UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

FORM 10-Q

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

For the quarterly period ended September 30, 2013

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

For the transition period from _____ to_____

Commission File Number 33-46104-FW

THERMOENERGY CORPORATION

(Exact name of registrant as specified in its charter)

Delaware	71-0659511
(State or other jurisdiction of	(I.R.S. Employer Identification No.)
incorporation or organization)

10 New Bond Street,
Worcester, Massachusetts	01606
(Address of Principal Executive Offices)	(Zip Code)

Registrant’s telephone number, including area code: (508) 854-1628

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No o

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

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

Large accelerated filer o	Accelerated filer o

Non-accelerated filer o (Do not check if a smaller reporting company)	Smaller reporting company x

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

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

Class – Common Stock, $.001 par value

Outstanding at November 8, 2013 – 135,760,516 shares

THERMOENERGY CORPORATION

INDEX

			Page No.

Part I.	Financial Information
	ITEM 1.	Financial Statements	3
		Consolidated Balance Sheets as of September 30, 2013 (Unaudited) and December 31, 2012	3
		Consolidated Statements of Operations for the three and nine months ended September 30, 2013 and 2012 (Unaudited)	4
		Consolidated Statements of Cash Flows for the nine months ended September 30, 2013 and 2012 (Unaudited)	5
		Notes to Consolidated Financial Statements (Unaudited)	6
	ITEM 2.	Management's Discussion and Analysis of Financial Condition and Results of Operations	16
	ITEM 3.	Quantitative and Qualitative Disclosures About Market Risk	21
	ITEM 4.	Controls and Procedures	21

Part II.	Other Information
	ITEM 1.	Legal Proceedings	22
	ITEM 1A.	Risk Factors	22
	ITEM 2.	Unregistered Sales of Equity Securities and Use of Proceeds	22
	ITEM 3.	Defaults Upon Senior Securities	22
	ITEM 4.	Mine Safety Disclosures	22
	ITEM 5.	Other Information	22
	ITEM 6.	Exhibits	22

Signatures			24

	2

PART I – FINANCIAL INFORMATION

ITEM 1. Financial Statements

THERMOENERGY CORPORATION

CONSOLIDATED BALANCE SHEETS

(in thousands, except share and par value amounts)

	September 30,		December 31,
	2013		2012
	(unaudited)
ASSETS
Current Assets:
Cash	$	3,300	$	4,657
Accounts receivable, net		405		1,246
Costs-in-excess of billings		299		597
Inventories		50		53
Deposits		1		1,566
Other current assets		222		146
Total Current Assets		4,277		8,265

Property and equipment, net		636		668
Other assets		40		—

TOTAL ASSETS	$	4,953	$	8,933

LIABILITIES AND STOCKHOLDERS' DEFICIENCY
Current Liabilities:
Accounts payable	$	731	$	2,143
Short term borrowings		4,000		4,191
Convertible debt, net - current portion		2,061		1,250
Billings-in-excess of costs		182		4,922
Derivative liabilities, current portion		141		20
Accrued contract costs		54		1,545
Other current liabilities		1,019		1,388
Total Current Liabilities		8,188		15,459

Long Term Liabilities:
Derivative liabilities		328		2,214
Convertible debt, net		—		1,838
Other long term liabilities		29		33
Total Long Term Liabilities		357		4,085

Total Liabilities		8,545		19,544

Commitments and contingencies (Note 10)

Series C Convertible Preferred Stock, $0.01 par value; liquidation preference of $1.52 per share: designated: 15,000,000 shares at September 30, 2013; issued and outstanding: 13,853,106 shares at September 30, 2013		8,971		—

Stockholders' Deficiency:
Preferred Stock, $0.01 par value: authorized: 50,000,000 shares at September 30, 2013 and 30,000,000 shares at December 31, 2012:
Series A Convertible Preferred Stock, liquidation value of $1.20 per share: designated, issued and outstanding: 208,334 shares at September 30, 2013 and December 31, 2012		2		2
Series B Convertible Preferred Stock, liquidation preference of $2.40 per share: designated: 1,000,000 shares at September 30, 2013 and 12,000,000 shares at December 31, 2012; issued and outstanding: 551,725 shares at September 30, 2013 and 11,664,993 shares at December 31, 2012		6		117
Series B-1 Convertible Preferred Stock, liquidation preference of $2.40 per share: designated: 11,000,000 shares at September 30, 2013; issued and outstanding: 8,919,854 shares at September 30, 2013		89		—
Common Stock, $0.001 par value: authorized: 800,000,000 shares at September 30, 2013 and 425,000,000 at December 31, 2012; issued: 135,894,313 shares at September 30, 2013 and 120,588,372 shares at December 31, 2012; outstanding: 135,760,516 shares at September 30, 2013 and 120,454,575 shares at December 31, 2012		136		120
Additional paid-in capital		108,415		110,062
Accumulated deficit		(121,193)		(120,892)
Treasury stock, at cost: 133,797 shares at September 30, 2013 and December 31, 2012		(18)		(18)
Total Stockholders’ Deficiency for ThermoEnergy Corporation		(12,563)		(10,609)
Noncontrolling interest		—		(2)
Total Stockholders’ Deficiency		(12,563)		(10,611)

TOTAL LIABILITIES AND STOCKHOLDERS’ DEFICIENCY	$	4,953	$	8,933

See notes to unaudited consolidated financial statements.

	3

THERMOENERGY CORPORATION

CONSOLIDATED STATEMENTS OF OPERATIONS

In thousands, except share and per share amounts

(Unaudited)

	Three Months Ended				Nine Months Ended
	September 30,				September 30,
	2013		2012		2013		2012

Revenue	$	532	$	2,032	$	2,621	$	5,620
Less: cost of revenue		870		2,031		2,948		5,238
Gross profit		(338)		1		(327)		382

Operating Expenses:
General and administrative		697		1,035		2,422		3,951
Engineering, research and development		69		160		437		363
Sales and marketing		435		598		1,261		2,188
Total operating expenses		1,201		1,793		4,120		6,502

Loss from operations		(1,539)		(1,792)		(4,447)		(6,120)

Other income (expense):
Gain on contract termination		—		—		4,878		—
Change in fair value of derivative liabilities		1,205		574		2,074		1,100
Other derivative expense		—		(565)		—		(565)
Interest expense, net		(109)		(101)		(2,483)		(355)
Equity in income (loss) of joint ventures		(202)		24		(296)		14
Other expense		(10)		(8)		(27)		(19)

Net loss		(655)		(1,868)		(301)		(5,945)
Net loss attributable to noncontrolling interest		—		—		—		2

Net loss attributable to ThermoEnergy Corporation	$	(655)	$	(1,868)	$	(301)	$	(5,943)

Loss per share attributable to ThermoEnergy Corporation, basic and diluted	$	(0.00)	$	(0.02)	$	(0.00)	$	(0.06)

Weighted average shares used in computing loss per share, basic and diluted		135,760,516		111,015,893		130,434,273		97,509,352

See notes to unaudited consolidated financial statements.

	4

THERMOENERGY CORPORATION

CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

(Unaudited)

	Nine Months Ended September 30,
	2013		2012
Operating Activities:
Net loss	$	(301)	$	(5,945)
Adjustment to reconcile net loss to net cash used in operating activities:
Gain on contract termination		(4,878)		—
Stock-based compensation expense		246		719
Equity in losses of joint venture		296		(14)
Derivative liability income		(2,074)		(1,100)
Other derivative expense		—		565
Common stock issued for services		—		89
Non-cash interest added to note receivable		(5)		—
Non-cash interest added to debt		121		113
Loss on disposal of equipment		—		131
Depreciation		146		81
Amortization of discount on convertible debt		2,180		134
Increase (decrease) in cash arising from changes in assets and liabilities:
Accounts receivable		841		2,885
Costs-in-excess of billings		298		(383)
Inventories		3		(118)
Deposits		1,565		(183)
Other current assets		(5)		248
Accounts payable		(1,412)		(434)
Billings-in-excess of costs		138		(1,793)
Accrued contract costs		(1,491)		1,033
Other current liabilities		55		(1,041)
Other long-term liabilities		(104)		(74)

Net cash used in operating activities		(4,381)		(5,087)

Investing Activities:
Investment in joint venture		(300)		(101)
Purchases of property and equipment		(114)		(134)

Net cash used in investing activities		(414)		(235)

Financing Activities:
Proceeds from short term borrowings		4,223		—
Repayment of short term borrowings and accrued commitment fees		(785)		—
Proceeds from issuance of common stock and warrants, net of issuance costs of $265		—		2,296
Proceeds from issuance of common stock, net of issuance costs of $38		—		498

Net cash provided by financing activities		3,438		2,794

Net change in cash		(1,357)		(2,528)
Cash, beginning of period		4,657		3,056
Cash, end of period	$	3,300	$	528

Supplemental schedule of non-cash financing activities:
Accrued interest added to debt	$	40	$	23
Debt discount recognized on convertible debt	$	1,217	$	—
Conversion of convertible debt and accrued interest to Series C Convertible Preferred Stock	$	5,264	$	—
Exchange of Series B Convertible Preferred Stock to Series C Convertible Preferred Stock	$	4,486	$	—
Exchange of Series B Convertible Preferred Stock to Series B-1 Convertible Preferred Stock	$	89	$	—
Cashless exercise of warrants for Common Stock	$	288	$	—
Anti-dilutive issuance of Common Stock to investors	$	91	$	—
Tender of Roenigk 2007 and 2008 Convertible Promissory Notes in exchange for Roenigk 2012 Convertible Promissory Note	$	—	$	1,877

See notes to unaudited consolidated financial statements.

	5

THERMOENERGY CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2013

(Unaudited)

Note 1: Organization and summary of significant accounting policies

Nature of business

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

The Company’s wastewater treatment systems are based on its proprietary Controlled Atmosphere Separation Technology (“CAST”) platform. The Company’s patented and proprietary platform technology is combined with off-the-shelf technologies (the “Technologies”) to provide systems that are inexpensive, easy to operate and reliable. The Company’s wastewater treatment systems have global applications in hydraulic fracturing (“fracking”) in the oil and gas industry, food and beverage processing, metal finishing, pulp and paper, petrochemical, refining, microchip and circuit board manufacturing, heavy manufacturing and municipal wastewater. The CAST platform technology is owned by the Company’s subsidiary, CASTion Corporation (“CASTion”).

The Company also owns patents on technology for the combustion of coal at high pressure using pure oxygen (oxy-combustion) for clean, coal-fired power generation while producing near zero air emissions and removing and capturing carbon dioxide in liquid form for sequestration or beneficial reuse. This technology is intended to be used to build new or to retrofit old fossil fuel power plants. This technology is held in the Company’s subsidiary, ThermoEnergy Power Systems, LLC (“TEPS”).

Principles of consolidation and basis of presentation

The unaudited consolidated financial statements include the accounts of the Company and its subsidiaries. All significant intercompany accounts and transactions have been eliminated in consolidation. The 15% third-party ownership interest in TEPS is recorded as a noncontrolling interest in the unaudited consolidated financial statements. Financial results for Unity Power Alliance (“UPA”) as a Joint Venture are accounted for under the equity method, as discussed in Note 5.

Certain prior year amounts have been reclassified to conform to current year classifications.

The accompanying unaudited interim consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) for interim financial information and with the instructions to Form 10-Q and Article 8-03 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by GAAP for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the three and nine-month periods ended September 30, 2013 are not necessarily indicative of the results that may be expected for the year ending December 31, 2013.

The preparation of these unaudited interim consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Actual results could differ from those estimates.

The balance sheet at December 31, 2012 has been derived from the audited financial statements at that date but does not include all of the information and footnotes required by GAAP for complete financial statements. For further information, refer to the financial statements and footnotes thereto included in the Annual Report on Form 10-K for the year ended December 31, 2012, filed on March 26, 2013, of ThermoEnergy Corporation.

Significant Accounting Policies

There have been no material changes to the Company’s significant accounting policies during the nine months ended September 30, 2013. For a complete summary of the Company’s significant accounting policies, please refer to Note 1 to the Company’s consolidated financial statements included in Item 8 of the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2012.

	6

THERMOENERGY CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2013

(Unaudited)

Note 2: Management's consideration of going concern matters

The accompanying financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America, which contemplate continuation of the Company as a going concern. However, the Company has sustained substantial losses from operations in recent years, and such losses have continued through the three and nine-month periods ended September 30, 2013. Furthermore, as discussed in Note 4, the Company’s contract with the New York City Department of Environmental Protection (“NYCDEP”) was terminated for convenience effective November 29, 2012.

At September 30, 2013, the Company had cash on hand of $3,300,000. The Company has incurred net losses from operations since inception, including a net loss of $301,000 during the nine-month period ended September 30, 2013 and had an accumulated deficit of approximately $121.2 million at September 30, 2013.

In view of the matters described in the preceding paragraph, recoverability of a major portion of the recorded asset amounts shown in the accompanying balance sheet is dependent upon continued operations of the Company, which in turn is dependent upon the Company’s ability to meet its financing requirements on a continuing basis, to maintain present financing, and to succeed in its future operations. The financial statements do not include any adjustments relating to the recoverability and classification of recorded asset amounts or amounts and classification of liabilities that might be necessary should the Company be unable to continue in existence.

These uncertainties raise substantial doubt about the Company's ability to continue as a going concern. The financial statements included in this Form 10-Q have been prepared on a going concern basis and as such do not include any adjustments that might result from the outcome of this uncertainty.

Management has determined that the financial success of the Company is dependent upon the Company’s ability to obtain profitability from contracts with financially sound third parties to pursue projects involving the Technologies. In addition, management will need to obtain substantial additional equity or debt financing that will allow the Company to operate until it becomes cash flow positive from operations. Even if the Company successfully obtains financing, there can be no assurance that this financing will be sufficient to continue operations for an extended period of time, and there is no assurance that the Company can obtain additional funding at reasonable terms.

As more fully described in Notes 6, 7 and 8, on April 5, 2013, the Company issued shares of Series C Convertible Preferred Stock in exchange for the entire principal and accrued interest amounts of the Company’s December 2011 Bridge Notes and the Company’s November 2012 Bridge Notes. Additionally, as more fully described in Note 6, the Company received proceeds totaling $4 million from the issuance of Bridge Notes to certain of its investors in August 2013.

Note 3: Revision of Prior Period Financial Statements

During the quarter ended September 30, 2013, management determined that the fair value of the anti-dilution provision embedded in the Company’s series C convertible preferred stock should have been valued as a derivative instrument. The Company has recorded $607,000 for the fair value at inception of the derivative instrument as derivative liabilities – long term and decreased additional paid-in capital for a corresponding amount to correct the presentation on the consolidated balance sheet as of September 30, 2013. Additionally, the decrease in the fair value of the derivative instrument from inception through September 30, 2013 of $279,000, of which $44,000 is related to the decrease in fair value of the derivative instrument from inception through June, 30, 2013, has been recorded as a decrease to derivative liabilities – long term and a corresponding amount recorded in change in fair value of derivative liabilities on the Company’s consolidated statement of operations. The error corrections are contained in this Quarterly Report on Form 10-Q. The Company will revise its consolidated balance sheet and consolidated statement of operations as of and for the three and six months ended June 30, 2013, to reflect this correction in all future filings that contain such consolidated financial statements. The adjustment increases the previously reported derivative liabilities – long term on the consolidated balance sheet by $607,000 and change in fair value of derivative liabilities on the consolidated statement of operations by $44,000 and decreases the previously reported additional paid in capital on the consolidated balance sheet by $563,000 as of and for the three and six months ended June 30, 2013. The impact of this error was limited to the quarter ended June 30, 2013.

In evaluating whether the Company’s previously issued consolidated financial statements were materially misstated, the Company considered the guidance in Accounting Standards Codification (ASC) Topic 250, “Accounting Changes and Error Corrections,” ASC Topic 250-10-S99-1, “Assessing Materiality,” and ASC Topic 250-10-S99-2, “Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements.” The error did not have a material impact on the Company’s net income or cash flows for the three and six-month periods ended June 30, 2013, and management does not consider this correction to be qualitatively material to the Company’s prior period consolidated financial statements.

	7

THERMOENERGY CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2013

(Unaudited)

Note 4: NYCDEP Contract

On August 22, 2012, the NYCDEP issued a stop work order to the Company relative to its contract to install an Ammonia Removal Process (“ARP”) system at the NYCDEP’s wastewater treatment facility in the 26^th Ward. The NYCDEP terminated the contract for convenience, effective November 29, 2012.

Upon notification of the contract termination, the Company cancelled all orders from its major vendors. The Company ceased recognition of revenues as of November 29, 2012 and recorded all incremental costs as period costs on its consolidated statement of operations.

The Company received all amounts billed to the NYCDEP related to this contract, and the Company delivered all equipment, including all material from third party vendors, to the NYCDEP during the first quarter of 2013. In June 2013, the Company received notice from the NYCDEP that the contract had been closed. Accordingly, the Company recorded a gain on contract termination of approximately $4.9 million in the second quarter of 2013, which represents the amount the Company billed in accordance with the contract in excess of revenues recognized.

Because of this contract termination, the Company's revenues, expenses, and income will be adversely affected in future periods, as this contract represented approximately 73% of the Company's revenues for the year ended December 31, 2012.

Note 5: Joint Ventures

Babcock-Thermo Clean Combustion LLC

On February 25, 2009, the Company’s majority-owned subsidiary, TEPS, and Babcock Power Development, LLC (“BPD”), a subsidiary of Babcock Power, Inc., entered into a Limited Liability Company Agreement (the “LLC Agreement”) establishing Babcock-Thermo Carbon Capture LLC, a Delaware limited liability company now known as Babcock-Thermo Clean Combustion LLC (the “Joint Venture”) for the purpose of developing and commercializing its pressurized oxy-combustion technology.

On March 2, 2012, TEPS entered into a Dissolution Agreement with BPD to terminate the Limited Liability Company Agreement and dissolve the Joint Venture, and the Joint Venture was dissolved on April 30, 2013.

Unity Power Alliance LLC

On March 8, 2012, the Company announced the formation of Unity Power Alliance LLC (“UPA”). UPA was formed with the intention to work with partners and stakeholders to develop and commercialize its pressurized oxycombustion technology. On July 16, 2012, Itea S.p.A. (“Itea”), an engineering and technology company headquartered in Italy, acquired a 50% ownership interest in UPA.

In September 2012, UPA was awarded a $1 million Phase 1 grant from the U.S. Department of Energy (“DOE”) to help fund a project on a cost-sharing basis under a special DOE program to advance technologies for efficient, clean coal power and carbon capture. As part of UPA's project, in October 2012, the Company received a $900,000 contract from UPA to build a bench-scale “flameless” combustion reactor under the grant. UPA and its subcontractors received contract definitization during the first quarter of 2013 and began to receive funding. As of September 30, 2013, UPA has received funding totaling $598,000 related to this grant. The Company has recorded revenues totaling $295,000 and $842,000 on a time and materials basis related to this contract in the three and nine-month periods ended September 30, 2013.

	8

THERMOENERGY CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2013

(Unaudited)

In accordance with ASC 810, “Consolidation,” the Company determined that it held a variable interest in UPA and that UPA was a variable-interest entity. However, the Company has concluded that it is not required to consolidate the financial statements of UPA as of and for the nine-month period ended September 30, 2013. The Company reviewed the most significant activities of UPA and determined that because the Company shares the power to direct the activities of UPA equally with Itea, it is not the primary beneficiary of UPA. Accordingly, the financial results of UPA are accounted for under the equity method of accounting. The carrying value of the Company’s investment in the Joint Venture is $0 as of September 30, 2013 and December 31, 2012, as the Company’s share of losses incurred by UPA exceeds the Company’s investments.

Note 6: Short term borrowings

Short term borrowings consisted of the following at September 30, 2013 and December 31, 2012 (in thousands):

	September 30,		December 31,
	2013		2012

Project Financing Line of Credit	$	—	$	491

November 2012 Bridge Notes, 8%, due April 15, 2013		—		3,700

August 2013 Bridge Notes, 12%, due February 1, 2014		4,000		—

	$	4,000	$	4,191

Project Financing Line of Credit

On October 4, 2012, the Company entered into a Loan Agreement (the “Loan Agreement”) with C13 Thermo LLC (the “Lender”), a related party whose owners are related to an officer of the Company. Under this Loan Agreement, the Lender established a credit facility allowing the Company to borrow up to $700,000 (the “Credit Facility”) to finance the fabrication and testing of an Ammonia Reduction Process system utilizing the Company’s proprietary technology (the “Project”). The Company issued to the Lender a promissory note in the principal amount of $700,000 (the “Note”).

Amounts borrowed under the Credit Facility did not bear interest (except in the case of an event of default, in which case all amounts borrowed, together with all fees, expenses and other amounts due, shall bear interest at the default rate of 8% per annum). Upon maturity of the Note, the Company was charged a commitment fee equal to 10% of the aggregate principal amount borrowed under the Credit Facility. All amounts due under the Note, together with all commitment fees incurred under the Loan Agreement, were originally due and payable on the earlier of (i) March 4, 2013 or (ii) the date on which the Company first draws against an irrevocable documentary letter of credit that has been issued for the Company’s benefit in connection with the Project. The Credit Facility was amended in March 2013 to extend the expiration date to the earlier of (i) April 5, 2013 or (ii) one business day following the date the Company first drew against the irrevocable documentary letter of credit. The Company could repay the Note in whole or in part at any time without premium or penalty. The Credit Facility was secured by all of the Company’s assets.

On April 5, 2013 the Company repaid in full all outstanding principal and accrued commitment fees totaling $785,000 related to this Credit Facility.

November 2012 Bridge Note Financing

On November 30, 2012 the Company entered into Bridge Loan Agreements with six of its principal investors pursuant to which the investors agreed to make bridge loans to the Company of $3.7 million in exchange for 8% Promissory Notes (the “November 2012 Bridge Notes”). The November 2012 Bridge Notes bore interest at the rate of 8% per year and were due and payable on April 15, 2013.

The November 2012 Bridge Notes contained other conventional terms, including representations and warranties regarding the Company’s business and assets and its authority to enter into such agreements, and provisions for acceleration of the Company’s obligations upon the occurrence of certain specified events of default.

	9

THERMOENERGY CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2013

(Unaudited)

On April 5, 2013 the investors converted the outstanding principal of the November 2012 Bridge Notes, plus accrued interest, into 5,005,250 shares of the Company’s Series C Convertible Preferred Stock and Warrants for the purchase of 50,052,500 shares of the Company’s Common Stock.

August 2013 Bridge Note Financing

On August 22, 2013 the Company entered into Bridge Loan Agreements with four of its principal investors pursuant to which the investors agreed to make bridge loans to the Company of $4 million in exchange for 12% Promissory Notes (the “August 2013 Bridge Notes”). The August 2013 Bridge Notes bear interest at the rate of 12% per year and are due and payable on February 1, 2014. The August 2013 Bridge Notes are secured by substantially all of the Company’s assets.

The August 2013 Bridge Notes contain other conventional terms, including representations and warranties regarding the Company’s business and assets and its authority to enter into such agreements, and provisions for acceleration of the Company’s obligations upon the occurrence of certain specified events of default.

Note 7: Convertible debt

Unsecured convertible debt consisted of the following at September 30, 2013 and December 31, 2012 (in thousands):

	September 30,		December 31,
	2013		2012
December 2011 Convertible Promissory Notes, 12.5%, due on demand on or after January 31, 2013	$	—	$	1,250
Roenigk 2012 Convertible Promissory Note, 8%, due March 31, 2014, less discount of $44 at September 30, 2013 and $106 at December 31, 2012		2,061		1,838
		2,061		3,088
Less: Current portion		(2,061)		(1,250)
	$	—	$	1,838

December 2011 Convertible Promissory Notes

On December 2, 2011 the Company entered into Bridge Loan Agreements with four of its principal investors pursuant to which the investors agreed to make bridge loans to the Company of $1.25 million in exchange for 12.5% Promissory Notes (the “December 2011 Bridge Notes”). The December 2011 Bridge Notes bore interest at the rate of 12.5% per year and were due and payable on December 31, 2012. The entire unpaid principal amount, together with all interest then accrued and unpaid under each December 2011 Bridge Note, was convertible into shares of a future series of Preferred Stock.

The December 2011 Bridge Notes contained other conventional provisions, including the acceleration of repayment obligations upon the occurrence of certain specified Events of Default.

On November 30, 2012, in conjunction with the issuance of the November 2012 Bridge Notes (see Note 6), the investors who participated in the December 2011 Bridge Note financing agreed to extend the maturity date such that the December 2011 Bridge Notes were due on demand on or after January 31, 2013. The Company accounted for this amendment as a debt modification.

On April 5, 2013 the investors converted the outstanding principal of the December 2011 Bridge Notes, plus accrued interest, into 1,921,303 shares of the Company’s Series C Convertible Preferred Stock and Warrants for the purchase of 19,213,030 shares of the Company’s Common Stock.

	10

THERMOENERGY CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2013

(Unaudited)

Roenigk 2012 Convertible Promissory Note

On June 20, 2012, the Company issued a Convertible Promissory Note dated April 1, 2012 (the “Note”) in the principal amount of $1,877,217 to the Roenigk Family Trust in exchange for a 5% Convertible Promissory Note issued on March 21, 2007 and due March 21, 2013 and a 5% Convertible Promissory Note issued on March 7, 2008 and due March 7, 2013 (the “Old Notes”). The Note bears interest at the rate of 5% per annum from April 1, 2012 through May 31, 2012, then bears interest at the rate of 8% per annum until the maturity date, March 31, 2014. The principal amount and accrued interest on the Note is convertible into shares of Common Stock at a conversion price of $0.50 per share at any time at the election of the holder. Interest on the Note is payable semi-annually. The Company may, at its discretion, defer any scheduled interest payment until the maturity date of the Note upon payment of a $5,000 deferral fee. The Company recorded $161,000 of accrued interest to the principal balance of the Note during the nine months ended September 30, 2013.

Note 8: Equity

On March 20, 2013, the Company’s shareholders approved an amendment to the Certificate of Incorporation for the following purposes:

	⋅	To increase the number of authorized shares of Common Stock to 800,000,000 and to increase the number of authorized shares of Preferred Stock to 50,000,000;
	⋅	To reduce the number of shares of Preferred Stock designated as “Series B Convertible Preferred Stock” from 12,000,000 to 1,000,000 and to re-designate the remaining 11,000,000 shares heretofore designated as “Series B Convertible Preferred Stock” as “Series B-1 Convertible Preferred Stock”, with the shares in each sub-series having identical voting powers, designations, preferences and relative, participating, optional or other special rights, and qualifications, limitations and restrictions except that the shares of Series B-1 Convertible Preferred Stock shall have priority in liquidation; and
	⋅	To designate 15,000,000 shares of the previously authorized but undesignated shares of Preferred Stock as “Series C Convertible Preferred Stock”.

Shares of Series B-1 Convertible Preferred Stock are convertible, at any time at the discretion of the holder, into ten shares of the Company’s Common Stock. Series B-1 Convertible Preferred Stock is identical to the Company’s Series B Convertible Preferred Stock in every respect except that holders of the Series B-1 Convertible Preferred Stock shall receive a liquidation preference equal to the Stated Value of their shares ($2.40 per share) plus all declared and unpaid dividends with respect thereto prior to any distribution to the holders of shares of Series B Convertible Preferred Stock.

Shares of Series C Convertible Preferred Stock are convertible, at any time at the discretion of the holder, into ten shares of the Company’s Common Stock, subject to conventional weighted-average anti-dilution adjustment in the event the Company issues or is deemed to have issued shares of Common Stock at a price less than $0.076 per share. The Series C Convertible Preferred Stock will be redeemable, at a price equal to $0.76 per share, plus all accrued and unpaid dividends thereon, at the election of the holders of 66-⅔% of the then-outstanding shares, in three equal annual installments on or after December 31, 2017.

Because the Company’s Series C Convertible Preferred Stock has a redemption feature, this class of preferred stock is recorded at its issuance date fair value and is classified as mezzanine equity on the Company’s Unaudited Consolidated Balance Sheet at September 30, 2013.

The Company’s Board of Directors consists of seven members, four of whom are elected by holders of the Company’s Series B Convertible Preferred Stock, Series B-1 Convertible Preferred Stock and Series C Convertible Preferred Stock, and three who are elected by the holders of the Company’s Common Stock.

The amendment to the Certificate of Incorporation became effective on April 5, 2013.

Common Stock

In 2011, the Company requested certain holders of Common Stock Purchase Warrants to exercise such warrants or to surrender such warrants in exchange for shares of Common Stock. On April 5, 2013, the Company issued an aggregate of 6,031,577 shares of Common Stock as consideration for the surrender of Warrants for the purchase of an aggregate of 39,205,234 shares.

	11

THERMOENERGY CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2013

(Unaudited)

Also, on April 5, 2013, the Company converted its December 2011 Bridge Notes and November 2012 Bridge Notes into shares of the Company’s Series C Convertible Preferred Stock. Because the effective issuance price of the Series C Convertible Preferred Stock was less than $0.10 per equivalent share of Common Stock, the Company issued to investors who purchased shares of the Company’s Common Stock and Warrants at closings on July 11, 2012, August 9, 2012 and October 9, 2012 (the “PIPE”), for no additional consideration, a sufficient number of additional shares of Common Stock so that the effective price per share of Common Stock paid by the PIPE Investors equals the effective issuance price of the shares of Series C Convertible Preferred Stock on an as-converted basis ($0.076 per share). Accordingly, on April 5, 2013, the Company issued a total of 9,274,364 shares of Common Stock to the PIPE Investors.

At September 30, 2013, approximately 425 million shares of Common Stock were reserved for future issuance under convertible debt and warrant agreements, stock option arrangements and other commitments.

Preferred Stock

As detailed in Notes 6 and 7, on April 5, 2013, holders of the Company’s December 2011 Bridge Notes and the Company’s November 2012 Bridge Notes exchanged such notes with an aggregate principal amount of $4,950,000 plus accrued interest totaling $314,177 for a total of 6,926,553 shares of the Company’s Series C Convertible Preferred Stock and Warrants for the purchase of a total of 69,265,530 shares of Common Stock.

The effective price of the Series C Convertible Preferred Stock was $0.76 per share (or $0.076 per equivalent share of Common Stock). The Warrants entitle the holders to purchase, at any time on or before April 5, 2018, shares of Common Stock at an exercise price of $0.114 per share. The Warrants contain other conventional terms, including provisions for adjustment in the exercise price and/or the securities issuable upon exercise in the event of certain specified extraordinary corporate events, such as stock splits, combinations, and stock dividends.

As additional consideration to the investors for their participation in the Bridge Note issuances mentioned above, for each $100 of principal and interest converted into Series C Convertible Preferred Stock and Warrants, each Investor exchanged 41.67 shares of Series B Convertible Preferred Stock held for 131.58 additional shares of Series C Convertible Preferred Stock (the number of shares of Series C Convertible Preferred Stock that would be purchased for $100 at a purchase price of $0.76 per share). Accordingly, the Company issued an aggregate of 6,926,553 additional shares of Series C Convertible Preferred Stock in exchange for an aggregate of 2,193,414 previously-outstanding shares of Series B Convertible Preferred Stock. The additional shares of Series C Convertible Preferred Stock were issued without warrant coverage. The shares of Series B Convertible Preferred Stock surrendered were cancelled and are no longer outstanding.

Additionally, as an inducement to effect the transactions on April 5, 2013 as detailed above, the Company agreed to allow such holders to exchange shares of Series B Convertible Preferred Stock for an equal number of shares of Series B-1 Convertible Preferred Stock. Accordingly, on April 5, 2013 the Company issued an aggregate of 8,839,500 shares of Series B-1 Convertible Preferred Stock in exchange for an equal number of shares of Series B Convertible Preferred Stock.

Stock Options

On March 20, 2013, the Company’s shareholders approved amendments to the 2008 Incentive Stock Plan (“the 2008 Plan”) to increase the number of shares available for grant to 40,000,000 and to increase the number of shares with respect to which automatic stock options are granted to non-employee Directors to 100,000.

During the nine-month period ended September 30, 2013, the Board of Directors awarded employees and an advisor to the Board of Directors a total of 14,450,000 stock options under the 2008 Plan. The options are exercisable at $0.0468 - $0.089 per share for a ten year period. The exercise price was equal to or greater than the market price on the respective grant dates. Options granted to non-employee directors vest on the date of the Company’s 2013 Annual Meeting of Stockholders; options granted to employees vest ratably over a four-year period.

	12

THERMOENERGY CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2013

(Unaudited)

The following table presents option expense included in expenses in the Company’s unaudited consolidated statements of operations for the nine-month periods ended September 30, 2013 and 2012:

	2013		2012

Cost of revenue	$	—	$	6
General and administrative		200		580
Engineering, research and development		34		70
Sales and marketing		12		63
Option expense before tax		246		719
Benefit for income tax		—		—
Net option expense	$	246	$	719

The fair value of options granted during the nine-month periods ended September 30, 2013 and 2012 were estimated at the date of grant using a Black-Scholes option pricing model with the following assumptions:

	2013			2012
Risk-free interest rate		0.92% - 1.07	%		0.83% - 2.23	%
Expected option life (years)		6.25			6.25 – 10.0
Expected volatility		90% - 91	%		91% - 92	%
Expected dividend rate		0	%		0	%

The risk-free interest rate is based on the U.S. Treasury yield curve in effect at the time of grant for periods over the expected life of the option. The expected option life represents the weighted average period of time that options granted are expected to be outstanding giving consideration to vesting schedules and the Company’s historical exercise patterns. Expected volatility is based on the historical volatility of the Company’s common stock over the expected life of the option granted.

Option expense for the nine-month periods ended September 30, 2013 and 2012 was calculated using an expected annual forfeiture rate of 5%.

A summary of the Company’s stock option activity and related information for the nine-month periods ended September 30, 2013 and 2012 follows:

	2013				2012
			Wtd. Avg.				Wtd. Avg.
			Exercise				Exercise
	Number of		Price per		Number of		Price per
	Shares		Share		Shares		Share
Outstanding, beginning of year		24,896,678	$	0.32		19,674,102	$	0.38
Granted		14,450,000	$	0.09		7,060,000	$	0.16
Canceled		(7,408,601)	$	0.28		(800,000)	$	0.30
Outstanding, end of period		31,938,077	$	0.22		25,934,102	$	0.32
Exercisable, end of period		16,372,452	$	0.35		13,733,112	$	0.41

The weighted average fair value of options granted was approximately $0.07 and $0.11 per share for the nine-month periods ended September 30, 2013 and 2012, respectively. The weighted average fair value of options vested was approximately $389,000 and $942,000 for the nine-month periods ended September 30, 2013 and 2012, respectively.

Exercise prices for options outstanding as of September 30, 2013 ranged from $0.0468 to $1.50. The weighted average remaining contractual life of those options was approximately 7.9 years at September 30, 2013. The weighted average remaining contractual life of options vested and exercisable was approximately 6.7 years at September 30, 2013.

At September 30, 2013, there was approximately $832,000 of total unrecognized compensation cost related to non-vested share-based compensation arrangements granted under the Company’s stock option plans. That cost is expected to be recognized over a weighted-average period of 1.4 years. The Company recognizes stock-based compensation on the graded-vesting method.

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THERMOENERGY CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2013

(Unaudited)

Warrants

At September 30, 2013, there were outstanding warrants for the purchase of 136,881,302 shares of the Company’s Common Stock at prices ranging from $0.10 per share to $0.55 per share (weighted average exercise price was $0.15 per share). The expiration dates of these warrants are as follows:

Year	Number of Warrants
2014		781,103
2015		296,293
2016		20,625,815
2017		44,570,061
After 2017		70,608,030
		136,881,302

Note 9: Derivative Liabilities

The Company has periodically issued Common Stock and Common Stock purchase warrants with anti-dilution provisions as additional consideration with certain debt instruments. Additionally, certain debt instruments have been convertible into shares of the Company’s Series C Convertible Preferred Stock, which are convertible into shares of the Company’s Common Stock and have anti-dilution provisions and liquidation preferences. Because these instruments contain provisions that are not indexed to the Company’s stock, the Company is required to record these as derivative instruments.

Liabilities measured at fair value on a recurring basis as of September 30, 2013 are as follows (in thousands):

			Fair Value Measurements at Reporting Date Using
Description	Balance as of September 30, 2013		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Derivative liabilities – current portion	$	141	$	-	$	-	$	141
Derivative liabilities – long-term portion		328		-		-		328

Total	$	469	$	-	$	-	$	469

The Monte Carlo simulation lattice model was used to determine the fair values at September 30, 2013. The significant assumptions were: exercise prices between $0.10 and $0.114; the Company’s stock price on September 30, 2013 of $0.04; expected volatility of 60%; risk free interest rate between 0.02% and 1.20%; a remaining contract term between four months and 54 months; and probability of financing options and effects on the Company’s capitalization.

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THERMOENERGY CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2013

(Unaudited)

Liabilities measured at fair value on a recurring basis as of December 31, 2012 are as follows: (in thousands)

			Fair Value Measurements at Reporting Date Using
Description		Balance as of December 31, 2012	Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)

Derivative liabilities – current portion	$	20	$	-	$	-	$	20
Derivative liabilities – long-term portion		2,214		-		-		2,214

Total	$	2,234	$	-	$	-	$	2,234

The Monte Carlo simulation lattice model was used to determine the fair values at December 31, 2012. The significant assumptions were: exercise prices between $0.10 and $0.36; the Company’s stock price on December 31, 2012 of $0.09; expected volatility of 55% - 75%; risk free interest rate between 0.16% and 0.72%; and a remaining contract term between five months and 55 months.

The following table sets forth a reconciliation of changes in the fair value of the Company’s derivative liabilities classified as Level 3 for the nine-month periods ended September 30, 2013 and 2012 (in thousands):

	2013		2012
Balance at beginning of period	$	2,234	$	807
Issuance of derivative instruments		607		2,734
Exercise of derivative instruments		(298)		—
Change in fair value		(2,074)		(1,100)

Balance at end of period	$	469	$	2,441

Note 10: Commitments and contingencies

The Company is involved from time to time in litigation incidental to the conduct of its business. Judgments could be rendered or settlements entered that could adversely affect the Company’s operating results or cash flows in a particular period. The Company routinely assesses all of its litigation and threatened litigation as to the probability of ultimately incurring a liability and records its best estimate of the ultimate loss in situations where it assesses the likelihood of loss as probable.

On July 16, 2012, Andrew T. Melton, the Company’s former Executive Vice President and Chief Financial Officer (“Melton”), filed a Complaint in the United States District Court, Eastern District of Arkansas alleging, among other things, wrongful termination of employment. On June 19, 2013, the lawsuit was dismissed upon motion of the plaintiff.

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ITEM 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

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

Forward Looking Information

The part of this Quarterly Report on Form 10-Q captioned “Management’s Discussion and Analysis of Financial Condition and Results of Operations” contains certain forward-looking statements, which involve risks and uncertainties. Forward-looking statements include, without limitation, statements as to our future financial position, business strategy, budgets, projected costs and plans and objectives of management for future operations. These statements are based on current expectations, estimates and projections about the industries in which we operate, and the beliefs and assumptions made by management. Readers should refer to the discussions under “Forward Looking Information” contained in our Annual Report on Form 10-K for the fiscal year ended December 31, 2012 concerning certain factors that could cause our actual results to differ materially from the results anticipated in such forward-looking statements. These discussions are hereby incorporated by reference into this Quarterly Report.

Overview

Founded in 1988, we are a diversified technologies company engaged in the worldwide development, sale and commercialization of patented and/or proprietary technologies for the recovery and recycling of wastewater, chemicals, metals, and nutrients from waste streams at oil and gas, biogas, power plant, industrial and municipal operations. In addition, we hold patents on technology for the combustion of coal at high pressure using pure oxygen (oxy-combustion) for clean, coal-fired power generation.

Wastewater Solutions

The Company has spent nearly two decades developing sustainable water treatment and recovery systems that help industries and municipalities operate more efficiently, save money, reduce their carbon footprint and meet their sustainability goals.

Award-Winning Technology

We believe our TurboFrac system provides versatile and cost effective solutions to recover and recycle clean, usable water from contaminated produce water, including water with high Total Dissolved Solids (“TDS”), created by the hydraulic fracturing of oil and gas wells. Our FracGen systems create hydraulic fracturing-grade water from briny water in local aquifers located in arid areas. FracGen reduces demand on local potable water supplies and reduces the need to transport fresh water from other geographic locations, reducing operating costs for drillers.

Our versatile, award-winning CAST® (Controlled Atmospheric Separation Technology), RCAST®, and high-flow TurboCAST systems can be utilized as an effective stand-alone wastewater, chemical, metal or nutrient recovery system, or as part of an integrated recovery solution. These state-of-the-art vacuum assisted distillation units offer significant advantages over other evaporative technologies such as thin film and nucleate boiling. They are specially designed for high-strength wastewaters with high Total Dissolved Solids and Total Suspended Solids typically found in industrial, municipal and agricultural recovery processes.

In industrial applications, our Zero-Liquid-Discharge (ZLD) Systems can recover nearly 100% of valuable chemical resources or wastewater for immediate reuse or recycling with no liquid leaving the facility. CAST concentrates mixed hazardous waste down to as little as 5% of its original volume for economical disposal or reclaim. This patented technology is designed and constructed to withstand the demands of harsh chemical environments.

Fast Return on Investment

We believe our wastewater recovery systems reduce costs by recovering process chemicals, metals, and clean water for reuse or recycling and eliminating most of the costly disposal of hazardous waste or process effluent. These solutions offer a solid return on our customers’ investments and a quick payback with continued savings and efficiency for many years.

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Our wastewater treatment systems not only meet local, state and federal environmental regulations, but typically provide a rapid rate of return on investment by recovering and reusing expensive feedstocks, reducing contaminated wastewater discharge and recovering and reusing wastewater used in process operations. Our systems utilize proven technology to cost effectively process and treat brackish and produced water in the hydraulic fracturing (“fracking”) process in the oil and gas industries. Our wastewater treatment systems also have global applications in aerospace, food and beverage processing, metal finishing, pulp and paper, petrochemical, refining, microchip and circuit board manufacturing, heavy manufacturing and municipal wastewater.

Specific wastewater solutions include:

· Creating new supplies of usable water and recycling wastewater in the oil and gas industry

· Recovering and recycling ammonia in industrial and municipal operations

· Recovering ammonia and creating fertilizer from anaerobic digesters

· Recovering chemicals or metals from industrial wastewater

· Recovering and recycling used glycol

Power Generation Technologies

We are also the owner of a patented pressurized oxycombustion technology that has the potential to convert fossil fuels (including coal, oil and natural gas) and biomass into electricity while producing near zero air emissions, and at the same time removing and capturing carbon dioxide in liquid form for sequestration or beneficial reuse. The technology is held by our subsidiary, ThermoEnergy Power Systems, LLC (“TEPS”) and is being developed and commercialized through a joint venture, Unity Power Alliance (UPA).

On June 20, 2012, we entered into an Agreement with Itea S.p.A. (“ITEA”) for the development of pressurized oxycombustion in North America. The two parties, through UPA, will utilize their patented technologies to advance, develop and promote the use of the coal application of pressurized oxycombustion, construct a pilot plant utilizing the technology, and pending the outcome of pilot plant testing, seek additional partners to construct a demonstration facility based on the technology as implemented in the pilot plant. ITEA was granted the option to acquire a 50% ownership interest in UPA for nominal consideration. On July 16, 2012, ITEA exercised its option and acquired the 50% ownership interest in UPA. As of September 30, 2013, the financial results of UPA are accounted for as a joint venture under the equity method of accounting and are not consolidated in our financial statements as a variable interest entity as defined by ASC 810, “Consolidation,” as we have concluded that we are not the primary beneficiary.

In September 2012, Unity Power Alliance received a $1 million Phase 1 grant from the U.S. Department of Energy (“DOE”) to help fund a project under a special DOE program to advance technologies for efficient, clean coal power and carbon capture. As part of UPA's project, in October 2012, we received a $900,000 contract from UPA to build a bench-scale “flameless” combustion reactor under the grant. We have received funding totaling $598,000 as of September 30, 2013, and we have recorded revenues of $295,000 and $842,000 on a time and materials basis related to this contract in the three and nine-month periods ended September 30, 2013, respectively. We expect the bench-scale unit will be operational during the fourth quarter of 2013.

Except for revenues from the UPA contract as stated above, we generate revenues from the sale and development of wastewater treatment systems. We enter into contracts with our customers to provide a wastewater treatment solution that meets the customer’s present and future needs. Our revenues are tied to the size and scale of the wastewater treatment systems required by our customers, as well as the progress made on each customer contract.

Historically we marketed and sold our products primarily in North America. In 2011, we began marketing and selling our products in South America, Asia and Europe. These marketing and sales activities are performed by our direct sales force and authorized independent sales representatives.

On August 22, 2012, the New York City Department of Environmental Regulation (“NYCDEP”) issued a stop work order to us relative to our contract to install an Ammonia Removal Process (“ARP”) system at the NYCDEP’s wastewater treatment facility in the 26^th Ward. The NYCDEP terminated the contract for convenience, effective November 29, 2012. Subsequently, we delivered all equipment, including all material from third party vendors, to the NYCDEP during the first quarter of 2013. In June 2013, we received notice from the NYCDEP that the contract was closed, resulting in a gain on contract termination of approximately $4.9 million during the second quarter of 2013.

Because of this contract termination, our revenues, expenses, and income will be adversely affected in future periods, as this contract represented approximately 73% of our revenues for the year ended December 31, 2012.

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We have made significant progress in strengthening our balance sheet through various conversions of debt into equity and building our business for future growth; however, we continue to incur net losses and negative cash flows from operations. We incurred net losses of $301,000 for the nine-month period ended September 30, 2013 and $7.4 million for the year ended December 31, 2012. Cash outflows from operations totaled $4.4 million for the nine-month period ended September 30, 2013 and $5.4 million for the year ended December 31, 2012. If we do not generate future orders from our sales pipeline, we will require additional financing and/or capital to continue to fund our operations.

Critical Accounting Policies and Revenue Accounting Guidance

Our financial statements have been prepared in accordance with accounting principles generally accepted in the United States (“GAAP”). Management believes there have been no material changes during the nine months ended September 30, 2013 to the critical accounting policies reported in Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” section in our Annual Report on Form 10-K for the fiscal year ended December 31, 2012.

Recently Issued Accounting Guidance

Accounting Standards Update (ASU) 2013-11, “Income Taxes (Topic 740) - Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists” was issued in July, 2013. The amendments in this update are effective for fiscal years, and interim periods within those years, beginning after December 15, 2013. Early adoption is permitted. The amendments should be applied prospectively to all unrecognized tax benefits that exist at the effective date. Retrospective application is permitted. The Company does not expect adoption of this ASU to have a material impact on its financial statements.

Results of Operations

Comparison of Quarters Ended September 30, 2013 and 2012

Revenues totaled $532,000 for the third quarter of 2013, a decrease of 74% compared to $2,032,000 for the third quarter of 2012. Revenues in the third quarter of 2013 were primarily derived from our work related to UPA’s grant with the DOE and service revenues from our existing customer base. Revenues in the third quarter of 2012 were primarily derived from our contract with the NYCDEP.

Gross loss for the third quarter of 2013 was ($338,000) compared to gross profit of $1,000 in the third quarter of 2012. We recognized a loss in 2013 related to cost overruns on the UPA contract driven by engineering and product design changes generated by our partner in the joint venture, who serves as the design engineer on the project. Additionally, we absorbed higher unallocated overhead costs in the third quarter of 2013. Gross profit in the third quarter of 2012 was primarily related to work performed on the NYCDEP contract prior to the issuance of the stop work order, offset by higher than expected production costs on our first mobile FracGen water production system.

General and administrative expenses totaled $697,000 for the third quarter of 2013, a decrease of $338,000 compared to $1,035,000 for the third quarter of 2012. The decrease is primarily due to financing expenses incurred in 2012 attributable to our financings that did not repeat in 2013, as well as lower non-cash stock option expenses.

Engineering, research and development expenses for the third quarter of 2013 totaled $69,000 compared to $160,000 for the third quarter of 2012. The decrease is attributable to lower headcount and lower non-cash stock option expenses in the third quarter of 2013 compared to 2012.

Sales and marketing expenses for the third quarter of 2013 totaled $435,000, a decrease of $163,000 compared to $598,000 for the third quarter of 2012. The decrease was due to a reduction in non-core international business development efforts and reduced unbillable pre-sale expenses, partially offset by increased spending related to our continued promotion and testing of our TurboFrac® technologies in the unconventional oil shale market.

Changes in the fair value of our derivative warrant liabilities resulted in the recognition of derivative mark-to-market income of $1,205,000 in the third quarter of 2013 compared to $574,000 in the third quarter of 2012. Income in the third quarter of 2013 relates primarily to the passage of time and lower probability of exercising certain derivative instruments; income in the third quarter of 2012 relates primarily to the passage of time and the decrease in our stock price.

Other derivative expense of $565,000 in the third quarter of 2012 represents the amounts by which the initial valuation of derivative liabilities created in conjunction with our financing transactions in July and August of 2012 exceeded the amounts raised by these financing transactions. We had no such expenses in the third quarter of 2013.

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We recognized losses in our joint ventures totaling $202,000 in the third quarter of 2013 compared to income of $24,000 in the third quarter of 2012. Losses in the third quarter of 2013 are attributable to UPA’s efforts on the grant with the DOE. Because this grant is a cost-sharing arrangement, UPA is required to absorb a portion of the costs necessary to complete this project. Income in the third quarter of 2012 is attributable to Itea, our joint venture partner in UPA, assuming certain expenses of UPA.

Interest expense was $109,000 during the third quarter of 2013 compared to $101,000 for the third quarter of 2012. This increase is due higher interest rates paid on our debt in 2013 compared to the third quarter of 2012.

Comparison of Nine-Month Periods Ended September 30, 2013 and 2012

Revenues totaled $2,621,000 for the first nine months of 2013 compared to $5,620,000 for the first nine months of 2012, a decrease of $2,999,000 or 53%. Revenues in 2013 were primarily driven by two industrial projects utilizing our Ammonia Recovery Process (“ARP”) technology, work related to UPA’s grant with the DOE and service revenues from our existing customer base. Revenues in 2012 were derived almost exclusively from construction-related activities on our NYCDEP contract.

Gross loss for the first nine months of 2013 was ($327,000) compared to gross profit of $382,000 in the first nine months of 2012. We recognized a loss in the third quarter of 2013 related to cost overruns on the UPA contract driven by engineering and product design changes generated by our partner in the joint venture, who serves as the design engineer on the project. The decrease is also attributable to recognizing lower margins on our active projects in 2013 compared to construction-related activities for the NYCDEP contract in 2012, as well as absorbing unallocated overhead costs during 2013.

General and administrative expenses decreased by $1,529,000, or 39%, to $2,422,000 from $3,951,000 in the nine-month period ended September 30, 2013 compared to 2012. The decrease is primarily due to significantly lower professional, consulting and stock option expenses in 2013 resulting from management’s efforts to reduce our cost structure.

Engineering, research and development expenses increased by $74,000, or 20%, to $437,000 from $363,000 in the nine-month period ended September 30, 2013 compared to 2012. The increase is attributable to reduced utilization of our engineering team on our various projects in 2013 compared to 2012, partially offset by lower headcount and non-cash stock option expenses in 2013. Costs directly related to our projects are charged to cost of sales.

Sales and marketing expenses decreased by $927,000, or 42%, to $1,261,000 from $2,188,000 in the nine-month period ended September 30, 2013 compared to 2012. We recorded a loss of $131,000 related to the disposal of a system previously used for pre-sales testing in the first quarter of 2012. This loss did not repeat in 2013. This decrease is also attributed to a reduction in non-core international business development efforts and reduced unbillable pre-sale expenses, partially offset by increased spending related to our continued promotion and testing of our TurboFrac® technologies in the unconventional oil shale market.

We recorded a non-cash gain of $4,878,000 related to the termination of our contract with the NYCDEP during the nine-month period ended September 30, 2013. This gain represents the amount by which our billings to the NYCDEP exceeded revenues recognized related to the contract. We did not record any such gains during the nine-month period ended September 30, 2012.

Changes in the fair value of our derivative warrant liabilities resulted in the recognition of derivative mark-to-market income of $2,074,000 in the nine-month period ended September 30, 2013 compared to $1,100,000 in the nine-month period ended September 30, 2012. Income in 2013 relates primarily to the passage of time, lower probability of exercising certain derivative instruments and decrease in our stock price. Income in 2012 relates to the change in our stock price and the passage of time.

We recognized losses in our joint ventures totaling $296,000 in the nine-month period ended September 30, 2013 compared to income of $14,000 in the nine-month period ended September 30, 2012. Losses in 2013 are attributable to UPA’s efforts on the grant with the DOE. Because this grant is a cost-sharing arrangement, UPA is required to absorb a portion of the costs necessary to complete this project. Income in the first nine months of 2012 is attributable to Itea assuming certain expenses of UPA in the third quarter of 2012.

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Interest expense was $2,483,000 in the nine-month period ended September 30, 2013 compared to $355,000 for the similar period of 2012. This increase is primarily due to amortization of debt discounts recognized on our December 2011 Bridge Notes and our November 2012 Bridge Notes in the third quarter of 2013.

Liquidity and Capital Resources

Cash and cash flow data for the periods presented were as follows (in thousands of dollars):

	Nine-Month Period Ended September 30,
	2013		2012

Cash	$	3,300	$	528

Net cash used in operating activities		(4,381)		(5,087)
Net cash used in investing activities		(414)		(235)
Net cash provided by financing activities		3,438		2,794

We have historically lacked the financial and other resources necessary to market the Technologies or to build demonstration projects without the financial backing of government or industrial partners. During 2013 and 2012, we funded our operations primarily from the sale of convertible debt, short-term borrowings, preferred stock and common stock, generally from stockholders and other parties who are sophisticated investors in clean technology. We raised $4 million of funding in 2013 and $7.3 million in 2012, and we will require substantial additional funding to continue existing operations. We believe that we will be able to obtain additional equity or debt financing; however, there is no certainty that we can obtain such financing or that we can do so at market terms and interest rates. These issues raise substantial doubt about our ability to continue as a going concern.

Cash used in operations amounted to $4,381,000 and $5,087,000 for the nine-month periods ended September 30, 2013 and 2012, respectively. Cash used in operations in 2013 is primarily a result of our continued net losses from operations as well as paying down our trade payables in 2013. Cash used in operations in 2012 is primarily the result of our continued net losses. Cash used in investing activities included the issuance of new loans receivable to UPA of $300,000 and $101,000 for the nine-month periods ended September 30, 2013 and 2012, respectively, and purchases of property and equipment of $114,000 and $134,000 for the nine-month periods ended September 30, 2013 and 2012, respectively. Cash provided by financing activities for the nine-month period ended September 30, 2013 included proceeds of $4 million from the issuance of our August 2013 Bridge Notes and advances from our project line of credit totaling $223,000, offset by the repayment in full of our project line of credit totaling $785,000; cash provided by financing activities for the nine-month period ended September 30, 2012 were derived from the exercise of common stock warrants, which generated net proceeds of $498,000, and the issuance of common stock and warrants, which generated net proceeds of $2,296,000.

On April 5, 2013, investors in our December 2011 Bridge Notes and November 2012 Bridge Notes exchanged such Notes with an aggregate principal amount of $4,950,000 plus accrued interest totaling $314,177 for a total of 6,926,553 shares of our Series C Convertible Preferred Stock and Warrants for the purchase of a total of 69,265,530 shares of Common Stock.

On April 5, 2013, we repaid in full all outstanding principal and accrued interest totaling $785,059 related to our Loan Agreement with C13 Thermo, LLC.

On August 22, 2013, we received proceeds totaling $4 million from the issuance of 12% Promissory Notes. These notes bear interest at the rate of 12% per year and are due and payable on February 1, 2014. The notes are secured by substantially all of the Company’s assets.

We continue to take measures to increase our sales pipeline to generate future business and to reduce our operating costs through a reduction in force and the elimination of certain non-essential administrative costs.

At September 30, 2013, we do not have sufficient working capital to satisfy our anticipated operating expenses for the next 12 months. As of September 30, 2013, we had a cash balance of $3.3 million and current liabilities of approximately $8.2 million, which consisted primarily of accounts payable of $731,000, short term borrowings of $4 million, convertible debt of approximately $2.1 million, derivative liabilities of $141,000 and other current liabilities of approximately $1 million.

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There can be no assurance that we will be able to book additional orders or obtain the funding necessary to continue our operations and development activities. Management continues to engage current and potential new investors in discussions for equity or debt financing to fund our operations until we can operate on a cash flow positive basis.

ITEM 3. Quantitative and Qualitative Disclosures About Market Risk

Not applicable.

ITEM 4. Controls and Procedures

Evaluation of Disclosure Controls and Procedures

The Company, under the direction of its Chief Executive Officer and Interim Chief Financial Officer, has established disclosure controls and procedures that are designed to ensure that information required to be disclosed by the Company in the reports that it files or submits under the Exchange Act, is recorded, processed, summarized, and reported within the time periods specified in the Commission’s rules and forms. The disclosure controls and procedures are also intended to ensure that such information is accumulated and communicated to the Company’s management, consisting of the Chief Executive Officer and Interim Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosures.

The Company’s Chief Executive Officer and Interim Chief Financial Officer carried out an evaluation of the effectiveness of disclosure controls and procedures as defined in Rules 13a-15(e) and 15d-15(e) of the Exchange Act as of the end of the period covered by this report. Based on this evaluation, the Company’s Chief Executive Officer and Interim Chief Financial Officer have concluded that the Company’s disclosure controls and procedures were not effective as of September 30, 2013 due to (i) our failure to adequately allocate proper and sufficient amount of resources to ensure that necessary internal controls were implemented and followed, specifically, but not limited, to the accounting and valuation of complex debt and equity transactions; (ii) a lack of segregation of duties in our significant accounting functions to ensure that internal controls were designed and operating effectively; and (iii) our contract administration procedures were deficient in that we have not been able to consistently estimate contract costs.

Changes in Internal Controls

In the first quarter of 2013, we reviewed and implemented new procedures to ensure that we budget and estimate contract costs accurately. We have yet to determine whether these new procedures are sufficient to remediate our material weakness in our contract administration procedures. We did not make any other changes to our internal controls over financial reporting during the quarter ended September 30, 2013 that materially affected, or are reasonably likely to materially affect, our internal controls over financial reporting.

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PART II — OTHER INFORMATION

ITEM 1. Legal Proceedings

From time to time, we may become subject to various legal proceedings that are incidental to the ordinary conduct of our business. We are not currently party to any material legal proceedings other than those listed above.

On July 16, 2012, Andrew T. Melton, our former Executive Vice President and Chief Financial Officer (“Melton”), filed a Complaint in the United States District Court, Eastern District of Arkansas alleging that his employment had been terminated in breach of his employment agreement and claiming damages in the aggregate amount of approximately $2.2 million, including unpaid salary, reimbursement of expenses, and other payments under his employment agreement. On June 19, 2013, the litigation was dismissed upon motion by the plaintiff.

ITEM 1A. Risk Factors

Not applicable.

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

None.

ITEM 3. Defaults Upon Senior Securities

None.

ITEM 4. Mine Safety Disclosures

None.

ITEM 5. Other Information

None.

ITEM 6. Exhibits

The following exhibits are filed as part of this report:

Exhibit No.		Description

10.1		Letter Agreement dated as of August 20, 2013 between Empire Capital Partners, L.P., Empire Capital Partners, Ltd., Empire Capital Partners Enhanced Master Fund, Ltd., Scott A. Fine and Peter J. Richards and certain of their affiliates and ThermoEnergy Corporation — Incorporated by reference to Exhibit 10.1 to Current Report on Form 8-K filed August 27, 2013.

10.2		Loan Agreement dated as of August 22, 2013 by and among ThermoEnergy Corporation and the Lenders party thereto — Incorporated by reference to Exhibit 10.2 to Current Report on Form 8-K filed August 27, 2013.

10.3		Form of Promissory Note issued pursuant to the Loan Agreement dated as of August 22, 2013 by and among ThermoEnergy Corporation and the Lenders party thereto — Incorporated by reference to Exhibit 10.3 to Current Report on Form 8-K filed August 27, 2013.

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10.4		Security Agreement dated as of August 22, 2013 by and among ThermoEnergy Corporation, the Secured Parties party thereto and Empire Capital Partners, LP, one of the Secured Parties, as agent for itself and the other Secured Parties — Incorporated by reference to Exhibit 10.4 to Current Report on Form 8-K filed August 27, 2013.

31.1		Sarbanes Oxley Act Section 302 Certificate of Principal Executive Officer — Filed herewith

31.2		Sarbanes Oxley Act Section 302 Certificate of Principal Financial Officer — Filed herewith

32.1		Sarbanes Oxley Act Section 906 Certificate of Principal Executive Officer — Filed herewith

32.2		Sarbanes Oxley Act Section 906 Certificate of Principal Financial Officer — Filed herewith

101.INS *		XBRL Instance Document

101.SCH *		XBRL Taxonomy Extension Schema Document

101.CAL *		XBRL Taxonomy Extension Calculation Linkbase Document

101.DEF *		XBRL Taxonomy Extension Definition Linkbase Document

101 LAB *		XBRL Extension Labels Linkbase Document

101.PRE *		XBRL Taxonomy Extension Presentation Linkbase Document

* In accordance with SEC rules, this interactive data file is deemed “furnished” and not “filed” for purposes of Sections 11 or 12 of the Securities Act of 1933 and Section 18 of the Securities and Exchange Act of 1934, and otherwise is not subject to liability under those sections or acts.

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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, thereunto duly authorized.

Date: November 14, 2013	THERMOENERGY CORPORATION

	/s/ James F. Wood
	James F. Wood
	Chairman and Chief Executive Officer

	/s/ Gregory M. Landegger
	Gregory M. Landegger
	Chief Operating Officer and Interim Chief Financial Officer

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THERMOENERGY CORP 10-Q