.16 years.

15Note 6—Customer Contract Terminations

~~Table~~During the first quarter of ~~Contents~~2009, five of the Company’s existing customer contracts were cancelled either pursuant to their contract terms or by mutual consent and the leased water treatment systems were returned to the Company. As a result of these contract terminations, the Company expensed certain previously capitalized costs in the amount of approximately $700 associated with these systems consisting primarily of spent resin and deployment costs. In addition, the Company accrued approximately $200 of decommissioning and resin disposal expenses in connection with the return of these systems. The total charge to income related to the termination of these contracts was approximately $900 in the first quarter of 2009 before approximately $400 in contract loss reserve reversals associated with the terminated contracts.

~~BASIN~~Note ~~WATER,~~7—Goodwill ~~INC.~~and ~~AND~~Intangible ~~SUBSIDIARIES~~Assets

~~NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS~~ Goodwill

~~(Unaudited)~~Goodwill represents the excess of the cost of an acquired entity over the net fair value of identifiable assets acquired and liabilities assumed. The carrying amount of goodwill as of March 31, 2009 and December 31, 2008 was $2,490.

~~(In~~Intangible ~~thousands,~~Assets ~~except share and per share data)~~

Note 6 —Goodwill and Intangible Assets

During the third quarter of 2008, the Company recorded a charge to earnings of approximately $5,000 to reduce the carrying value of the goodwill related to the MPT acquisition, which was included in selling, general and administrative expense. The primary factors impacting management’s assessment of value included slower-than-anticipated growth rates and a decline in the customer base of MPT, both of which have resulted in a significant decline in MPT’s future revenues and cash flows since its acquisition in September 2007. The Company’s goodwill at September 30, 2008 increased due to the acquisition of Envirogen, as discussed in Note 3.

Goodwill represents the excess of the cost of an acquired entity over the net fair value of identifiable assets acquired and liabilities assumed. The following table presents the changes in the carrying amounts of goodwill for the nine months ended September 30, 2008:

Balance at December 31, 2007	$	6,323
Acquisition of Envirogen business during the period		1,423
Adjustments to MPT goodwill		(21	)
Impairment of MPT goodwill		(4,952	)
Balance at September 30, 2008	$	2,773

Net intangible assets are as shown in the following table as of the dates indicated:

	September 30,2008			December 31,2007
	March 31,2009			December 31,2008
Deferred stock based compensation	$	37		$	157
Service agreements and contracts	$	1,438		$	1,438
Service agreements and contracts		1,438			1,355
Customer relationships		681			681
Customer relationships		691			569
Covenant not to compete		322			322
Trade name		543			~~180~~543
Accumulated amortization		(~~461~~742	)		(~~115~~602	)
Intangible assets, net	$	2,~~570~~242		$	2,~~468~~382

~~Note~~The 7amortization periods of intangible assets are as follows: customer relationships—~~Notes~~15 years; ~~Payable~~covenant not to compete—three years; trade name—two years; and service agreements and contracts—six years.

InPatent June 2007, the Company sold 10 of its water treatment systems to a special purpose entity, VL Capital (VLC). The total sales price was $3,853, consisting of $500 in cash to be paid to the Company plus a securedCosts ~~note payable in 72 monthly installments of $56 beginning April 2008, with a net present value of $3,353, calculated using an imputed interest rate of 5.0% per annum.~~

~~VLC,~~The inCompany ~~turn,~~capitalizes ~~received~~costs aof ~~loan~~patent ofapplications. ~~$500~~When ~~from~~patents aare ~~finance~~issued, ~~company~~the toCompany ~~fund~~amortizes the ~~cash~~patent ~~payment~~cost toover the ~~Company.~~life ~~This~~of the ~~non-interest~~patent, ~~bearing~~usually ~~loan~~17 years. If a patent is ~~due~~denied, incapitalized ~~nine~~patent ~~monthly~~costs ~~installments~~are ofwritten ~~$63~~off ~~plus~~in 71the ~~monthly~~period ~~installments~~in ofwhich ~~$7 beginning~~the ~~August~~patent ~~2008~~application is denied.

~~The~~12 Company has determined that, in accordance with the provisions of FIN 46(R), the financial statements of VLC should be included in the consolidated financial statements of the Company. Accordingly, both the sale of equipment to VLC and the notes receivable from VLC have been eliminated in consolidation, and the Company has now included in its consolidated financial statements the notes payable by VLC to the finance company. Notes payable by VLC to a finance company consisted of the following:

	September 30,2008			December 31,2007
Note payable to a financing company, non-interest bearing, imputed interest rate of 68.9% per annum, payable in 80 monthly installments beginning on August 1, 2008 and ending on March 1, 2014	$	167		$	352
Less: current portion of notes payable		(56	)		(239	)
Notes payable, net of current portion	$	111		$	113

BASIN WATER, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

(In thousands, except share and per share data)

Note 8—~~Contract~~Investment ~~Loss~~in ~~Reserve~~Empire Water Corporation (Empire)

~~During~~In April and May 2007, the ~~latter~~Company ~~half~~entered into a letter of ~~2006~~intent and then an agreement to acquire certain water rights and related assets from various parties at a total cost of $1,500, of which a deposit of $100 was made by the Company at the time of execution of the letter of intent. In December 2007, the Company ~~analyzed~~sold ~~operating~~to ~~results~~Empire ~~for~~its ~~each~~rights ~~water~~to ~~service~~purchase ~~agreement~~certain collective assets from unrelated parties including (~~WSA~~a) a canal located in San Bernardino and ~~determined~~Riverside counties in Southern California that ~~certain~~is approximately eighteen miles in length, ~~generally~~ ~~older~~(b) rights ~~contracts~~to ~~were~~pump ~~operating~~water atfrom ~~net~~the ~~cash~~San ~~flow~~Bernardino ~~losses~~Basin, and (c) other equipment and tangible and intangible personal property of the sellers. ~~Under~~As consideration for the ~~WSAs~~sale of the rights to purchase these assets, the Company ~~provides~~received to6,000,000 ~~its~~shares ~~customers~~of ~~operations~~Empire ~~and~~common ~~maintenance~~stock, ~~services~~which ~~for~~represented ~~water~~an ~~treatment~~ownership ~~units~~interest ~~previously~~of ~~sold~~approximately 32% orin ~~leased~~Empire toas ~~those~~of ~~customers~~December 31, 2007 and 2008. ~~These~~In ~~contracts~~connection ~~have sustained~~with ~~increasing~~the ~~operating~~settlement ~~costs~~of ~~such~~a aslawsuit ~~waste~~in ~~disposal~~February ~~and~~2009, ~~salt~~the ~~purchase~~Company ~~costs~~transferred as150,000 shares of Empire common stock to Opus Trust, Inc. (see Note 11). After this transfer, the ~~direct~~Company owned ~~result~~5,850,000 shares of ~~higher~~Empire ~~fuel~~common stock, ~~salt~~which ~~and~~represents ~~other~~an ~~third-party~~ownership ~~costs~~interest of approximately 31% in Empire as of March 31, 2009.

~~These~~The ~~contracts~~Company ~~did~~recorded ~~not~~the ~~allow~~December ~~management~~2007 totransaction ~~renegotiate~~under ~~terms~~the toequity ~~recover~~method; ~~such~~therefore, ~~increased~~under ~~costs.~~EITF ~~Management~~01-2 ~~determined~~the ~~that~~Company ~~these~~recorded ~~contracts~~a ~~would~~partial ~~continue~~gain toof ~~generate~~approximately ~~net~~$3,100 ~~operating~~on ~~cash~~the ~~flow~~transaction. ~~losses~~The ~~through~~Company determined the ~~end~~gain ofby (a) estimating the ~~contract~~fair ~~period.~~value ~~Accordingly,~~of ~~the~~such ~~Company~~stock ~~recorded~~based upon concurrent sales of Empire common stock to third parties, less a ~~reserve~~discount for ~~future~~risk ~~contract~~and ~~losses~~illiquidity inand ~~the~~including ~~amount~~a reimbursement of ~~approximately~~certain ~~$3,700~~due indiligence costs pursuant to the ~~quarter~~terms ~~ended~~of ~~December 31~~the agreement with Empire, ~~2006.~~which ~~This~~amounted ~~amount~~to ~~represented~~an ~~management’s~~estimated ~~estimate~~fair value of ~~the~~approximately ~~losses~~$4,904; (b) subtracting the Company’s ~~expected~~basis toin ~~incur~~the ~~during~~assets ~~the~~sold, ~~remaining~~amounting ~~term~~to ofapproximately $354, and (c) reducing the ~~initial~~resulting ~~period~~gain of ~~these~~$4,550 ~~contracts~~by ~~excluding~~the ~~renewal~~Company’s 32% ~~periods,~~ownership ifinterest ~~any~~in Empire, ~~related~~for toa ~~such~~reduction ~~contracts~~of $1,456.

During ~~2007~~the quarter ended September 30, ~~additional~~2008, ~~older~~the ~~legacy~~Company ~~contracts~~assessed ~~became~~its investment ~~operational~~in ~~and~~Empire. ~~were~~Based ~~operated~~upon ~~during~~current ~~the~~market ~~busy~~conditions, ~~higher~~Empire’s ~~volume~~financial ~~summer~~condition, ~~months.~~and ~~Based~~the onCompany’s ~~the~~understanding ~~new~~of ~~operating~~Empire’s ~~history~~business prospects, ~~especially~~the ~~during~~Company determined that the ~~third~~carrying ~~quarter~~value of ~~2007~~its investment in Empire should be reduced by approximately $1,900 at September 30, 2008. As part of this assessment, the Company determined that ~~the~~a ~~original~~portion ~~reserve~~of the impairment was ~~not~~attributable ~~adequate.~~to ~~Management~~the ~~reviewed~~deferred ~~each~~revenue ~~contract’s~~recorded ~~financial~~at ~~performance~~the ~~and~~date ~~identified~~that the ~~future~~Company ~~expected~~sold ~~losses~~assets ~~for~~to Empire, ~~these~~as ~~contracts,~~the ~~resulting~~Company inhas anevaluated ~~approximate~~the ~~$6,800~~underlying ~~(as~~assets ~~restated;~~associated ~~see following~~with ~~paragraph)~~the ~~increase~~deferred torevenue ~~the~~and ~~reserve~~concluded ~~which~~that ~~was~~such ~~charged~~assets are impaired to ~~cost~~the extent of ~~contract~~the ~~revenues~~Company’s 32% ownership interest in Empire. Accordingly, the ~~quarter~~Company ~~ended~~reduced deferred revenue-affiliate by $659 at September 30, ~~2007~~2008.

~~Also~~In March 2009, as ~~discussed~~Empire inannounced ~~Note~~that 3it towould ~~the~~no ~~Company’s~~longer ~~restated~~operate ~~consolidated~~as ~~financial~~a ~~statements~~public company ~~included~~and init subsequently deregistered its ~~Annual~~common ~~Report~~stock onwith ~~Form~~the ~~10-K/A~~Securities ~~for~~and ~~the~~Exchange ~~year~~Commission. ~~ended~~Following ~~December 31,~~its ~~2007~~announcement, the ~~Company~~quoted ~~subsequently~~market ~~determined~~price ~~that~~for anEmpire’s ~~error~~common ~~was~~stock ~~made~~declined inprecipitously. ~~the calculation~~These ofdevelopments, ~~the~~along ~~reserve~~with Empire’s ~~for~~continued ~~contract~~uncertain ~~losses~~status atas ~~September 30,~~a ~~2007.~~development ~~Specifically~~stage company, ~~with~~and ~~regard~~inability to ~~one~~obtain ofadditional ~~its~~funding ~~service~~to ~~contracts,~~sustain itits ~~was~~operations, ~~assumed~~raise ~~that~~substantial adoubt ~~possible~~about ~~facility~~its ~~expansion~~ability ~~would~~to ~~result~~continue inas ~~higher~~a ~~service~~going ~~fees~~concern. toAccordingly, the ~~customer, thus~~Company ~~eliminating~~determined ~~estimated~~that ~~operating~~its ~~losses~~investment onin ~~this~~Empire ~~contract~~was ~~beyond~~substantially ~~2008.~~impaired Asas aof ~~result~~March 31, ~~the~~2009 ~~Company~~and ~~increased~~wrote ~~the~~down ~~reserve~~its ~~for~~remaining ~~contract~~investment ~~losses~~by ~~(and~~approximately ~~the~~$1,700. ~~related~~After ~~cost~~reducing ofdeferred ~~contract~~revenue-affiliate ~~revenues)~~ by approximately $1,800, ~~million~~this resulted in a charge to other expense of approximately $900 in the quarter ended ~~September~~ March 3031, ~~2007 to correct this error~~2009.

~~Actual~~Note ~~losses~~9—Notes onPayable the underlying contracts are being charged against the reserve as incurred. Such charges against the reserve totaled approximately $800 during each of the nine-month periods ended September 30, 2008 and 2007, respectively. The reserve for contract losses included in the condensed consolidated balance sheet, both short- and long-term, as of September 30, 2008 was $8,329. The changes in the reserve are as follows:

	Nine Months EndedSeptember 30,
	2008			2007
Beginning balance	$	9,112		$	3,725
Additions to contract loss reserve		40			6,777
Actual contract losses charged against the reserve		(823	)		(765	)
Ending balance	$	8,329		$	9,737

The following table summarizes notes payable as of March 31, 2009 and December 31, 2008:


	March 31, 2009			December 31, 2008
Note payable to a financing company, non-interest bearing, imputed interest rate of 68.9% per annum, payable in 80 monthly installments beginning on August 1, 2008 and ending on March 1, 2014	$	155		$	155
Contract payable to a financing company in nine monthly installments including interest at 4.6% per annum		155			362

Total notes payable		310			517
Less: current portion of notes payable		(202	)		(408	)

Notes payable, net of current portion	$	108		$	109

Notes Payable to Finance Companies

In June 2007, the Company sold 10 of its water treatment systems to a special purpose entity, VL Capital (VLC). The total sales price was $3,853, consisting of $500 in cash to be paid to the Company plus notes issued by VLC to the Company payable in 72 monthly installments of $56 beginning April 2008, with a net present value of $3,353, calculated using an imputed interest rate of 5.0% per annum. VLC, in turn, received a loan of $500 from a finance company to fund the cash payment to the Company. This non-interest bearing loan is due in nine monthly installments of $63 plus 71 monthly installments of $7 beginning August 2008.

The Company has determined that, in accordance with the provisions of FIN 46(R), Consolidation of Variable Interest Entities (revised December 2003)—an interpretation of ARB No. 51, the financial statements of VLC should be included in the consolidated financial statements of the Company. Accordingly, both the sale of equipment to VLC and the note receivable from VLC have been eliminated in consolidation, and the Company has included in its consolidated financial statements the note payable by VLC to the finance company. As of March 31, 2009, there was $155 outstanding under this note payable.

BASIN WATER, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

(In thousands, except share and per share data)

Note 9—Notes ~~Investment~~Payable ~~in Empire Water Corporation~~ (~~Empire~~continued)

InThe ~~May 2007, the~~ Company ~~entered~~also ~~into~~has ana ~~agreement~~contract topayable ~~acquire certain water rights and related assets. In December 2007, the Company sold~~ to ~~Empire its rights to purchase certain collective assets from unrelated parties including (~~a~~) a~~ ~~canal~~financing ~~located~~company in San Bernardino and Riverside counties in Southern California that is approximately 18 miles in length, (b) rights to pump water from the San Bernardino Basin, and (c) other equipment and tangible and intangible personal property of the sellers. As consideration for ~~the~~a ~~sale~~portion of ~~these~~its ~~assets~~insurance premiums, ~~the~~payable ~~Company~~in ~~received~~nine ~~6,000,000~~monthly ~~shares~~installments of ~~Empire common stock, which represents an~~$51 ~~ownership~~beginning ~~interest of approximately 32%~~ in ~~Empire~~November as2008 ofand ~~December 31,~~ending ~~2007~~in ~~and~~July ~~September 30, 2008~~2009.

~~The~~Note Company accounted for the December 2007 transaction under the equity method; therefore under EITF 01-2 the Company recorded a partial gain of approximately $3,100 on the transaction. The Company determined the gain by estimating the fair value of such stock based upon concurrent sales of Empire common stock to third parties, and reducing the fair value by the Company’s ownership interest in Empire. This reduction of approximately $1,500 was recorded as deferred revenue10—~~affiliate~~Contract onLoss ~~the~~Reserve ~~balance sheet of the Company at December 31, 2007 and September 30, 2008.~~

InThe ~~addition,~~reserve ~~the~~for ~~Company~~contract ~~has~~losses ~~concluded~~included ~~that~~in the ~~assets~~consolidated ~~sold~~balance ~~under~~sheet, ~~the agreement~~both ~~did~~short- ~~not~~and ~~constitute the sale of a business as contemplated by EITF 98~~long-3term, as ~~the rights conveyed to Empire were not an integrated set~~ of ~~activities and assets conducted and managed for the purpose of providing a return or other economic benefits. The Company also does not believe the transaction was covered under SAB Topic 5.U.~~March 31, as2009 ~~1) Empire is not a highly leveraged entity, 2) the underlying assets sold to Empire have historically produced cash flows, 3) substantial capital has been raised by Empire from outside investors~~ and ~~4) the Company does not have any actual or implied commitment to support Empire. According to Empire’s Annual Report on Form 10-K for the year ended June 30,~~ 2008, ~~Empire~~were approximately ~~raised a total of~~ $47,~~750 in~~300 ~~financing through June 2008~~ and ~~had~~ $18,~~300 in cash as of June 30~~700, ~~2008~~respectively. ~~Empire also disclosed that it intends to raise an additional $16,000 or joint venture its assets with a municipal or financial partner to fully implement its plan of operation.~~ The ~~Company~~changes isin ~~not~~the ~~aware~~reserve offor ~~any~~contract ~~parties~~losses ~~obliged~~are toas ~~provide~~follows: ~~Empire with financial support in the future.~~

During the quarter ended September 30, 2008, the Company assessed its investment in an affiliate, Empire. Based upon current market conditions, Empire’s financial condition, and the Company’s understanding of Empire’s business prospects, the Company determined that the carrying value of its investment in Empire should be reduced by approximately $1,900 at September 30, 2008. As part of this assessment, the Company determined that a portion of the impairment is attributable to the deferred revenue recorded at the date that the Company sold assets to Empire, as the Company has evaluated the underlying assets associated with the deferred revenue and concluded that such assets are impaired to the extent of the Company’s 32% ownership interest in Empire. Accordingly, the Company has reduced deferred revenue-affiliate by $659 at September 30, 2008. The difference between the $1,936 impairment to investment in affiliate and the $659 reduction of deferred revenue-affiliate is included as other expense of $1,277 in the statements of operations for the three- and nine-month periods ended September 30, 2008.


	Three Months Ended March 31,
	2009			2008
Beginning balance	$	7,970		$	9,112
Additions to contract loss reserve		—			—
Reductions in contract loss reserves due to contract terminations		(448	)		—
Actual contract losses charged against reserve		(194	)		(367	)

Ending balance		7,328			8,745
Less: current portion		(1,640	)		(2,153	)

Long-term portion	$	5,688		$	6,592

~~As of~~Included ~~September 30,~~in ~~2008,~~ the ~~Company~~total ~~has~~contract ~~recorded~~loss ~~its~~reserve ~~investment in Empire~~ at ~~approximately $2~~March 31,~~100,~~ ~~while~~2009 ~~the amount of underlying equity in the net assets of Empire~~ is approximately $21,~~900.~~200 ~~The difference of approximately $800 represents the~~related ~~excess~~to ofservice ~~the~~contracts ~~Company’s~~for ~~32%~~water ~~interest~~treatment insystems ~~the~~which ~~net~~have ~~assets~~not ofyet ~~Empire~~become ~~over~~operational ~~the~~but ~~market~~are ~~value~~anticipated ofto ~~the~~go ~~Company’s~~online ~~investment~~ in ~~Empire. As required under~~ the equity method of accounting, the Company has also recorded approximately $200 and $700 of other expense during the three months and nine months ended September 30, 2008, respectively which represents the Company’s 32% interest in Empire’s loss for such periodsfuture.

The Company ~~quoted~~is ~~market~~in ~~price~~ongoing ~~for~~discussions ~~Empire’s~~with ~~common~~several ~~stock~~customers asin ofan ~~September~~effort ~~26,~~to ~~2008~~reduce ~~was~~the ~~$2.40~~current ~~per~~and ~~share~~expected operating losses associated with certain water services agreements. ToWhile the ~~Company’s~~ultimate ~~knowledge,~~outcome ~~there~~of ~~have~~such ~~been~~discussions nocannot be predicted with ~~significant~~certainty, ~~intervening~~it ~~events~~is ~~relating~~reasonably possible that such negotiations may result in amendments to ~~Empire~~existing ~~since~~contracts ~~its~~or ~~last~~new ~~available~~contracts ~~financial~~which ~~statements~~will result in reduced future operating losses and a reduction in the amount of the required reserve for contract losses. However, at this time, such contract amendments or new contracts have not yet been finalized.

~~The~~14 ~~following tables present summarized information as to the assets, liabilities and results of operations for Empire for the periods indicated:~~

	September 30,2008
	(Unaudited)
Current assets	$	619
Land and water rights		3,870
Property and equipment, net		4,372
Other assets		557
Total assets	$	9,418
Current liabilities	$	167
Other liabilities		—
Shareholders’ equity		9,251
Total liabilities and shareholders’ equity	$	9,418

BASIN WATER, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

(In thousands, except share and per share data)

Note 911—~~Investment~~Litigation ~~in Empire Water Corporation (Empire) (continued)~~

	Year EndedJune 30,2008			Three MonthsEndedSeptember 30,2008
	(Unaudited)			(Unaudited)
Revenues	$	33		$	25
Production costs		49			32
Gross loss		(16	)		(7	)
General and administrative expenses		1,500			696
Depreciation expense		1			1
Loss from operations		(1,517	)		(704	)
Other income		7			5
Net loss	$	(1,510	)	$	(699	)

On December 27, 2007 and January 2, 2008, two purported securities class action complaints were filed in the United States District Court for the Central District of California against the Company, Peter L. Jensen, Michael M. Stark and Thomas C. Tekulve (collectively referred to as the Basin defendants) for violations of the Exchange Act. These lawsuits, which contain similar allegations, are captioned Poulos v. Basin Water, et al., Case No. CV 07-8359 GW (FFMx) and Nofer v. Basin Water, et al., Case No. CV 08-0002 SGL (JCRx). The lawsuits were subsequently consolidated, and on October 3, 2008 a Consolidated Amended Complaint (CAC) was filed which alleges that the Company deliberately understated the reserves it took for certain unprofitable contracts, and committed various intentional violations of GAAP during a putative class period between November 14, 2006 and August 8, 2008 (the Federal Lawsuit). The suit did not state a specific amount of damages. On February 19, 2009, the Company and its insurance carriers reached an agreement in principle to settle the class action with representatives of the class. The settlement is still subject to preparation of a final settlement agreement, following which the Company would intend to seek preliminary approval from the Court so that class members can receive notice of the settlement, providing them with the opportunity to accept its terms or to opt out and choose whether to pursue their own individual claims. Following a fair period of notice to the class, it would be the Company’s intention to seek final Court approval of the settlement and the dismissal of all claims against us. The Company denies all of the allegations in the lawsuit and believes that its disclosures were appropriate under the law. Nevertheless, management has agreed to settle the litigation in order to avoid costly and time-consuming litigation. Management does not expect a cash effect of the settlement on the Company as the entire settlement amount is expected to be paid by the Company’s liability insurers.

~~Note~~On ~~10—Consolidated~~January 31, ~~Statements~~2008, Loren Charif, a purported stockholder of ~~Cash~~the ~~Flows~~Company, filed a shareholder derivative lawsuit in the Superior Court of the State of California, County of San Bernardino, against certain of the Company’s executive officers and its current directors. The complaint assumes the truth of the aforementioned allegations in the federal securities class action lawsuits and in connection with those allegations alleges, among other things, breaches of fiduciary duties, waste of corporate assets, unjust enrichment and violations of California Corporations Code pertaining to allegations of improper selling. The suit does not state a specific amount of damages. On November 12, 2008, the Company obtained an order staying this action until a final determination occurs in the Federal Lawsuit.

On March 10, 2009, Demetrice Ledbetter, III, a purported shareholder of the Company, filed a shareholder derivative lawsuit in the United States District Court for the Central District of California against certain current and former executive officers and directors of the Company. The ~~following~~complaint ~~information~~assumes ~~supplements~~the truth of the federal securities class action lawsuits described in the Company’s ~~consolidated~~Annual ~~statements~~Report on Form 10-K/A for the year ended December 31, 2007 and in connection with those allegations alleges, among other things, breaches of ~~cash~~fiduciary ~~flows:~~duty, waste of corporate assets, abuse of control, gross mismanagement, unjust enrichment, and claims for contribution and indemnification. The suit does not state a specific amount of damages.

	Nine Months EndedSeptember 30,
	2008			2007Restated
	(Unaudited)
Supplemental disclosures of cash flow information:
Cash paid during the period for:
Interest	$	210		$	147
Income taxes	$	—		$	—
Cash paid for acquisitions:
Fair value of assets acquired	$	2,021		$	9,431
Liabilities assumed		(50	)		(3,200	)
Cash paid for acquisition (net of cash acquired)	$	1,971		$	6,231
Non-cash investing and financing activities:
Common stock issued for acquisition	$	—		$	5,266
Receivables satisfied for acquisition	$	4,727		$	—
Property returned from seller	$	(2,596	)	$	—

In May 2009, the Company learned that the Division of Enforcement of the Securities and Exchange Commission has opened a formal investigation in relation to the events and allegations set forth in the class actions and derivative actions noted above.

~~Note~~On ~~11—~~February 5, 2009, the Company, BionBasin, Inc. (Bion), ~~Impairment~~Opus Trust, Inc. (Opus Trust) and Martin Benowitz, individually and as Trustee of the Martin A. Benowitz Qualified Profit Sharing Plan (Benowitz), entered into a Settlement Agreement and Mutual Release Agreement (the Settlement Agreement) to settle, among other things, certain claims related to (a) ion exchange units previously sold to Opus Trust by Bion, including a unit that was damaged by an uninsured motorist, (b) Benowitz’ acquisition and sale of the Company’s common stock and (c) Opus Trust’s acquisition of Bion common stock (collectively, the Dispute). Pursuant to the terms of the Settlement Agreement, (a) the Company paid $125 to Opus Trust and transferred to Opus Trust 150,000 shares of Empire Water Corporation common stock (all of which was expensed in the year ended December 31, 2008), (b) Opus Trust transferred to the Company all shares of Bion common stock (500,000 shares) held by Opus Trust and title to the ion exchange units previously sold to Opus Trust, (c) Opus Trust and Benowitz released the Company and Bion from any and all claims and actions arising from the Dispute, (d) the Company and Bion released Opus Trust and Benowitz from any and all claims and actions arising from the Dispute and (e) the parties agreed not to make negative references to the character or business reputation of the parties to the Settlement Agreement.

~~During~~15 the third quarter of 2008, the Company recorded a charge to earnings of $740, classified in the accompanying condensed consolidated statement of operations as research and development expense, to write off certain assets related to the development of the Company’s proprietary Bion Exchange technology. Management determined this impairment charge was required due to uncertainties regarding the future commercial viability of the technology which were, in part, due to the economics of competing technologies with respect to biological processes intended to reduce the costs of treatment of contaminated water.

BASIN WATER, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

(In thousands, except share and per share data)

Note 12—Litigation

On October 26, 2007, Veolia Water North America Operating Services, LLC and certain other related parties filed a lawsuit in the United States District Court of the Middle District of Florida, Tampa Division, naming as defendants Basin Water-MPT, Inc. (a wholly owned subsidiary of Basin Water, Inc.) and two of its employees, one of whom is the son of the Company’s President and Chief Executive Officer. Subsequently, the plaintiffs amended their complaint to add as defendants Basin Water, Inc. and Michael M. Stark, the Company’s President and Chief Executive Officer, to the lawsuit. The lawsuit alleges, among other things, certain claims related to trade secrets and unfair trade practices relating to treatment of by-products produced as a result of the phosphate mining industry. In December 2008, this litigation and the underlying disputes were resolved by agreement, resulting in a payment by the Company of $230 with the remainder of the settlement being paid by the Company’s insurer.

On January 31, 2008, Loren Charif, a purported stockholder of the Company, filed a shareholder derivative lawsuit in the Superior Court of the State of California, County of San Bernardino, against certain of the Company’s executive officers and its current directors. The complaint assumes the truth of the aforementioned allegations in the federal securities class action lawsuits and in connection with those allegations alleges, among other things, breaches of fiduciary duties, waste of corporate assets, unjust enrichment and violations of California Corporations Code pertaining to allegations of improper selling. On November 12, 2008, the Company obtained an order staying this action until a final determination occurs in the Federal Lawsuit. The suit does not state a specific amount of damages.

From time to time, the Company is involved in legal and administrative disputes and proceedings arising in the ordinary course of business, which management believes are not material to the conduct of the Company’s business. With respect to these ordinary matters, management believes that the Company has adequate accruals for expected costs, and the Company may also have effective legal defenses.

FORWARD-LOOKING STATEMENTS

This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act (the Exchange Act) of 1934, as amended, which are subject to the “Safe Harbor” created by those sections. Any such forward-looking statements would be contained principally in “Risk Factors” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations.” Forward-looking statements include information concerning our possible or assumed future results of operations, business strategies, financing plans, competitive position, industry environment, potential growth opportunities and the effects of regulation. Forward-looking statements include all statements that are not historical facts and can be identified by terms such as “anticipates,” “believes,” “could,” “estimates,” “expects,” “intends,” “may,” “plans,” “potential,” “predicts,” “projects,” “should,” “will,” “would” or similar expressions.

Forward-looking statements involve known and unknown risks, uncertainties and other factors which may cause our actual results, performance or achievements to be materially different from any future results, performance or achievements expressed or implied by the forward-looking statements. We discuss many of these risks in greater detail in Part I, Item 1A of our Annual Report on Form 10-K/A for the year ended December 31, ~~2007~~2008 and our other filings with the SEC. Given these uncertainties, you should not place undue reliance on these forward-looking statements. Also, forward-looking statements represent our management’s beliefs and assumptions only as of the date of this Quarterly Report on Form 10-Q. You should read this Quarterly Report on Form 10-Q along with our Annual Report on Form 10-K/A for the year ended December 31, ~~2007~~2008 completely and with the understanding that our actual future results may be materially different from what we expect.

We assume no obligation to update these forward-looking statements publicly, or to update the reasons actual results could differ materially from those anticipated in these forward-looking statements, even if new information becomes available in the future.

The following discussion and analysis should be read in conjunction with the unaudited financial statements and notes thereto included in Part I, Item 1 of this Quarterly Report on Form 10-Q.

Item 2.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Overview

Basin Water, Inc. and its subsidiaries (the Company) design, build and implement systems for the treatment of contaminated groundwater, municipal and industrial wastewater, industrial process water and air streams from municipal and industrial sources. Customers can choose between purchasing the Company’s systems and entering into long-term contracting arrangements for the Company’s systems. The Company also offers long-term contracts for the treatment of water produced from installed treatment systems as well as other water treatment-related services.

In 2007 and ~~the first nine months of~~ 2008, we derived most of our revenues from designing, assembling and servicing our proprietary ion-exchange systems for the treatment of contaminated groundwater for use as drinking water. Also, in 2007 and 2008, we launched major initiatives, both external and internal, to facilitate our transformation into a water services company focused on development of our technology+services business model. Using this model, we seek opportunities to combine proprietary or specialized technologies with long-term relationships built through performance-based service agreements to meet groundwater treatment, industrial water and wastewater treatment and resource recovery needs. By expanding the array of technologies we offer through our technology+services model beyond our proprietary ion-exchange technology, we believe we can expand the potential pool of customers, markets and geographic areas for our services.

While we ~~have~~ commenced a number of new initiatives in 2007 and 2008, we continue to derive a significant part of our revenues from selling and servicing our proprietary, ion-exchange, onsite regenerable treatment system. That system reduces groundwater contaminant levels in what we believe is an efficient, flexible and cost-effective manner. Our system produces what we believe are very low waste rates, can meet a wide range of volume requirements and is capable of removing multiple chemical contaminants at a single site. These systems regenerate the resin by using a salt brine solution to remove the contaminants from the resin so that it can be used again in the ion-exchange process. We market these systems to utilities, cities, municipalities, special districts, real estate developers, investor-owned utilities and other organizations for use in treating groundwater that does not comply with federal or state drinking water regulations due to the presence of chemical contaminants.

~~Building~~16 on our success in the market for treating groundwater to be used for drinking water, we are taking steps to become a next generation water services company that succeeds by combining the strengths of our existing businesses and employees with the offering of cutting edge technology and site-tailored solutions. We plan to employ this model across a broad range of treatment scenarios in municipal and industrial water markets.

~~The~~We ~~Company~~are ~~restated~~taking ~~its~~steps ~~previously~~to ~~reported~~become ~~consolidated~~a ~~financial~~next ~~statements~~generation ~~for~~water ~~the~~services ~~years~~company ~~ended December 31,~~that ~~2007~~succeeds ~~and~~by ~~2006~~combining ~~and~~ the strengths ~~quarterly~~of ~~periods~~our ~~therein,~~existing asbusinesses ~~well as the quarterly period ended March 31, 2008. See Notes 3~~ and 4employees towith the ~~consolidated~~offering ~~financial~~of ~~statements~~cutting ~~included~~edge intechnology ~~the~~and ~~Company’s~~site-tailored ~~Annual~~solutions. ~~Report~~Subject onto ~~Form 10-K/A for~~ the ~~fiscal~~availability ~~year~~of ~~ended~~capital ~~December 31~~resources, ~~2007~~we ~~and~~plan ~~Note 3~~ to ~~the~~employ ~~condensed~~this ~~consolidated~~model ~~financial~~across ~~statements~~a ~~included~~broad inrange ~~the~~of ~~Company’s~~treatment ~~Quarterly~~scenarios in ~~Report~~municipal onand ~~Form~~industrial ~~10-Q/A~~water ~~for the fiscal quarter ended March 31, 2008~~markets.

We make available free of charge through our internet website our press releases, our Annual Report on Form 10-K/A, Quarterly Reports on Form 10-Q (including this Quarterly Report on Form 10-Q), Current Reports on Form 8-K and all other required filings with the Securities and Exchange Commission (SEC) and amendments thereto as soon as reasonably practical after they are electronically filed with, or furnished to, the SEC. Our principal executive offices are located at 9302 Pittsburgh Avenue, Suite 210, Rancho Cucamonga, California 91730, and our telephone number is (888) 481-6811. Our website address is www.basinwater.com. The information on our website is neither part of nor incorporated by reference into this Quarterly Report on Form 10-Q.

Results of Operations

The following table sets forth key components of our results of operations for the periods indicated, both in thousands of dollars and as a percentage of revenues:

	Three Months Ended September 30,										Nine Months Ended September 30,
	Three Months Ended March 31,
	2008			% ofRevenues		2007Restated			% ofRevenues		2008			% ofRevenues		2007Restated			% ofRevenues
	2009			% ofRevenues		2008			% ofRevenues
	(dollars in thousands)										~~(dollars in thousands)~~
Revenues
System sales	$	~~665~~1,422		2340	%	$	~~625~~1,064		2637	%	$	~~2,603~~		30	%	$	~~2,739~~		43	%
Contract revenues		2,~~182~~130		7760	%		1,~~781~~785		7463	%		~~6,202~~		70	%		~~3,631~~		57	%
Total revenues		23,~~847~~552		100	%		2,~~406~~849		100	%		~~8,805~~		~~100~~	%		~~6,370~~		~~100~~	%
Cost of revenues
Cost of system sales		~~878~~1,072		3130	%		~~2,471~~833		~~103~~29	%		~~2,708~~		31	%		~~5,303~~		83	%
Cost of contract revenues		21,~~144~~879		7553	%		81,~~851~~487		~~367~~52	%		~~5,921~~		67	%		~~10,633~~		~~167~~	%
Depreciation expense		~~205~~260		7	%		~~142~~199		67	%		~~603~~		7	%		~~346~~		6	%
Total cost of revenues		3,~~227~~211		~~113~~90	%		112,~~464~~519		~~476~~88	%		~~9,232~~		~~105~~	%		~~16,282~~		~~256~~	%
Gross loss		(380	)	-13	%		(9,058	)	-376	%		(427	)	-5	%		(9,912	)	-156	%
Gross profit		341		10	%		330		12	%
Research and development expense		~~882~~43		311	%		~~152~~74		73	%		~~1,101~~		13	%		~~398~~		6	%
Selling, general and administrative expense		115,~~891~~385		~~418~~152	%		35,~~399~~645		~~141~~198	%		~~22,589~~		~~257~~	%		~~8,019~~		~~126~~	%
Loss from operations		(135,~~153~~087	)	-~~462~~144	%		(125,~~609~~389	)	-~~524~~189	%		~~(24,117~~	)	~~-274~~	%		~~(18,329~~	)	~~-288~~	%
Other income (loss)		(1,409	)	-49	%		702		29	%		(1,436	)	-16	%		1,580		25	%
Other income (expense)		(889	)	-25	%		279		10	%
Loss before income taxes		(14,562	)	-511	%		(11,907	)	-495	%		(25,553	)	-290	%		(16,749	)	-263	%
Loss before taxes		(5,976	)	-169	%		(5,110	)	-179	%
Income tax benefit		—					—					—					—
Loss before noncontrolling interest		(145,~~562~~976	)	-~~511~~169	%		(115,~~907~~110	)	-~~495~~179	%		~~(25,553~~	)	~~-290~~	%		~~(16,749~~	)	~~-263~~	%
Less: net income attributable to noncontrolling interest		(9146	)	-31	%		—(74	)	0-3	%		~~(258~~	)	-3	%		~~(74~~	)	-1	%
Net loss	$	(146,~~653~~022	)	-~~514~~170	%	$	(115,~~907~~184	)	-~~495~~182	%	$	~~(25,811~~	)	~~-293~~	%	$	~~(16,823~~	)	~~-264~~	%

2217

Three Months Ended ~~September~~March 3031, ~~2008~~2009 and ~~2007~~2008

The following table summarizes the significant components of revenues, cost of revenues and gross profit or loss for the three months ended ~~September~~ March 3031, 2009 ~~2008~~ compared to the same period in the prior year:

	Three Months EndedSeptember 30,						Increase (Decrease)
	2009			2008			Increase(Decrease)
	2008			2007
	(In thousands)
Revenues:
Large system sales	$	—		$	132		$	(132	)
System sales		1,422			1,064			358
Standard system sales		665			493			172
Contract operations		2,130			1,785			345
Contract operations		2,182			1,781			401
Total Revenues		3,552			2,849			703
Total Revenues		2,847			2,406			441
Cost of Revenues:
Large system sales		—			1,921			(1,921	)
System sales		1,072			833			239
Standard system sales		878			550			328
Contract operations		1,650			1,854			(204	)
Contract operations		2,271			2,427			(156	)
Net change in contract loss reserve		(642	)		(367	)		(275	)
Net change in contract loss reserve		(127	)		6,424			(6,551	)
Contract termination costs		871			—			871
Depreciation expense		~~205~~260			~~142~~199			6361
Total Cost of Revenues		3,~~227~~211			112,~~464~~519			~~(8,237~~692	)
Gross Profit (Loss):
Gross Profit:
Large system sales		—			(1,789	)		1,789
System sales		350			231			119
Standard system sales		(213	)		(57	)		(156	)
Contract operations		(651	)		(268	)		(383	)
Contract operations		(294	)		(788	)		494
Reserve for future contract operations		642			367			275
Net change in contract loss reserve		127			(6,424	)		6,551
Total Gross Profit	$	341		$	330		$	11
Total Gross Loss	$	(380	)	$	(9,058	)	$	8,678

Revenues

Revenues ~~were~~increased by $20.87 million, ~~and~~or 24%, to $23.46 million ~~during~~in the ~~three~~first ~~months~~quarter ~~ended~~of ~~September 30,~~2009 ~~2008~~from ~~and~~$2.9 ~~2007,~~million ~~respectively~~during the first quarter of 2008. Revenues from system sales ~~remained~~increased ~~unchanged~~by at $0.64 million, or 36%, to $1.4 million in the ~~third~~first quarter of ~~2008~~2009 ~~when compared~~from to$1.1 million in the ~~same~~first ~~period~~quarter inof ~~2007~~2008. ~~Contract~~In ~~revenues~~September ~~increased~~2008, ~~from~~we acquired Envirogen, which contributed $1.80 million of system sales during the ~~third~~first quarter of ~~2007 to $2~~2009.2 ~~million~~At ~~during~~ the same ~~period~~time, ofour ~~2008,~~system ansales revenue ~~increase~~other ofthan from Envirogen decreased by $0.47 million, or 2264%, asto ~~two~~$0.4 ~~large~~million ~~systems~~in ~~were~~the ~~placed~~first inthree ~~service~~months ~~with customers~~of ~~during~~2009 ~~late~~compared ~~2007~~to $1.1 Inmillion ~~addition,~~in wethe ~~acquired~~same ~~MPT~~period in ~~September~~2008. ~~2007,~~Contract ~~which~~operations ~~contributed~~revenues increased from $01.8 million during the first quarter of 2008 to $2.1 million during the same period of ~~system~~2009, ~~sales~~an ~~and~~increase of $0.53 million, or 17%. The acquisition of ~~contract~~Envirogen ~~operations~~had no impact on contract revenues ~~for~~in the ~~third~~first quarter of ~~2008~~2009.

Cost of Revenues

Cost of revenues ~~decreased~~increased by $80.27 million, or 7228%, to $3.2 million during the ~~third~~first quarter of ~~2008~~2009 compared to $112.45 million during the same period in ~~2007~~2008. ~~due~~Cost toof asystem ~~provision~~sales ofincreased to $61.81 million toin ~~increase~~ the ~~reserve~~first ~~for~~quarter ~~contract~~of ~~losses~~2009 compared to $0.8 million in the ~~2007~~first ~~third~~ quarter of 2008. ~~Cost~~The September 2008 acquisition of ~~system~~Envirogen ~~sales decreased~~resulted in approximately $10.65 million in cost of revenues in the ~~third~~first quarter of ~~2008~~2009, ~~when~~ compared to the ~~same~~$1.0 ~~period~~million of revenue contributed by Envirogen in ~~2007~~the assame ~~there~~period. ~~were~~Gross noprofit ~~large~~on Envirogen system sales induring the ~~third~~ quarter ended March 31, 2009 was favorably impacted by the close out of ~~2008~~two projects at higher than expected gross margins.

~~The~~In ~~aforementioned~~addition, ~~decrease~~the increase in ~~the~~ cost of ~~system~~revenues ~~sales~~ was ~~accompanied~~due byto aapproximately ~~decrease of~~ $0.19 million of contract termination costs which were incurred in the ~~cost~~first quarter of 2009. During the first quarter of 2009, five of our existing customer contracts were cancelled either pursuant to their contract ~~revenues~~terms ~~from~~or by mutual consent and the leased water treatment systems returned to us. As a result of these contract terminations, we expensed certain previously capitalized costs of approximately $20.47 million inassociated ~~the~~with ~~third~~these ~~quarter~~systems consisting primarily of ~~2007~~spent toresin and deployment costs. In addition, we accrued approximately $20.32 million of decommissioning and resin disposal expenses in ~~the~~connection ~~third~~with the ~~quarter~~return of ~~2008~~these systems. The ~~acquisition~~total charge to income related to the termination of ~~MPT~~these ~~contributed~~contracts was approximately $0.39 million toin the ~~cost~~first quarter of ~~contract~~2009 ~~revenues~~before approximately $0.4 million in ~~the~~contract ~~third~~loss ~~quarter~~reserve ofreversals ~~2008~~associated with the terminated contracts.

~~Operating~~The aforementioned increase in the cost of system sales was accompanied by a decrease of $0.2 million in the cost of contract revenues from $1.9 million in the first quarter of 2008 to $1.7 million in the first quarter of 2009. Operating costs include salt, waste disposal and field service labor ~~expense~~and related expenses. ~~The~~In ~~2008~~the ~~increase~~first quarter of 2009, we had decreases in ~~cost~~labor, waste disposal and supply expenses. The decrease in labor is reflective of ~~two~~our ~~large~~reduced ~~systems~~workforce ~~that~~in ~~were~~the ~~placed~~first inquarter ~~service~~of 2009 when compared to the same period in ~~late~~2008. ~~2007~~In addition, aswe ~~well~~implemented asmeasures ~~the~~to ~~general~~improve ~~increases~~our efficiency in ~~costs~~field service, ~~for~~resulting ~~labor~~in the decreased waste and ~~supplies~~supply expenses. Operating costs for the ~~third~~first quarter of ~~2008~~2009 and ~~2007~~2008 were partially offset by $0.12 million and $0.4 million, respectively, of charges against the related reserves for operating losses. The acquisition of Envirogen had no impact on cost of contract revenues in the first quarter of 2009.

2318

Gross Profit ~~(Loss)~~

We recorded gross ~~loss~~profit of $0.43 million during ~~the~~each ~~third quarter~~ of ~~2008 compared to a gross loss of $9.1 million during~~ the ~~third~~first ~~quarter~~quarters of ~~2007.~~2009 ~~Our~~and ~~system sales gross loss decreased by $1.6 million in the third quarter of~~ 2008, ~~from $1~~respectively.8 ~~million~~In 2009, gross ~~loss~~profit inwas ~~the~~negatively ~~third~~impacted ~~quarter~~by ~~of 2007 to a $0.2 million gross loss for~~ the ~~same~~aforementioned ~~period~~net ~~in 2008. Meanwhile, our~~ contract ~~operations~~termination ~~gross~~costs ~~loss~~of ~~decreased~~approximately to $0.35 million recorded in the ~~third~~first quarter of ~~2008 compared to $0~~2009.~~8 million~~ inThese ~~the comparable period of 2007. Our~~ contract ~~operations~~termination ~~gross~~costs ~~loss~~were ~~was~~offset ~~impacted~~in part by higher ~~volume-related~~gross ~~contract~~profit ~~operating~~on ~~costs,~~system ~~increased~~sales ~~field~~in ~~service~~the ~~labor,~~first ~~and~~quarter ~~engineering~~of ~~expense~~2009, inprimarily ~~addition~~attributable to ~~the increases in cost of revenues as described above~~Envirogen.

Research and Development Expense

Research and development expense was ~~approximately~~less than $0.91 million ~~and~~in ~~$0.2~~each ~~million~~of ~~for~~ the three ~~months~~-~~ended~~month ~~September~~periods ~~30,~~ended ~~2008 and 2007~~March 31, ~~respectively.~~2009 ~~We incurred research~~ and development costs for outside consultant expenses, research material costs and personnel costs. In addition, as discussed in Note 11 to the condensed consolidated financial statements, during the quarter ended September 30, 2008~~, we recorded a $0~~.7 ~~million charge to write off certain assets related to the development of our Bion technology.~~

Selling, General and Administrative Expense

The following table summarizes the significant components of selling, general and administrative (SG&A) expense for the three months ended ~~September~~ March 3031, ~~2008~~2009 compared to the same period in the prior year.

	Three Months EndedSeptember 30,				Increase(Decrease)
	2009		2008		Increase(Decrease)
	2008		2007
	(In thousands)
Compensation and benefits	$	12,~~767~~108	$	~~996~~2,003	$	~~771~~105
Professional fees		2,315		542		1,773
Severance, consulting and stock-based compensation - former Chairman and CEO		—		983		(983	)
Travel and entertainment		292		147		145
Professional fees		611		832		(221	)
Goodwill impairment		4,952		—		4,952
Restatement expenses		486		—		486
Stock-based compensation expense		223		213		10
Travel and entertainment		264		310		(46	)
Restricted stock expense		455		233		222
Stock-based compensation expense		218		261		(43	)
Depreciation and amortization		403		42		361
Restricted stock expense		334		250		84
Directors’ fees and public company costs		659		226		433
Amortization - intangibles		179		143		36
Bad debt expense		344		164		180
Depreciation		118		67		51
Outside selling, marketing & promotion		110		354		(244	)
Directors’ fees and public company costs		365		162		203
Facility costs		215		250		(35	)
Bad debt expense		100		153		(53	)
Insurance		84		64		20
Outside selling, marketing & promotion		86		83		3
Other SG&A expense		72		168		(96	)
Insurance		127		80		47
Total SG&A Expense	$	11,891	$	3,399	$	8,492
Communications		46		43		3
Facility expense		251		190		61
Other SG&A expense		92		85		7
Total SG&A Expense	$	5,385	$	5,645	$	(260	)

SG&A expense ~~increased~~decreased by $80.53 million, or ~~250~~5%, to $115.94 million during the ~~third~~first quarter of ~~2008~~2009 from $35.47 million during the same period of ~~2007~~2008. The ~~increase~~decrease was ~~primarily~~ due toin apart ~~charge~~ to ~~reduce~~approximately ~~the~~$1.0 ~~carrying~~million ~~value~~in ofseverance ~~goodwill~~and inother ~~the~~compensation ~~amount~~expenses ofrelated ~~$5.0~~to ~~million,~~our asformer ~~well~~Chairman asand ~~higher~~CEO ~~compensation,~~during ~~benefits,~~the ~~and~~first ~~travel~~quarter ~~costs~~of ~~reflective~~2008. ofNo ~~the~~significant ~~increase~~severance inpayments ~~personnel~~were ~~supporting~~made ~~our~~in ~~operations,~~the ~~including~~first ~~$0.5~~quarter ~~million~~of ~~relating~~2009. toOur ~~MPT.~~professional ~~Additionally,~~fees wewere ~~had~~approximately ~~increased~~$0.2 ~~professional~~million ~~fees~~less in the ~~third~~first quarter of ~~2008~~2009 when compared to the ~~year-ago~~same period, ~~primarily~~in ~~for~~2008, as legal fees ~~resulting~~were ~~from shareholder~~reduced ~~litigation~~as settlements and ~~related~~insurance deductible ~~investigations.~~levels ~~Stock-based~~were ~~compensation,~~reached ~~including restricted stock expense, was recorded~~ in ~~accordance with~~ the ~~provisions~~last ofhalf ~~SFAS No. 123(R) and increased in the third quarter~~ of 2008 ~~compared to 2007 because of stock options granted at the end of 2007~~ and early ~~2008,~~2009 ~~and~~for ~~restricted~~certain ~~stock~~outstanding ~~and~~litigation ~~stock options granted to our directors in May, 2008~~matters. ~~The~~These ~~above~~reductions ~~increases~~ in SG&A expense were partially offset by aapproximately ~~decrease~~$0.5 inmillion ~~our~~of ~~outside~~expenses ~~sales, marketing~~incurred ~~and~~in ~~promotion~~connection ~~expense.~~with In the restatement ~~prior~~of ~~year,~~our we2007 ~~relied primarily on outside sales~~ and ~~marketing~~2006 ~~consultants~~financial statements. In ~~late 2007~~addition, weEnvirogen ~~expanded~~accounted ~~our~~for ~~sales~~approximately ~~force~~$0.7 ~~and,~~million ~~in the third quarter~~ of ~~2008, we terminated outside sales and marketing consultants. As a result,~~ our ~~external marketing expense decreased.~~ SG&A expense in the first quarter ~~ended~~of ~~September 30~~2009, ~~2008~~consisting ~~included~~primarily ~~approximately $0.8 million as a result~~ of ~~our~~compensation ~~acquisition~~and ofbenefits, ~~MPT.~~offsetting ~~MPT~~otherwise lower ~~also~~staffing ~~accounted~~costs ~~for~~due ~~most~~to ofa ~~the~~reduced $0headcount.1 ~~million increase in our amortization and depreciation expense.~~

2419

Other Income (Expense)

The following table summarizes the significant components of other income and expense for the quarter ended ~~September~~March 3031, ~~2008~~2009 compared to the same period in the prior year.

	Three Months EndedSeptember 30,						Expense(Increase)Decrease
	2009			2008			Expense(Increase)Decrease
	2008			2007
	(In thousands)
Interest income	$	~~164~~28		$	~~683~~358		$	(~~519~~330	)
Interest expense		(65	)		(81	)		16
Interest expense - notes & loans		(7	)		(41	)		34
Equity in loss of affiliate		~~(223~~—	)		—(40	)		~~(223~~40	)
Impairment charge - investment in affiliate		(~~1,277~~910	)		—			(~~1,277~~910	)
Other income (expense)		(8	)		100			(108	)
Other		—			2			(2	)
Total Other Income (Expense)	$	(~~1,409~~889	)	$	~~702~~279		$	(21,~~111~~168	)

Other expense was approximately $10.49 million during the ~~third~~ quarter ofended ~~2008~~March 31, ~~compared~~2009 compared to ~~$0.7 million~~other income of ~~other~~approximately ~~income~~$0.3 million in the ~~third~~first quarter of ~~2007~~2008. The principal factor affecting other expense in the ~~2008~~2009 quarter is the charge to earnings of approximately $10.39 million to write ~~down~~off the carrying value of our investment in Empire, of which we hold an approximate 3231% interest. ~~Based~~As ~~upon~~discussed ~~current~~in ~~market~~Note ~~conditions,~~8 ~~Empire’s~~to ~~financial~~the ~~condition,~~unaudited ~~and~~condensed ~~our~~consolidated ~~understanding~~financial ~~of Empire’s business prospects~~statements, we determined that the carrying value of our investment in Empire should be reduced by approximately $1.9 7 million, offset by a reduction of approximately $0.68 million in deferred revenue~~-affiliate.~~ ~~Equity~~– ~~in loss of~~ affiliate ~~in the 2008 quarter represents our share of the net loss of Empire, an affiliate in which we own an approximate 32% interest~~.

~~Since~~We ~~receiving~~earn ~~the net proceeds of our initial public offering in mid-May, 2006, we have earned~~ interest income on our invested cash balances. Interest income decreased due to both lower cash balances as we used cash for our operations and lower interest rates on money market funds during the ~~third~~first quarter of ~~2008~~2009 compared to the same period in ~~2007~~2008.

Nine Months Ended September 30, 2008 and 2007

The following table summarizes the significant components of revenues, cost of revenues and gross profit or loss for the nine months ended September 30, 2008 compared to the same period in the prior year:

	Nine Months EndedSeptember 30,						Increase(Decrease)
	2008			2007
	(In thousands)
Revenues:
Large system sales	$	—		$	1,907		$	(1,907	)
Standard system sales		2,603			832			1,771
Contract operations		6,202			3,631			2,571
Total Revenues		8,805			6,370			2,435
Cost of Revenues:
Large system sales		—			4,399			(4,399	)
Standard system sales		2,708			904			1,804
Contract operations		6,704			4,621			2,083
Net change in contract loss reserve		(783	)		6,012			(6,795	)
Depreciation expense		603			346			257
Total Cost of Revenues		9,232			16,282			(7,050	)
Gross Profit (Loss):
Large system sales		—			(2,492	)		2,492
Standard system sales		(105	)		(72	)		(33	)
Contract operations		(1,105	)		(1,336	)		231
Net change in contract loss reserve		783			(6,012	)		6,795
Total Gross Loss	$	(427	)	$	(9,912	)	$	9,485

Revenues

Revenues were $8.8 million and $6.4 million during the nine months ended September 30, 2008 and 2007, respectively. Revenues from system sales decreased $0.1 million, or 4% to $2.6 million in the nine months ended September 30, 2008 when compared to the same period in 2007. Contract revenues increased from $3.6 million during the first nine months of 2007 to $6.2 million during the same period of 2008, an increase of $2.6 million, or 72% primarily as the result of two large systems placed in service with customers during late 2007. In addition, we acquired MPT in September 2007, which contributed $1.7 million to contract revenues for the first nine months of 2008.

Cost of Revenues

Cost of revenues decreased by $7.1 million, or 44% to $9.2 million during the nine months ended September 30, 2008 compared to $16.3 million during the same period in 2007. Cost of systems sold decreased by $2.6 million from $5.3 million in the first nine months of 2007 compared to $2.7 million in the same period of 2008. The decrease reflects the reduction in the number of systems sold in the first nine months of 2008 when compared to the same period in 2007, primarily from our large system sales. The decrease in number of systems sold was partially offset by approximately $0.2 million of one-time start up costs for one of our construction projects. We also incurred approximately $0.7 million of under-absorbed overhead, as our production facilities operated at less than capacity.

The aforementioned decrease in the cost of system sales was offset by an increase of $2.1 million, or 46% in the cost of contract revenues from $4.6 million in the first nine months of 2007 to $6.7 million in the same period of 2008. During the first nine months of 2008, we recorded expense of $0.4 million for damages to an installed system which resulted from an accident. We had more systems in operation during the first nine months of 2008 when compared to same period in 2007, and we also placed two large systems into service in late 2007, which contributed to the increase in operating costs. Additionally, we acquired MPT in mid-September 2007, which contributed $1.0 million of operating expense during 2008.

Operating costs include salt, waste disposal and field service labor expense. The increase in cost is reflective of additional systems in service in 2008 when compared to 2007, as well as the impact of the acquisition of MPT in September, 2007. We also experienced general increases in costs for labor and supplies. Contract revenue operating costs for the nine-month period ended September 30, 2008 were partially offset by $0.8 million of charges against the contract loss reserve for operating losses which had been recorded in prior periods. In the third quarter of 2007, we increased the reserve for contract losses by $6.8 million, which was partially offset by $0.8 million of losses applied against the reserve during the first nine months of 2008.

Gross Profit (Loss)

We recorded a gross loss of $0.4 million during the nine-month period ended September 30, 2008 compared to a $9.9 million gross loss during the same period of 2007. Our system sales gross loss decreased by $2.5 million to $0.1 million in the first nine months of 2008 from a gross loss of $2.6 million in the same period of 2007. Meanwhile, our contract operations gross loss decreased to $1.1 million in the first nine months of 2008 from $1.3 million in the same period of 2007. Our contract operations gross loss was impacted by higher volume-related contract operating costs, increased field service labor, and engineering expense in addition to the increases in cost of revenues as described above.

Research and Development Expense

Research and development expense was approximately $1.1 million and $0.4 million for the nine months ended September 30, 2008 and 2007, respectively. We incurred research and development costs for outside consultant expenses, research material costs and personnel costs. In addition, during the quarter ended September 30, 2008, we recorded a $0.7 million charge to write off certain assets related to the development of our Bion technology. See Note 11 to the condensed consolidated financial statements for further discussion.

Selling, General and Administrative Expense

The following table summarizes the significant components of selling, general and administrative (SG&A) expense for the nine months ended September 30, 2008 compared to the same period in the prior year.

	Nine Months EndedSeptember 30,				Increase(Decrease)
	2008		2007
	(In thousands)
Compensation and benefits	$	5,895	$	2,691	$	3,204
Severance, consulting and stock-based compensation - former Chairman and CEO		983		—		983
Professional fees		3,797		1,160		2,637
Travel and entertainment		921		423		498
Goodwill impairment		4,952		—		4,952
Stock-based compensation expense		784		607		177
Restricted stock expense		972		624		348
Depreciation and amortization		703		63		640
Directors’ fees and public company costs		1,260		604		656
Bad debt expense		562		199		363
Outside selling, marketing & promotion		626		886		(260	)
Facility costs		628		307		321
Insurance		254		147		107
Other SG&A expense		252		308		(56	)
Total SG&A Expense	$	22,589	$	8,019	$	14,570

SG&A expense increased by $14.6 million, or 183%, to $22.6 million during the first nine months of 2008 from $8.0 million during the same period of 2007. The increase was largely attributable to goodwill impairment charge totaling $5.0 million related to our MPT business, as well as higher compensation, benefits, and travel costs reflective of the increase in personnel supporting our operations. We took an impairment charge for our MPT assets based on slower growth rates, and a decline in our MPT customer base, which we believe will have a permanent effect on MPT’s future revenues and cash flows. SG&A expense also increased due to costs associated with the resignation of our former Chairman and CEO totaling $1.0 million, which included a cash severance payment, stock-based compensation expense associated with options awarded in prior periods and consulting payments to be made over a two-year period. Professional fees increased by $2.6 million in the first nine months of 2008 when compared to 2007, primarily for legal fees related to shareholder litigation and related investigations. Our facility costs were higher as a result of an expansion of our office facilities and equipment to accommodate our increased staffing, as well as, the effects of our acquisition of MPT. Public company expense increased primarily due to higher director fees in 2008. Stock-based compensation including restricted stock expense was recorded in accordance with the provisions of SFAS No. 123(R) and increased in the first nine months of 2008 when compared to the same period in 2007. The increases were primarily due to stock options granted at the end of 2007 and early 2008, and restricted stock and stock options granted to our directors in May 2008. SG&A expense included approximately $2.4 million, excluding the effect of the impairment charges, during the first nine months of 2008 as a result of our acquisition of MPT in September 2007. The MPT acquisition accounted for approximately $1.4 million of the increase in compensation and benefits, as well as most of the $0.2 million increase in our amortization and depreciation expense.

Other Income (Expense)

The following table summarizes the significant components of other income and expense for the nine months ended September 30, 2008 compared to the same period in the prior year.

	Nine Months EndedSeptember 30,						Expense(Increase)Decrease
	2008			2007
	(In thousands)
Interest income	$	765		$	2,108		$	(1,343	)
Interest expense		(210	)		(180	)		(30	)
Amortization - fair value of warrants		—			(449	)		449
Equity in loss of affiliate		(703	)		—			(703	)
Impairment of investment in affiliate		(1,277	)		—			(1,277	)
Other income (expense)		(11	)		101			(112	)
Total Other Income (Expense)	$	(1,436	)	$	1,580		$	(3,016	)

Other expense was approximately $1.4 million during the first nine months of 2008 compared to other income of approximately $1.6 million in the same period of 2007. Since receiving the net proceeds of our initial public offering in mid-May, 2006, we have earned interest income on our invested cash balances. Interest income decreased due to both lower cash balances as we used cash for our operations and lower interest rates on money market funds during the first nine months of 2008 compared to the same period in 2007. Equity in loss of affiliate in the nine-month period ending September 30, 2008 represents our 32% share of the net loss of Empire for the nine months ended September 30, 2008. We also recorded a change to earnings of approximately $1.3 million to write down the carrying value of our investment in Empire. Based upon current market conditions, Empire’s financial condition and our understanding of Empire’s business prospects, we determined that the carrying value of our investment in Empire should be reduced by approximately $1.9 million, offset by a reduction of approximately $0.6 million in deferred revenue-affiliate, in the quarter ended September 30, 2008.

Liquidity and Capital Resources

At ~~September~~March 3031, 2009 ~~2008,~~ we had approximately $168.98 million in cash and cash equivalents, including $0.4 million resulting from the consolidation of VL Capital, which funds of VL Capital are not available to us to support our liquidity needs. We have invested substantially all of our available cash balances in money market funds placed with reputable institutions for which credit loss is not anticipated. The following table summarizes our primary sources and uses of cash in the periods presented.

	Nine Months EndedSeptember 30,
	Three Months EndedMarch 31,
	2008			2007
	2009			2008
	(in thousands)
Net cash provided by (used) in:
Net cash used in:
Operating activities	$	(122,~~910~~281	)	$	(67,~~133~~460	)
Investing activities		(~~6,078~~632	)		(~~10,845~~597	)
Financing activities		(~~168~~209	)		~~1,618~~(89	)
Net decrease in cash and cash equivalents	$	(193,~~156~~122	)	$	(158,~~360~~146	)

Operating Activities

Net cash used in operating activities was approximately $122.93 million for the first ~~nine~~three months of ~~2008~~2009 compared to net cash used ~~in operating activities~~ of $67.15 million for the comparable period ofin ~~2007~~2008. InWe ~~addition to~~recorded ~~our~~a net loss of $256.8 0 million, ~~which included $11.1 million of non-cash expenses, cash used~~ in ~~operating activities during~~ the first ~~nine~~quarter ~~months~~ of ~~2008~~2009 which was negatively impacted by a $0.7 million increase in accounts receivable, a $0.5 million increase in inventory, a $0.8 million decrease in contract loss reserve and a $0.6 million increase in net other assets and liabilities. These uses of cash were offset by a $21.89 million decrease in ~~unbilled~~ receivables, a $0.~~5 million decrease in prepaid expenses, a $0.~~4 million increase in ~~accounts~~deferred ~~payable~~revenues, ~~and~~ a $0.69 million ~~increase~~write indown ~~accrued expenses. For the first nine months~~ of ~~2007, net cash used in operating activities was $6.1 million. In addition to~~ our ~~net~~investment ~~loss of $16.8 million, including non-cash expenses of $2.7 million, cash used~~ in ~~operating~~Empire ~~activities~~and ~~during~~ the ~~first nine months of 2007 reflects an increase in accounts receivable of~~ $0.8 7 million, aexpense ~~$0.5~~of ~~million increase in prepaid expenses, a $1.2 million decrease in~~previously ~~accrued~~capitalized ~~expenses~~costs ~~and~~associated awith ~~$0.8~~the ~~million~~termination ~~increase in other assets and liabilities, all~~ of ~~which~~certain ~~were offset by a $4~~contracts.0 ~~million decrease in unbilled receivables, a $1.7 million increases in accounts payable and a $6.0 million increase in contract loss reserve.~~

28In 2008, in addition to our net loss of $5.2 million, cash used in operating activities was primarily due to an increase in other assets and liabilities of $1.4 million including approximately $0.9 million of bid deposits, a net decrease in accounts payable of $0.7 million, a $0.4 million increase in inventory, and a $0.4 million decrease in contract loss reserve.

Investing Activities

Net cash used in investing activities was ~~approximately~~ $60.16 million ~~for~~in the first ~~nine~~three months of ~~2008,~~2009 ~~compared~~which towas ~~net~~consistent ~~cash~~with ~~used in investing activities of $10.8 million during~~ the ~~same period in 2007. Cash used in investing activities for the~~ first ~~nine~~three months of 2008 ~~and 2007 includes capital expenditures for building water treatment systems for sale or lease to customers in the amount of $4~~.~~1 million and $4.5 million, respectively. Beginning in the~~ 2007 fourth quarter, we began investing in the construction of water treatment units for specific customers for which sales have not yet materialized. We expect to sell or lease these water treatment units in the future.

Financing Activities

Net cash used in ~~financing~~ financing activities was approximately $0.2 million for the first ~~nine~~three months of ~~2008~~2009 compared to net cash ~~provided~~used ~~by financing activities of $1.6 million~~ in ~~the same period of 2007. Net cash provided by~~ financing activities ~~for the first nine months~~ of ~~2007 reflects~~approximately $30.1 million in ~~net proceeds from~~ the ~~exercise~~same ofperiod ~~warrants, offset in part by $2.3 million in repayments~~ of ~~notes payable and capital leases~~2008.

Liquidity and Capital Resources

Our future capital requirements will depend on many factors, including our level of revenues, the expansion and success of our sales and marketing activities, the success of our strategic relationships in the marketing of our treatment systems, our ability to sell existing systems or place them under long-term contracts and provide service under our long-term contracts and the continued market acceptance of our systems and services.

WeAt ~~anticipate~~March 31, ~~that~~2009 we ~~may~~had ~~need additional~~approximately ~~capital~~$8.4 tomillion ~~finance~~and ~~our~~as ~~operations~~of ~~over~~May 15, ~~the~~2009 ~~next~~we 12had ~~months~~approximately $7.3 Inmillion ~~such~~in ancash ~~event,~~and wecash ~~would~~equivalents (excluding ~~seek~~cash balances resulting from the consolidation of VL Capital which are not available to ~~raise~~us ~~additional~~to ~~capital~~support ~~through~~our aliquidity ~~combination~~needs). ofWe ~~bank~~have ~~credit~~invested ~~facilities,~~substantially ~~issuance~~all of ~~long-term~~our ~~debt~~available ~~and~~cash ~~private~~funds orin ~~public~~money ~~debt~~market orfunds ~~equity~~placed with reputable ~~offerings~~institutions for which credit loss is not anticipated.

~~The~~We ~~U.S. credit markets~~ have ~~recently~~ experienced significant ~~dislocations~~negative ~~and~~cash ~~liquidity~~flows ~~disruptions~~from ~~which~~operating ~~have~~and ~~caused spreads~~investing onactivities ~~prospective~~since ~~debt~~2006, ~~financings~~including toduring ~~widen~~the ~~considerably.~~first ~~These~~quarter ~~circumstances~~of ~~have~~2009, ~~materially~~and ~~impacted~~we ~~liquidity~~expect into ~~the~~consume ~~debt~~additional ~~markets,~~cash ~~making~~for ~~financing~~such ~~terms~~activities for ~~borrowers~~the ~~less~~foreseeable ~~attractive,~~future. ~~and~~We inhad ~~certain~~a ~~cases~~net ~~have~~loss ~~resulted~~of inapproximately $6.0 million for the ~~unavailability~~three ~~of certain~~months ~~types~~ended ofMarch 31, 2009 ~~debt~~and ~~financing.~~incurred ~~These~~net ~~events~~losses induring the ~~credit~~past ~~markets,~~two asfiscal ~~well~~years asended ~~deteriorating~~December 31, ~~market~~2008 ~~conditions,~~and ~~have~~2007 ~~also~~of ~~had~~approximately an$32.5 ~~adverse~~million ~~effect~~and on$18.3 ~~other~~million, ~~financial~~respectively. ~~markets~~Unless inand ~~the~~until ~~United~~we ~~States,~~are ~~including~~able ~~the~~to ~~equity~~generate ~~markets,~~sufficient ~~which~~revenues ~~may~~from ~~make~~our itsystem ~~more~~sales ~~difficult~~and orcontract ~~costly~~services, ~~for~~we usexpect tosuch ~~raise~~losses ~~capital~~to ~~through~~continue in the ~~issuance~~future. ofTherefore ~~common~~our ~~stock~~ability orto ~~other~~continue ~~equity~~to ~~securities.~~operate Ifour webusiness ~~were~~over ~~unable~~the tonext ~~obtain~~12 ~~additional~~months ~~capital~~is ~~through~~highly ~~one~~dependent oron ~~more~~the amount of ~~these~~cash ~~sources,~~and ~~our~~cash ~~ability~~equivalents toon ~~continue~~hand combined with our ability ~~operations~~to ~~and~~raise ~~grow~~capital ~~our revenues~~to ~~may~~support beour ~~adversely~~future ~~impacted~~operations.

Additional capital, whether obtained through financial markets (in the form of public or private debt or equity) or collaborative or other arrangements with water providers, corporate partners or from other sources, may not be available at all, when needed, or on terms acceptable to us. If additional funds are raised through the issuance of additional common stock, other equity securities or indebtedness, the percentage ownership of our then-current stockholders may be diluted substantially and the equity or debt securities issued to new investors may have rights, preferences or privileges senior to those of the holders of our then-existing capital stock.

The U.S. credit markets have recently experienced significant dislocations and liquidity disruptions which have caused spreads on prospective debt financings to widen considerably. These circumstances have materially impacted liquidity in the debt markets, making financing terms for borrowers less attractive, and in certain cases have resulted in the unavailability of certain types of debt financing. These events in the credit markets as well as deteriorating market conditions have also had an adverse effect on other financial markets in the United States, including the equity markets, which we expect will make it very difficult and costly for us to raise capital through the issuance of debt, common stock or other equity securities. To date, our efforts to secure additional capital from debt or equity financing have been unsuccessful. If adequate funds are not available or are not available on acceptable terms, we may not be able to continue operations, resulting in significant harm to our financial condition and prospects and a decline in our stock price. This raises substantial doubt as to our ability to continue as a going concern.

Our independent auditors’ report for the year ended December 31, 2008 includes an explanatory paragraph stating that our recurring losses from operations and negative cash flows raise substantial doubt about our ability to continue as a going concern. If we are unable to obtain additional financing on commercially reasonable terms, our business, financial condition and results of operations will be materially and adversely affected and we may be unable to continue as a going concern. The question about our ability to continue as a going concern may also limit our ability to obtain financing on acceptable terms or at all, and may limit our ability to obtain new business due to potential customers’ concern about our ability to provide water treatment and other services. If we are unable to continue as a going concern, we may elect or be required to seek protection from creditors by filing a voluntary petition in bankruptcy or may be subject to an involuntary petition in bankruptcy. In such a case, we may have to liquidate our assets and may receive less than the value at which those assets are carried on our financial statements, and it is likely that investors will lose all or a part of their investment.

As previously announced, our Board of Directors has engaged Canaccord Adams to conduct a review of the Company’s strategic alternatives. These alternatives include the sale of some or all of our assets or stock, a merger or other business combination involving the Company, third party investment and other strategic alternatives. The Company and Canaccord Adams have engaged in confidential discussions with a number of potential counterparties regarding a strategic transaction, most of which have involved a sale of substantially all of our assets under Section 363 of the Bankruptcy Code intended to result in continuation of the Company’s current business. However, there can be no assurance that these efforts will result in any specific transaction or that any transaction that is consummated will be favorable to our stockholders.

Outstanding Indebtedness

At ~~September~~ March 3031, ~~2008~~2009, we had no outstanding indebtedness except for approximately $0.2 million of notes payable to a finance company in connection with the consolidation of VLC and approximately $0.1 million of notes payable to another finance company for insurance premiums. See Note 79 to our unaudited condensed consolidated financial statements for further discussion.

~~Contractual~~21 ~~Obligations~~

The following table summarizes our known contractual obligations to make future cash payments as of September 30, 2008 as well as an estimate of the periods during which these payments are expected to be made.

Payments Due by Period	Less than 1Year(2008-2009)		1 to 3Years(2009-2011)		3 to 5Years(2012-2013)		More than5 Years(After 2013)		Total
	(In thousands)
Long-term debt obligations	$	56	$	13	$	52	$	46	$	167
Capital lease obligations		10		8		—		—		18
Operating lease obligations		724		1,336		413		—		2,473
Capital commitments (1)		392		—		—		—		392
Purchase commitments (2)		—		—		—		—		—
Totals	$	1,182	$	1,357	$	465	$	46	$	3,050

(1)-Represents estimated costs to complete groundwater treatment systems under current contracts with customers

(2)-There are no minimum purchase arrangements with vendors

Contractual Obligations

The following table summarizes our known contractual obligations to make future cash payments as of March 31, 2009 as well as an estimate of the periods during which these payments are expected to be made.


Payments Due by Period	Less than 1 Year (2009-2010)		1 to 3 Years (2010-2012)		3 to 5 Years (2012-2014)		More than 5 Years (After 2014)		Total
	(In thousands)
Long-term debt obligations	$	202	$	22	$	86	$	—	$	310
Capital lease obligations		13		—		—		—		13
Operating lease obligations		800		1,045		127		—		1,972
Capital commitments (1)		4,008		—		—		—		4,008
Purchase commitments (2)		—		—		—		—		—

Totals	$	5,023	$	1,067	$	213	$	—	$	6,303

(1)- Represents estimated costs to complete groundwater treatment systems under current contracts with customers

(2)- There are no minimum purchase arrangements with vendors

Capital Expenditures

~~Capital~~Our capital expenditures ~~totaled $4.1 million~~ in the first ~~nine~~three months of 2009 and 2008 ~~compared~~were toapproximately $40.56 million, ~~for the comparable period of 2007~~respectively. Our capital expenditures are primarily for groundwater treatment systems that we build and then contract to customers under long-term contracts. Our future capital expenditures will fluctuate depending on the number of our systems we place with customers under long-term contracts. Inand the ~~third~~availability ~~quarter~~ of ~~2008,~~cash weresources ~~scaled~~to ~~back~~fund ~~our~~such ~~manufacturing operations~~expenditures. ~~We intend to outsource these operations in the future.~~

Item 3.

Quantitative and Qualitative Disclosures About Market Risk

Market risk represents the risk of loss arising from adverse changes in market rates and foreign exchange rates. At ~~September~~March 3031, ~~2008~~2009, other than the non-interest bearing notes payable by VL Capital to a financing company and short-term notes payable to finance insurance premiums (see Note 7 9 to the condensed consolidated financial statements), we had no outstanding indebtedness. The amount of our outstanding debt at any time may fluctuate and we may from time to time be subject to refinancing risk. A hypothetical 100 basis point increase in interest rates would not have a material effect on our annual interest expense, our results of operations or financial condition. We derive substantially all of our revenues from sales within the United States. Since transactions in foreign currencies are immaterial to us as a whole, we do not consider it necessary to hedge against currency risk.

~~The~~As noted above, the U.S. credit markets have recently experienced significant dislocations and liquidity disruptions which have caused spreads on prospective debt financings to widen considerably. These circumstances have materially impacted liquidity in the debt markets, making financing terms for borrowers less attractive, and in certain cases have resulted in the unavailability of certain types of debt financing. These events in the credit markets, as well as deteriorating market conditions, have also had an adverse effect on other financial markets in the United States, including the equity markets, which may make it more difficult or costly for us to raise capital through the issuance of common stock or other equity securities.

Item 4.

Controls and Procedures

(a) Evaluation of Disclosure Controls and Procedures

We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in our Exchange Act reports is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by us in the reports that we file or submit under the Exchange Act is accumulated and communicated to our management, including our chief executive officer (CEO) and chief financial officer (CFO), as appropriate to allow for timely decisions regarding required disclosure. In designing and evaluating our disclosure controls and procedures, we recognize that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and management is required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures.

Management, with participation by our CEO and CFO, has designed the Company’s disclosure controls and procedures to provide reasonable assurance of of achieving the desired objectives. As required by SEC Rule 13a-15(b), in connection with filing this Quarterly Report on Form 10-Q, management conducted an evaluation, with the participation of our CEO and CFO, of the ~~effectiveness of the design and~~ operation of our disclosure controls and procedures, as such term is defined under Rule 13a-15(e) promulgated under the Exchange Act, as of September 30, 2008, the end of the period covered by this report.

~~Based~~22 upon that evaluation as of September 30, 2008 and the evaluation conducted by management in connection with the audit of the Company’s Restated financial statements for the years ended December 31, 2007 and 2006, we identified material weaknesses in our internal control over financial reporting that still existed as of September 30, 2008. A material weakness is a deficiency, or a combination of deficiencies, in internal control over financial reporting such that there is a reasonable possibility that a material misstatement of our annual or interim financial statements will not be prevented or detected on a timely basis.

As a result of these material weaknesses, our CEO and CFO concluded that our disclosure controls and procedures were not effective at the reasonable assurance level as of September 30, 2008.

(b) Management’s Evaluation of Internal Control over Financial Reporting (Restated).

~~designed~~effectiveness ~~by, or under the supervision~~ of, ~~our CEO and CFO, and effected by our board of directors, management and other personnel, to provide reasonable assurance regarding~~ the ~~reliability~~design ~~of financial reporting~~ and ~~the~~operation ~~preparation~~ of ~~financial~~our ~~statements~~disclosure ~~for~~controls ~~external purposes in accordance with generally accepted accounting principles (GAAP)~~ and ~~includes those policies and~~ procedures, ~~that: (1) pertain~~as tosuch ~~the~~term ~~maintenance~~is ofdefined ~~records~~under ~~that~~Rule ~~in reasonable detail accurately and fairly reflect our transactions and disposition of our assets;~~ 13a-15(2e) ~~provide~~ ~~reasonable~~promulgated ~~assurance~~under ~~that transactions are recorded as necessary to permit~~the ~~preparation~~Exchange ~~of financial statements in accordance with GAAP~~Act, ~~and~~as ~~that our receipts and expenditures are being made only in accordance with authorizations~~ of ~~our management and directors; and (3)~~March ~~provide~~31, ~~reasonable assurance regarding prevention or timely detection of unauthorized acquisition~~2009, ~~use~~the orend ~~disposition~~ of ~~our~~the ~~assets~~period ~~that~~covered ~~could~~by ~~have~~this ~~a material effect on the financial statements~~report.

~~Our~~Based ~~management~~upon ~~performed~~the anevaluation ~~assessment~~conducted ofby management in connection with the ~~effectiveness~~audit of ~~our~~the ~~internal~~Company’s ~~control~~financial ~~over~~statements ~~financial~~for ~~reporting~~the asyear ofended December 31, ~~2007~~2008, ~~based~~and ~~upon~~in ~~the~~connection ~~Internal~~with ~~Control – Integrated Framework issued by~~ the ~~Committee~~restatement of ~~Sponsoring Organizations~~our offinancial statements for the ~~Treadway~~years ~~Commission.~~ended ~~Based~~December 31, on2007 ~~that~~and ~~evaluation~~2006, ~~management~~we ~~concluded~~identified material ~~that~~weaknesses in our internal control over financial reporting ~~was~~that ~~not~~existed ~~effective~~ as of December 31, ~~2007~~2008 and that we believe still existed as of March 31, 2009. A material weakness is a ~~result~~deficiency, or a combination of ~~the~~deficiencies, in internal control over financial reporting such that there is a reasonable possibility that a material ~~weaknesses~~misstatement ~~described~~of ~~below~~our annual or interim financial statements will not be prevented or detected on a timely basis.

~~The~~As ~~ineffectiveness~~a result of ~~internal~~these ~~control~~material ~~over financial reporting as of December 31~~weaknesses, ~~2007~~our ~~stemmed~~CEO ~~from several significant factors. The organization structure was changing as we hired additional management,~~ and weCFO ~~were~~concluded ~~establishing~~that ~~new accounting information systems. This placed additional stress on the organization and~~ our ~~internal~~disclosure controls asand ~~these~~procedures ~~new structures~~ were ~~being instituted~~not ~~within~~effective ~~the~~at ~~Company. Additionally,~~ the ~~acquisition~~reasonable assurance oflevel ~~MPT~~as ~~in the third quarter~~ of ~~2007 caused additional changes to our organization structure and accounting systems. These changes in our management~~March 31, ~~reporting structure and our accounting information systems resulted in a material weakness in our internal control over financial reporting~~2009.

In(b) ~~connection~~Management’s ~~with~~Evaluation ~~the restatement~~ of ~~our~~Internal ~~consolidated~~Control ~~financial statements, we have identified the following additional material weaknesses in our internal control~~ over ~~financial~~Financial ~~reporting~~Reporting ~~that existed as of December 31, 2007:~~

Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Rule 13a-15(f) of the Exchange Act. Internal control over financial reporting refers to a process designed by, or under the supervision of, our CEO and CFO, and effected by our 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 (GAAP) and includes those policies and procedures that: (1) pertain to the maintenance of records that in reasonable detail accurately and fairly reflect our transactions and disposition of our assets; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with GAAP, and that our receipts and expenditures are being made only in accordance with authorizations of our management and directors; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of our assets that could have a material effect on the financial statements.

Our management performed an assessment of the effectiveness of our internal control over financial reporting as of December 31, 2008 based upon the Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on that evaluation, management concluded that our internal control over financial reporting was not effective as of December 31, 2008 as a result of the material weaknesses described below. We believe these material weaknesses still existed as of March 31, 2009.

The ineffectiveness of internal control over financial reporting as of December 31, 2008 stemmed from several significant factors. The organization structure was changing as we hired additional management, and we were establishing new accounting processes and procedures. Additionally, the integration of recently-acquired businesses, namely MPT in late 2007 and Envirogen in late 2008, caused additional changes to our organization structure and accounting systems. This placed additional stress on the organization and our internal controls as these new structures were being instituted within the Company. These changes in our management, reporting structure and our accounting systems and processes resulted in a material weakness in our internal control over financial reporting.

In connection with the restatement of our consolidated financial statements, we have identified the following material weaknesses in our internal control over financial reporting that continued to exist as of March 31, 2009:

•

A lack of sufficient personnel with appropriate knowledge, experience and training in applying GAAP to transactions and the correct application of revenue recognition principles required under GAAP;

• A lack of effective checks and balances between the former CFO and accounting and legal functions with respect to the negotiation, structuring and accounting for transactions, including water treatment unit sales and water service agreements;

•

A failure to maintain adequately organized business records and complete documentation for sales contracts, many of which lacked execution dates, signatures by Company or counterparty representatives; the use of draft or non-standard arrangements; and the lack of adequate written agreements to memorialize significant transactions;

•

Insufficient information systems and processes to accumulate information to timely identify and address business and accounting issues;

•

A lack of sufficiently detailed written accounting policies and procedures with respect to the timing and recognition of sales transactions and an insufficient process at the time of the transactions to monitor compliance with such policies and procedures; and

•

A failure to maintain an effective internal audit function.

~~We believe that these material weaknesses still existed as of September 30, 2008.~~ In light of these material weaknesses, we performed additional analyses and procedures in order to conclude that our unaudited consolidated financial statements for the three-~~months~~month ~~and nine-months~~ period ended ~~September~~March 3031, ~~2008~~2009 included in this Quarterly Report on Form 10-Q were fairly presented in accordance with GAAP. Accordingly, management believes that despite our material weaknesses, our unaudited consolidated financial statements for the three-month ~~months~~period ~~and nine months~~ ended ~~September~~March 3031, ~~2008~~2009 are fairly presented in accordance with GAAP.

~~Based~~23 on our remediation efforts described below, we expect to enhance our internal control over financial reporting with the goal of remediating the foregoing material weaknesses by December 31, 2009. The effectiveness of the measures we implement in this regard will be subject to ongoing management review supported by confirmation and testing by management and by our internal auditors, as well as audit committee oversight. As a result, we expect that additional changes could be made to our internal control over financial reporting and our disclosure controls and procedures. In addition, we may in the future identify additional material weaknesses in our internal control over financial reporting that we have not identified as of the date of this report.

Based on our remediation efforts described below, we expect to enhance our internal control over financial reporting with the goal of remediating the foregoing material weaknesses by December 31, 2009. The effectiveness of the measures we implement in this regard will be subject to ongoing management review supported by confirmation and testing by management and by our internal auditors, as well as audit committee oversight. As a result, we expect that additional changes could be made to our internal control over financial reporting and our disclosure controls and procedures. In addition, we may in the future identify additional material weaknesses in our internal control over financial reporting that we have not identified as of the date of this report.

(c) Plan for Remediation of Material Weaknesses

We have implemented a number of changes designed to improve our internal control over financial reporting such as:

•

We hired a new CFO in June 2008;

•

We retained an experienced consultant to assist us in our efforts to comply with Section 404 of the Sarbanes-Oxley Act of 2002;

•

We have developed and are implementing our accounting policies and procedures with enhanced controls surrounding expenditures, cutoff dates and payroll processing and procedures;

• With respect to revenue recognition, we now require the CFO and either the General Counsel or the CEO to provide formal written or electronic approval of all sales contracts;

•

We have developed procedures and internal documentation to reduce the risks associated with non-routine transaction documents;

• We have developed policies and procedures designed to ensure that the appropriate authorized officers receive ~~information regarding proposed transactions~~ on a timely basis information regarding proposed transactions prior to execution and approval of such transactions;

•

With respect to non-routine transactions, we have adopted additional procedures designed to ensure the correct accounting treatment of such transactions including, where appropriate, retention of outside accounting specialists where additional expertise is determined to be advisable based upon the nature of the transaction; and

•

We have implemented new financial systems designed to enhance our financial reporting process.

WeSubject to the availability of resources in light of our liquidity situation, we intend to take the following additional remediation efforts:

•

increase our accounting and finance resources and/or the accounting qualifications of current personnel;

•

conduct additional employee training relating to existing and newly implemented policies and procedures;

•

realign our internal audit review and internal reporting function in a manner designed to ensure compliance with written accounting and revenue recognition procedures;

•

adopt additional procedures with respect to monitoring and internal communication within the organization; and

•

implement new policies and procedures designed to improve cutoff, reporting and processing functions.

We believe these remediation efforts will continue to improve our internal control over financial reporting.

We have incurred, and expect to continue to incur, substantial expenses relating to the remediation of the material weaknesses in our internal control over financial reporting. The effectiveness of our internal control over financial reporting may in the future be limited by:

•

failure of the effectiveness of our policies, procedures and information systems and processes;

•

delays in upgrading financial software systems; and

•

the possibility that enhancements to our disclosure controls and procedures or internal control over financial reporting may not adequately assure timely and accurate financial information.

(d) Changes in Internal Control over Financial Reporting

Other than as described above, there were no changes in our internal control over financial reporting during the quarter ended ~~September~~March 3031, ~~2008 that~~2009 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

3224

Part II Other Information

Item 1.

Legal Proceedings

On ~~October~~ December 2627, 2007, ~~Veolia Water~~and ~~North~~January 2, ~~America Operating Services~~2008, ~~LLC~~two ~~and~~purported ~~certain~~securities ~~other~~class ~~related~~action ~~parties~~complaints were filed ~~a lawsuit~~ in the United States District Court offor the ~~Middle~~Central District of ~~Florida~~California against our Company, ~~Tampa~~Peter ~~Division~~L. Jensen, ~~naming~~Michael M. Stark and Thomas C. Tekulve (collectively referred to as the Basin defendants) for violations of the Exchange Act. These lawsuits, which contain similar allegations, are captioned Poulos v. Basin Water~~-MPT~~, ~~Inc~~et al., (aCase ~~wholly~~No. ~~owned subsidiary~~CV of07-8359 GW (FFMx) and Nofer v. Basin Water, ~~Inc~~et al., Case No. CV 08-0002 SGL (JCRx). ~~and~~The ~~two~~lawsuits ofwere ~~its~~subsequently ~~employees~~consolidated, ~~one~~and ofon ~~whom~~October 3, is2008 a Consolidated Amended Complaint (CAC) was filed which alleges that the ~~son~~Company ofdeliberately ~~our~~understated ~~President~~the ~~and~~reserves it ~~Chief~~took ~~Executive~~for ~~Officer.~~certain ~~Subsequently~~unprofitable contracts, ~~the~~and ~~plaintiffs~~committed ~~amended~~various ~~their~~intentional ~~complaint~~violations toof ~~add~~GAAP asduring ~~defendants~~a ~~Basin~~putative ~~Water~~class period between November 14, ~~Inc.~~2006 and ~~Michael~~August 8, M2008 (the Federal Lawsuit). ~~Stark,~~The ~~our~~suit did not state a specific amount of ~~President~~damages. On February 19, 2009, we and ~~Chief~~our ~~Executive~~insurance ~~Officer,~~carriers reached an agreement in principle to settle the ~~lawsuit~~class action with representatives of the class. The ~~lawsuit~~settlement ~~alleges~~is still subject to preparation of a final settlement agreement, following ~~among~~which ~~other~~we ~~things~~would intend to seek preliminary approval from the Court so that class members can receive notice of the settlement, ~~certain~~providing ~~claims~~them ~~related~~with the opportunity to ~~trade~~accept ~~secrets~~its ~~and~~terms ~~unfair~~or ~~trade~~to ~~practices~~opt ~~relating~~out and choose whether to ~~treatment~~pursue oftheir ~~by-products~~own individual ~~produced~~claims. asFollowing a ~~result~~fair period of notice to the ~~phosphate~~class, ~~mining industry.~~it Inwould ~~December~~be ~~2008,~~our ~~this~~intention ~~litigation~~to seek final Court approval of the settlement and the ~~underlying~~dismissal ~~disputes~~of ~~were~~all ~~resolved~~claims byagainst ~~agreement,~~us. ~~resulting~~We deny all of the allegations in athe ~~payment~~lawsuit byand usbelieve ofthat our ~~$230~~disclosures were appropriate under the law. Nevertheless,~~000~~ ~~with~~we have agreed to settle the ~~remainder~~litigation in order to avoid costly and time-consuming litigation. We do not expect a cash effect of this settlement on our Company as the entire settlement amount ~~being~~is expected to be paid by our ~~insurer~~liability insurers.

On ~~December 27, 2007 and~~ January 231, 2008, ~~two~~Loren ~~purported~~Charif, ~~securities~~a ~~class~~purported ~~action~~stockholder ~~complaints~~of ~~were~~our Company, filed ina ~~the~~shareholder ~~United~~derivative ~~States~~lawsuit ~~District~~in ~~Court for~~ the ~~Central~~Superior ~~District~~Court of ~~California~~the ~~against~~State ~~the~~of ~~Company~~California, ~~Peter~~County L.of ~~Jensen~~San Bernardino, ~~Michael~~against M.certain ~~Stark~~of our current and ~~Thomas~~former C.executive ~~Tekulve~~officers ~~(collectively~~and ~~referred~~our tocurrent asdirectors. ~~the~~The ~~Basin~~complaint ~~defendants)~~assumes ~~for~~the ~~violations~~truth of the aforementioned ~~Exchange Act. These lawsuits, which contain similar~~ allegations~~, are~~ ~~captioned~~in ~~Poulos~~the v.federal ~~Basin~~securities ~~Water,~~class etaction ~~al.,~~lawsuits ~~Case No. CV 07-8359 GW (FFMx)~~ and ~~Nofer~~in v.connection ~~Basin~~with ~~Water,~~those etallegations ~~al.~~alleges, ~~Case~~among ~~No.~~other CVthings, ~~08-0002~~breaches ~~SGL~~of ~~(JCRx).~~fiduciary ~~The~~duties, ~~lawsuits~~waste ~~were~~of ~~subsequently~~corporate ~~consolidated~~assets, ~~and~~unjust onenrichment ~~October 3,~~and ~~2008~~violations aof ~~Consolidated~~California ~~Amended~~Corporations ~~Complaint~~Code ~~(CAC)~~pertaining ~~was~~to ~~filed~~allegations ~~which~~of ~~alleges~~improper ~~that~~selling. ~~the~~The ~~Company~~suit ~~deliberately~~does ~~understated~~not ~~the~~state ~~reserves~~a itspecific ~~took~~amount ~~for~~of ~~certain~~damages. ~~unprofitable~~On ~~contracts~~November 12, ~~and~~2008, ~~committed~~we ~~various~~obtained ~~intentional~~an ~~violations~~order ofstaying ~~GAAP~~this ~~during~~action until a ~~putative~~final ~~class~~determination ~~period~~occurs ~~between November 14,~~in ~~2006 and August 8, 2008 (~~the Federal Lawsuit.~~) The suit does not state a specific amount of damages.~~

On ~~January~~ March 3110, ~~2008~~2009, ~~Loren~~Demetrice ~~Charif~~Ledbetter, III, a purported ~~stockholder~~shareholder of our ~~company~~Company, filed a shareholder derivative lawsuit in the United ~~Superior~~States District Court offor the ~~State~~Central District of California, ~~County of San Bernardino,~~ against certain ofcurrent ~~our~~and former executive officers and ~~our current~~ directors. The complaint assumes the truth of the aforementioned ~~allegations in the~~ federal securities class action lawsuits and in connection with those allegations alleges, among other things, breaches of fiduciary ~~duties~~duty, waste of corporate assets, ~~unjust~~abuse ~~enrichment and violations~~ of ~~California~~control, ~~Corporations~~gross ~~Code~~mismanagement, ~~pertaining~~unjust ~~to allegations of improper selling. On November 12~~enrichment, ~~2008,~~and weclaims ~~obtained~~for ancontribution ~~order~~and ~~staying this action until a final determination occurs in the Federal Lawsuit~~indemnification. The suit does not state a specific amount of damages.

~~From~~In ~~time~~May ~~to time~~2009, wethe ~~are~~Company ~~involved~~learned inthat ~~legal~~the ~~and~~Division ~~administrative~~of ~~disputes~~Enforcement ~~and proceedings~~of ~~arising in~~ the ~~ordinary~~Securities ~~course~~and ofExchange ~~business,~~Commission ~~which~~has weopened a ~~believe~~formal ~~are~~investigation ~~not~~in ~~material~~relation to the ~~conduct~~events ofand ~~our~~allegations ~~business.~~set ~~With~~forth ~~respect~~in ~~to these ordinary matters, management believes that~~ the ~~Company~~class ~~has~~actions ~~adequate accruals for expected costs,~~ and ~~the Company~~derivative ~~may~~actions ~~also~~noted ~~have effective legal defenses~~above.

From time to time, we are involved in legal and administrative disputes and proceedings arising in the ordinary course of business, which we believe are not material to the conduct of our business. With respect to these ordinary matters, management believes that we have adequate accruals for related costs, and we may also have effective legal defenses.

Item 1A.

Risk Factors

A description of the risk factors associated with our business is contained in Part I, Item 1A, “Risk Factors,” of our recently filed Annual Report on Form 10-K/A for the year ended December 31, ~~2007~~2008. These cautionary statements are to be used as a reference in connection with any forward-looking statements. The factors, risks and uncertainties identified in these cautionary statements are in addition to those contained in any other cautionary statements, written or oral, which may be made or otherwise addressed in connection with a forward-looking statement or contained in any of our subsequent filings with the Securities and Exchange Commission. There have been no material changes in our risk factors from those disclosed in our Annual Report on Form 10-K/A for the year ended December 31, ~~2007~~2008. You should carefully consider the risk factors discussed in our Annual Report on Form 10-K/A, as well as the other information in this report, before deciding whether to invest in shares of our common stock. The occurrence of any of the risks discussed in our Annual Report on Form 10-K/A could harm our business, financial condition, results of operations or growth prospects.

~~Item~~25 ~~2. Unregistered Sales of Equity Securities and Use of Proceeds~~

There have been no repurchases of our common stock during the nine months ended September 30, 2008 under the stock repurchase program authorized by our Board of Directors in May 2007 that allowed us to repurchase up to $10 million of our common stock. The shares could be repurchased at times and prices as determined by management, and may be completed through open market or privately negotiated transactions. The repurchase program provides that repurchases must be made in accordance with the terms and subject to the restrictions of Rule 10b-18 under the Exchange Act, as amended.

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

There have been no repurchases of our common stock during the three months ended March 31, 2009 under the stock repurchase program authorized by our Board of Directors in May 2007 that allowed us to repurchase up to $10 million of our common stock. The shares could be repurchased at times and prices as determined by management, and may be completed through open market or privately negotiated transactions. The repurchase program provides that repurchases must be made in accordance with the terms and subject to the restrictions of Rule 10b-18 under the Exchange Act, as amended.

Item 3.

Defaults Upon Senior Securities

None.

Item 4.

Submission of Matters to a Vote of Security Holders

None.

Item 5.

Other Information

None.

Item 6.

Exhibits

2.2†		Asset Purchase Agreement, dated as of September 18, 2008, by and among Shaw Environmental & Infrastructure, Inc., Shaw Environmental, Inc., Envirogen, Inc. and Registrant (1)
10.39		Settlement Agreement, dated as of September 18, 2008, by and among Shaw Environmental & Infrastructure, Inc., Shaw Environmental, Inc. and Registrant (1)
10.40†		Biological Materials Sales Agreement, dated as of September 18, 2008, by and between Shaw Environmental, Inc. and Registrant (1)
10.41		Resignation Letter Agreement, dated October 13, 2008, between the Registrant and Thomas C. Tekulve (2)
31.1		Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002, filed herewith.
31.2		Certification of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002, filed herewith.
32.1*		Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
32.2*		Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

(1) Filed with the Registrant’s Current Report on Form 8-K on September 22, 2008

(2) Filed with the Registrant’s Current Report on Form 8-K on October 14, 2008

These certifications are being furnished solely to accompany this quarterly report pursuant to 18 U.S.C. Section 1350, and are not being filed for purposes of Section 18 of the Exchange Act and are not to be incorporated by reference into any filing of Basin Water, Inc., whether made before or after the date hereof, regardless of any general incorporation language in such filing.

†26 ~~Confidential treatment has been requested for portions of this exhibit.~~

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereto duly authorized.

Date: February 10, 2009	BY:	/s/ W. CHRISTOPHER CHISHOLM
Date: May 22, 2009		BY:	/s/ W. CHRISTOPHER CHISHOLM
		~~W. Christopher Chisholm~~	W. Christopher Chisholm
		~~Chief Financial Officer~~	Chief Financial Officer
		~~(Principal Financial and Accounting Officer)~~	(Principal Financial and Accounting Officer)

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Filing Compare · Basin Water, Inc.