UNITED STATES
 SECURITIES
AND EXCHANGE COMMISSION
 WASHINGTON,
D.C. 20549
 
 FORM
10-Q
 
 QUARTERLY
REPORT PURSUANT TO SECTION 13 OR 15 (D) OF THE
 SECURITIES
EXCHANGE ACT OF 1934
 
 FOR THE
QUARTERLY PERIOD ENDED JUNE 30, 2008
 
 Commission
File Number: #033-31067
 
 ECO2 PLASTICS,
INC.
 (Exact
name of small business issuer as specified in its charter)
 
 Delaware
 (State or
other jurisdiction of incorporation or organization)
 
 31-1705310
 (IRS
Employer Identification Number)
 
 680
Second Street, Suite 200
 San
Francisco, CA 94107
 (Address
of principal executive offices)(Zip Code)
 
 (415)
829-6000
 (Registrant's
telephone no., including area code)
 
 Indicate
by check mark whether the registrant (1) has filed all reports required to be
filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the
preceding 12 months (or for such shorter period that the registrant was required
to file such reports), and (2) has been subject to such filing requirements for
the past 90 days. Yes [X] No [ ]
 
 Indicate
by check mark whether the registrant is a shell company (as defined in Rule
12b-2 of the Exchange Act).  Yes [ ] No [X]
 
 The
number of shares of the Company's common stock issued and outstanding on June
30, 2008 is 549,441,434.
 
 Indicate
by check mark whether the registrant is a large accelerated filer [ ], an
accelerated filer [ ], a non-accelerated filer [ ], or a smaller reporting
company [X].
 
 
 
  1
  
 ECO2 PLASTICS,
INC.
 FORM
10-Q
  TABLE OF
CONTENTS
 PagePART
      I
              
              FINANCIAL
      INFORMATION
              3Item
      1
              
              Financial
      Statements
              3Item
      2
              
              Management's
      Discussion and Analysis of Financial Condition and Results of
      Operations
              17Item
      3
              
              Quantitative
      and Qualitative Disclosures About Market Risk
              22Item
      4
              
              Controls
      and Procedures
              23PART
      II
              
              OTHER
      INFORMATION
              24Item
      1
              
              Legal
      Proceedings
              24Item
      1A
              
              Risk
      Factors
              24Item
      2
              
              Unregistered
      Sales of Equity Securities and Use of Proceeds
              26Item
      3
              
              Defaults
      Upon Senior Securities
              27Item
      4
              
              Submission
      of Matters to a Vote of Security Holders
              27Item
      5
              
              Other
      Information
              28Item
      6
              
              Exhibits
              28Signatures
              29
 2
 
 PART I - FINANCIAL
INFORMATION
 Item
1.    Financial
Statements
 ECO2
      Plastics, Inc.Condensed
      Balance Sheets(in
      thousands, except share and per share data)June
      30,
                
                
                December
      31,2008
                
                
                2007(unaudited)Cash
      and cash equivalents
                
                $
                1,165
                
                
                $
                101Accounts
      receivable, net of allowance of $48
                
                
                702
                
                
                
                581Inventory
                
                
                228
                
                
                
                475Prepaid
      expenses and other current assets
                
                
                -
                
                
                
                2Total
      current assets
                
                
                2,095
                
                
                
                1,159Property
      and equipment, net
                
                
                7,692
                
                
                
                7,864Deferred
      debt issue costs, net
                
                
                -
                
                
                
                445Other
      assets
                
                
                68
                
                
                
                47Total
      assets
                
                $
                9,855
                
                
                $
                9,515Current
      liabilitiesAccounts
      payable
                
                $
                1,824
                
                
                $
                2,900Accounts
      payable to related parties
                
                
                126
                
                
                
                692Accrued
      liabilities
                
                
                500
                
                
                
                645Accrued
      interest on notes payableDue
      to related parties
                
                
                2
                
                
                
                846Due
      to others
                
                
                -
                
                
                
                801Notes
      payable, net of debt discountDue
      to related parties, net of debt discount of $0 and $1,856
                
                
                95
                
                
                
                7,415Due
      to others, net of debt discount of $0 and $2,558
                
                
                -
                
                
                
                5,910Current
      portion of note payable to California Integrated Waste Management
      Board
                
                
                205
                
                
                
                200Participation
      Certificates obligations issued prior to 2004
                
                
                354
                
                
                
                354Total
      current liabilities
                
                
                3,106
                
                
                
                19,763Note
      payable to California Integrated Waste Management Board, net of current
      portion
                
                
                1,384
                
                
                
                1,507Total
      liabilities
                
                
                4,490
                
                
                
                21,270Commitments
      and contingencies (Note 7)Stockholders'
      equity (deficit)Preferred
      stock, $0.001 par value, 700,000,000 shares authorized,Series
      A convertible, 152,843,413 shares authorized, issued andoutstanding,
      preference in liquidation $4,585
                
                
                153
                
                
                
                -Series
      B-1 convertible, 336,240,040 shares authorized, issuedand
      outstanding, preference in liquidation $6,725
                
                
                336
                
                
                
                -Series
      B-2 convertible, 10,916,546 shares authorized, none issued and
      outstanding
                
                
                -Common
      stock, $0.001 par value, 1,500,000,000 shares authorized,543,761,445
      and 190,920,594 shares issued and outstanding
                
                
                544
                
                
                
                191180,000
      and 7,180,000 shares issuable
                
                
                -
                
                
                
                7Additional
      paid-in capital
                
                
                96,174
                
                
                
                66,843Deferred
      stock-based consulting
                
                
                (15
                )
                
                
                (24
                )Accumulated
      deficit
                
                
                (91,827
                )
                
                
                (78,772
                )Total
      stockholders' equity (deficit)
                
                
                5,365
                
                
                
                (11,755
                )Total
      liabilities and stockholders' equity (deficit)
                
                $
                9,855
                
                
                $
                9,515See
      accompanying notes to condensed financial
  statements.
  3
  ECO2
      Plastics, Inc.Condensed
      Statements of Operations(in
      thousands, except per share data)(unaudited)Three
      months ended June 30,
                
                
                Six
      months ended June 30,2008
                
                
                2007
                
                
                2008
                
                
                2007Revenue
                
                $
                1,410
                
                
                $
                418
                
                
                $
                2,920
                
                
                $
                517Cost
      of goods sold
                
                
                1,366
                
                
                
                430
                
                
                
                2,959
                
                
                
                604Gross
      margin
                
                
                44
                
                
                
                (12
                )
                
                
                (39
                )
                
                
                (87
                )Operating
      expensesPlant
      operations and technology development
                
                
                1,960
                
                
                
                1,515
                
                
                
                3,824
                
                
                
                2,556General
      and administrative, including share-basedpayments
      of $351 and $910 and $801 and $2,067
                
                
                1,087
                
                
                
                2,369
                
                
                
                2,401
                
                
                
                4,654Settlement
      expense paid in shares of common stock
                
                
                -
                
                
                
                740
                
                
                
                -
                
                
                
                740Total
      operating expenses
                
                
                3,047
                
                
                
                4,624
                
                
                
                6,225
                
                
                
                7,950Loss  from
      operations
                
                
                (3,003
                )
                
                
                (4,636
                )
                
                
                (6,264
                )
                
                
                (8,037
                )Other
      income (expense)Interest
      expense, including amortization of debt discount anddebt
      issue costs of $502 and $3,357 and $2,763 and $6,438
                
                
                (691
                )
                
                
                (3,739
                
                
                
                (3,333
                )
                
                
                (7,148
                )Excess
      of fair value of common stock issued inexchange
      for accounts payable, notes and accruedinterest
      payable and warrants
                
                
                -
                
                
                
                -
                
                
                
                (3,458
                )
                
                
                -Total
      other income (expense)
                
                
                (691
                )
                
                
                (3,739
                )
                
                
                (6,791
                )
                
                
                (7,148
                )Loss
      before income taxes
                
                
                (3,694
                )
                
                
                (8,375
                )
                
                
                (13,055
                )
                
                
                (15,185
                )Income
      taxes
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                -Net
      loss
                
                $
                (3,694
                )
                
                $
                (8,375
                )
                
                $
                (13,055
                )
                
                $
                (15,185
                )Net
      loss per common share, basic and diluted
                
                $
                (0.01
                )
                
                $
                (0.06
                )
                
                $
                (0.03
                )
                
                $
                (0.11
                )Weighted
      average shares used in computingnet
      loss per common share, basic and diluted
                
                
                543,069
                
                
                
                135,024
                
                
                
                428,208
                
                
                
                133,139See
      accompanying notes to condensed financial statements.
  4
  ECO2
      Plastics, Inc.Condensed
      Statement of Changes in Stockholders' Equity (Deficit)For
      the Six Months Ended June 30, 2008(in
      thousands, except share data)(unaudited)Common
      Stock
                
                
                Additional
                
                
                DeferredConvertible
      Preferred Stock
                
                
                Common
      stock
                
                
                Issuable
                
                
                paid-in
                
                
                stock-based
                
                
                AccumulatedSeries
      A
                
                
                Series
      B-1
                
                
                Shares
                
                
                Amount
                
                
                Shares
                
                
                Amount
                
                
                capital
                
                
                consulting
                
                
                deficit
                
                
                TotalShares
                
                
                Amount
                
                
                Shares
                
                
                AmountBalance
      at December 31, 2007
                
                
                -
                
                
                $
                -
                
                
                
                -
                
                
                $
                -
                
                
                
                190,920,594
                
                
                $
                191
                
                
                
                7,180,000
                
                
                $
                7
                
                
                $
                66,843
                
                
                $
                (24
                )
                
                $
                (78,772
                )
                
                $
                (11,755
                )Amortization of deferred stock-basedconsulting
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                9
                
                
                
                
                
                
                
                9Value of warrants issued with notespayable
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                540
                
                
                
                
                
                
                
                
                
                
                
                540Stock-based compensation expense
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                801
                
                
                
                
                
                
                
                
                
                
                
                801Shares issued in exchange foraccounts payable
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                15,944,077
                
                
                
                16
                
                
                
                
                
                
                
                
                
                
                
                813
                
                
                
                
                
                
                
                
                
                
                
                829Shares vested for executivecompensation
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                4,400,000
                
                
                
                4
                
                
                
                
                
                
                
                
                
                
                
                (4
                )
                
                
                
                
                
                
                
                
                
                
                -Shares issued in exchange fornotes
      payable, accruedinterest
      and warrants
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                325,853,917
                
                
                
                326
                
                
                
                
                
                
                
                
                
                
                
                15,550
                
                
                
                
                
                
                
                
                
                
                
                15,876Issuance of shares previouslyrecorded
      as issuable
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                7,000,000
                
                
                
                7
                
                
                
                (7,000,000
                )
                
                
                (7
                )
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                -Preferred
      shares issued inexchange for:Notes
      payable and related accruedinterest
                
                
                152,843,413
                
                
                
                153
                
                
                
                111,240,040
                
                
                
                111
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                7,598
                
                
                
                
                
                
                
                
                
                
                
                7,862Cash
                
                
                
                
                
                
                
                
                
                
                165,000,000
                
                
                
                165
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                3,135
                
                
                
                
                
                
                
                
                
                
                
                3,300"old" Series A preferred stock
                
                
                
                
                
                
                
                
                
                
                60,000,000
                
                
                
                60
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                1,140
                
                
                
                
                
                
                
                
                
                
                
                1,200Stock
      issue costs
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                (242
                )
                
                
                
                
                
                
                
                
                
                
                (242
                )Decrease in shares issuable previouslyrecorded
      as issued in 2006
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                (357,143
                )
                
                
                -
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                -Net loss for the six months endedJune 30, 2008
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                (13,055
                )
                
                
                (13,055
                )Balance
      at June 30, 2008
                
                
                152,843,413
                
                
                $
                153
                
                
                
                336,240,040
                
                
                $
                336
                
                
                
                543,761,445
                
                
                $
                544
                
                
                
                180,000
                
                
                $
                -
                
                
                $
                96,174
                
                
                $
                (15
                )
                
                $
                (91,827
                )
                
                $
                5,365See
      accompanying notes to financial
statements.
  5
 ECO2
      Plastics, Inc.Condensed
      Statements of Cash Flows(in
      thousands)(unaudited)Six
      months ended June 30,2008
                
                
                2007Cash
      flows from operating activities:Net
      loss
                
                $
                (13,055
                )
                
                $
                (15,185
                )Adjustments
      to reconcile net loss to net cash used by operating
      activities:Depreciation
      and amortization
                
                
                720
                
                
                
                492Excess
      of fair value of common stock issued in exchangefor
      accounts payable, notes payable, accrued interest and
    warrants
                
                
                3,458
                
                
                
                -Stock-based
      compensation and settlement expense
                
                
                812
                
                
                
                3,547Amortization
      of debt issue costs  and discount
                
                
                2,763
                
                
                
                6,438Expenses
      paid by issuance of notes payable
                
                
                -
                
                
                
                75Changes
      in operating assets and liabilities:Accounts
      receivable
                
                
                (121
                )
                
                
                (331
                )Inventory
                
                
                247
                
                
                
                8Prepaid
      expenses and other assets
                
                
                (19
                )
                
                
                34Accounts
      payable
                
                
                (889
                )
                
                
                1,050Accrued
      liabilities
                
                
                437
                
                
                
                -Other
                
                
                -
                
                
                
                396Net
      cash used by operating activities
                
                
                (5,647
                )
                
                
                (3,476
                )Cash
      flows from investing activities:Purchase
      of property, plant & equipment
                
                
                (548
                )
                
                
                (2,151
                )Net
      cash used by investing activities
                
                
                (548
                )
                
                
                (2,151
                )Cash
      flows from financing activities:Payments
      on CIWMB note payable
                
                
                (119
                )
                
                
                (113
                )Proceeds
      from issuance of notes payable
                
                
                3,595
                
                
                
                5,822Repayments
      of notes payable
                
                
                (475
                )
                
                
                -Proceeds
      from issuance of preferred stock
                
                
                4,500
                
                
                
                -Principal
      payments on capital lease obligations
                
                
                -
                
                
                
                (11
                )Proceeds
      from exercise of warrants
                
                
                -
                
                
                
                2Payments
      of stock issue costs
                
                
                (242
                )
                
                
                -Payments
      of debt issue costs
                
                
                -
                
                
                
                (156
                )Net
      cash provided  by financing activities
                
                
                7,259
                
                
                
                5,544Net
      increase (decrease)  in cash and cash
equivalents
                
                
                1,064
                
                
                
                (83
                )Cash
      and cash equivalents, beginning of period
                
                
                101
                
                
                
                97Cash
      and cash equivalents, end of period
                
                $
                1,165
                
                
                $
                14Supplemental
      disclosures of cash flow information:Cash
      paid for interest
                
                $
                57
                
                
                $
                40Cash
      paid for income taxes
                
                $
                -
                
                
                $
                -Supplemental
      disclosures of non-cash investing and financing
activities:Debt
      discounts
                
                $
                1,899Deferred
      debt issue costs
                
                $
                -
                
                
                $
                95Common
      stock exchanged for notes payable, accrued interest and
      warrants
                
                $
                13,031
                
                
                $
                -Common
      stock exchanged for accounts payable and accrued
    liabilities
                
                $
                754
                
                
                $
                123Preferred
      stock exchanged for notes payable and accrued interest
                
                $
                7,862
                
                
                $
                -See
      accompanying notes to condensed financial statements.
  6
  ECO2 Plastics,
Inc.
 Notes
to Condensed Financial Statements
 June
30, 2008
 (unaudited)
 
 Note
1. Description of Business and Summary of Significant Accounting
Policies
  Organization and
Business – ECO2 Plastics,
Inc., (“ECO2”) or the
(“Company”) was incorporated under the laws of the State of Delaware in 2000,
and formed for the purpose of acquiring certain patented technology and the
development of a worldwide market for its usage.  In March 2007, the
Company changed its name from Itec Environmental Group, Inc.
  ECO2 has
developed a unique and revolutionary patented process and system, referred to as
the Eco2TM
Environmental System (the “Eco2
Environmental System”). The Eco2
Environmental System cleans post-consumer plastics, without the use of water, at
a substantial cost savings versus traditional methods (the “Process”). This
Process is licensed from Honeywell Federal Manufacturing & Technologies, LLC
(“Honeywell”) and the Department of Energy on an exclusive basis for the patent
life. Since its inception, ECO2has
invested in the development of the technology and equipment comprising the
Eco2
Environmental System, which includes a “Process Patent” granted in 2007. This
included building several scaled up versions of the Prototype Eco2
Environmental System (the “Prototype”), testing of the Prototypes, building a
pilot plant, evaluating the product produced by the Prototype and real-time
testing. The Company’s first full scale production facility was constructed in
Riverbank, California and is now producing saleable product and ramping up to
full scale operations as it further develops the process.  ECO2’s goal is
to build and operate plastic recycling plants in the USA that utilize the
Eco2
Environmental System and to expand the Eco2
Environmental System worldwide. ECO2’s growth
strategy includes organic growth, strategic acquisitions and licensing or
partnership agreements, where appropriate.
 
 Business risks and
uncertainties - The Company operates in the evolving field of plastics
materials recycling and its business is reliant on its licensing of technology
from Honeywell. New developments could both significantly and adversely affect
existing and emerging technologies in the field. The Company's success in
developing additional marketable products and processes and achieving a
competitive position will depend on, among other things, its ability to attract
and retain qualified management personnel and to raise sufficient capital to
meet its operating and development needs. There can be no assurance that the
Company will be successful in accomplishing its objectives.
 
 Basis of presentation and
Going Concern - The accompanying financial statements have been prepared
in conformity with accounting principles generally accepted in the United States
of America, which contemplate the Company’s continuation as a going concern.
Since inception, the Company has reported losses and operating activities have
used cash, and it has a working capital deficiency that has raised substantial
doubt about its ability to continue as a going concern. The Company reported a
net loss of approximately $13.1 million for the six months ended June 30, 2008,
and $32.6 million for the year ended December 31, 2007, and operating activities
used cash of approximately $5.6 million during the six months ended June 30,
2008 and $7.2 million for the year ended December 31, 2007, and as of June 30,
2008, had stockholders’ equity of $5.4 million, including accumulated losses
from inception of $91.8 million.
  Company
management intends to raise additional debt and equity financing to fund future
capital expenditures, operations and to provide additional working
capital.  During the three months ended June 30, 2008, the Company
received $1.2 million from loans from new and existing investors, and received
$4.5 million from sales of 225 million shares of its convertible preferred
stock, and issued approximately 264 million shares of its convertible preferred
stock in exchange for outstanding promissory notes having a principal balance of
approximately $7.5 million and related accrued interest payable of
$525,000.   During the three months ended March 31, 2008, the
Company (i) received approximately $2.2 million from loans from new and
existing investors, (ii) entered into agreements with holders of certain notes
payable pursuant to which the Company issued approximately 243.9 million shares
of Company common stock in consideration for conversion of all convertible notes
payable of  $13.2 million together with related accrued interest
of approximately $1.7 million and the surrender of outstanding warrants to
purchase approximately 38.6 million shares of Company common stock, (iii)
entered into agreements with related party and non-related party creditors
providing for issuance of  approximately 15.9 million shares of
Company common stock as payment for accounts payable or accrued amounts owed of
$754,000, and (iv) entered into agreements with holders of warrants to purchase
Company common stock pursuant to which the Company issued 81.9 million shares of
its common stock in exchange for the cancellation of warrants to purchase
approximately 124.2 million shares.  All such securities have been
issued as of June 30, 2008.  The Company’s Board of Directors and
Chief Executive Officer continue to be actively involved in discussions and
negotiations to fund the Company’s remaining capitalization efforts. The focus
of these efforts is to sufficiently capitalize the Company with a goal of paying
down excessively late accounts payable balances, fund the development of the
Company’s next generation liquid carbon dioxide processing equipment, provide
adequate working capital necessary to move the Company to generating positive
cash flow from operations, eliminate all short term debt obligations, which will
result in a positive equity balance. As of June 30, 2008, the Company’s
stockholders’ equity balance was approximately $5.4 million.  There is
no assurance that continued financing proceeds will be obtained in sufficient
amounts necessary to meet the Company's needs. In view of these matters,
continuation as a going concern is dependent upon the Company's ability to meet
its financing requirements, raise additional capital, and the future success of
its operations or completion of a successful business
combination.
  7
  
 The
accompanying financial statements do not include any adjustments to reflect the
possible future effects on the recoverability and classification of assets or
the amounts and classifications of liabilities that may result from the possible
inability of the Company to continue as a going concern.
 
 Interim financial
statements - The accompanying unaudited condensed financial statements
and related notes are presented in accordance with the rules and regulations of
the Securities and Exchange Commission with regard to interim financial
information. Accordingly, the condensed financial statements do not include all
of the information and notes to financial statements required by accounting
principles generally accepted in the United States of America for complete
financial statements. In the opinion of management, all adjustments, consisting
of normal recurring adjustments, considered necessary for a fair presentation of
the Company’s financial position, results of operations and cash flows for the
interim periods presented have been included. Results of operations for the June
30, 2008 interim periods are not necessarily indicative of the results to be
expected for the entire fiscal year ending December 31, 2008 or for any other
future interim period. The accompanying unaudited interim condensed financial
statements should be read in conjunction with the audited annual financial
statements included in the Company’s December 31, 2007 Annual Report on Form
10-KSB.
  Significant
accounting policies used in preparation of the Company’s financial statements
are disclosed in the notes to its audited annual financial statements for the
year ended December 31, 2007. A condensed summary of disclosures regarding
certain of such policies are set forth below.
 
 Use of estimates in the
preparation of financial statements - Preparation of financial statements
in conformity with generally accepted accounting principles requires management
to make estimates and assumptions that affect reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the financial statements and reported amounts of revenue and expenses during the
reporting period. Actual results could differ from those estimates. The more
significant accounting estimates inherent in the preparation of the Company's
financial statements include estimates as to the depreciable lives of property
and equipment, valuation of accounts receivable and inventories, valuation of
equity related instruments and derivatives issued and issuable, and valuation
allowance for deferred income tax assets.
 
 Cash and cash
equivalents - The Company considers deposits that can be redeemed on
demand and investments that have original maturities of less than three months
when purchased to be cash equivalents.
 
 Contingencies -
Certain conditions may exist as of the date financial statements are issued,
which may result in a loss to the Company, but which will only be resolved when
one or more future events occur or fail to occur. Company management and its
legal counsel assess such contingent liabilities, and such assessment inherently
involves an exercise of judgment. In assessing loss contingencies related to
legal proceedings that are pending against the Company or unasserted claims that
may result in such proceedings, the Company's legal counsel evaluates the
perceived merits of any legal proceedings or unasserted claims as well as the
perceived merits of the amount of relief sought or expected to be sought
therein. If the assessment of a contingency indicates that it is probable that a
liability has been incurred and the amount of the liability can be reasonably
estimated, then the estimated liability would be accrued in the Company's
financial statements. If the assessment indicates that a potentially material
loss contingency is not probable but is reasonably possible, or is probable but
cannot be reasonably estimated, then the nature of the contingent liability,
together with an estimate of the range of possible loss if determinable would be
disclosed.
  Revenue recognition -
The Company recognizes revenue when there is persuasive evidence of an
arrangement, the product has been delivered to the customer, the sales price is
fixed or determinable, and collectability is reasonably assured. The Company
recognizes revenues from sales of recycled products upon shipment to
customers.  Amounts received in advance of when products are delivered
are recorded as liabilities in the accompanying balance
sheet.  Research or other types of grants from governmental agencies
or private organizations are recognized as revenues if evidence of an
arrangement exists, the amounts are determinable and collectability is
reasonably assured with no further obligations or contingencies
remaining.
 
 Cost of goods
sold – Cost of goods sold includes the cost of raw materials
processed, and on occasion, write-downs for scrap and waste
product.
  Basic and diluted net loss
per share - Basic net loss per common share is computed by dividing net
loss by the weighted-average number of common shares outstanding during the
period. Diluted net loss per common share is determined using the
weighted-average number of common shares outstanding during the periods,
adjusted for the dilutive effect of common stock equivalents, consisting of
shares that might be issued upon conversion of preferred stock, exercise of
common stock options, warrants or convertible promissory notes. In periods where
losses are reported, the weighted-average number of common shares outstanding
excludes common stock equivalents, because their inclusion would be
anti-dilutive.  Computations of net loss per share for interim periods
ended June 30, 2008, exclude 54,382,297 shares issuable upon exercise of
outstanding warrants to purchase common stock, and 489,083,464 shares issuable
upon conversion of outstanding convertible preferred stock. Computations of net
loss per share for the interim periods ended June 30, 2007, exclude 154,570,564
shares relating to common stock issuable upon conversion of convertible notes
payable, and 134,752,489 shares issuable upon exercise of outstanding and
issuable warrants. These common stock equivalents could have the effect of
decreasing diluted net income per share in future periods.
  8
  
 
 Reclassifications –
Certain amounts in 2007 financial statements have been reclassified to conform
to 2008 presentations.
 
 Recent accounting
pronouncements - Effective January 1, 2008, the Company adopted SFAS
No. 157, “Fair Value Measurements” (“SFAS 157”), for financial assets and
liabilities. Adoption of SFAS 157 did not have a material impact on the
Company’s results of operations, financial position or liquidity. This standard
defines fair value, provides guidance for measuring fair value and requires
certain disclosures. This standard does not require any new fair value
measurements, but rather applies to all other accounting pronouncements that
require or permit fair value measurements. This standard does not apply
measurements related to share-based payments. SFAS 157 discusses valuation
techniques, such as the market approach (comparable market prices), the income
approach (present value of future income or cash flow), and the cost approach
(cost to replace the service capacity of an asset or replacement cost). The
statement utilizes a fair value hierarchy that prioritizes the inputs to
valuation techniques used to measure fair value into three broad levels. The
following is a brief description of those three levels:
  Level
1: Observable inputs such as quoted prices (unadjusted) in active
markets for identical assets or liabilities.
  Level
2: Inputs other than quoted prices that are observable for the asset or
liability, either directly or indirectly. These include quoted prices for
similar assets or liabilities in active markets and quoted prices for identical
or similar assets or liabilities in markets that are not active.
  Level
3: Unobservable inputs that reflect the reporting entity’s own
assumptions.
  The
Company’s financial assets subject to fair value measurements are comprised of
cash and cash equivalents of $1,165,000 all of which are valued using Level 1
observable inputs.
  In
February 2008, the Financial Accounting Standards Board, or FASB, issued FASB
Staff Position No. FAS 157-2, “Effective Date of FASB Statement No. 157”,
which provides a one year deferral of the effective date of SFAS 157 for
non-financial assets and non-financial liabilities, except those that are
recognized or disclosed in the financial statements at fair value at least
annually. Therefore, the Company adopted the provisions of SFAS 157 with respect
to its financial assets and liabilities only.
 
 In
February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial
Assets and Financial Liabilities (“SFAS 159”), which is effective for
fiscal years beginning after November 15, 2007.  Adoption of SFAS 159
did not have a material impact on the Company’s results of operations, financial
position or liquidity.
 
 In June
2007, the Emerging Issues Task Force of the FASB issued EITF Issue No. 07-3,
Accounting for Nonrefundable
Advance Payments for Goods or Services to be Used in Future Research and
Development Activities, (“EITF 07-3”) which is effective for fiscal years
beginning after December 15, 2007. EITF 07-3 requires that nonrefundable advance
payments for future research and development activities be deferred and
capitalized. Such amounts will be recognized as an expense as goods are
delivered or services are performed. Adoption of EITF 07-3 did not have a
material impact on the Company’s results of operations, financial position or
liquidity.
  In
December 2007, the FASB issued SFAS No. 141(R), “Business Combinations”(“SFAS 141(R)”), which replaces SFAS No. 141. SFAS No. 141(R) establishes
principles and requirements for how an acquirer recognizes and measures in its
financial statements the identifiable assets acquired, the liabilities assumed,
any non-controlling interest in the acquiree and the goodwill acquired. The
Statement also establishes disclosure requirements which will enable users to
evaluate the nature and financial effects of the business combination. SFAS
141(R) is effective for fiscal years beginning after December 15, 2008. The
adoption of SFAS 141(R) will have an impact on accounting for future business
combinations once adopted.
  In
December 2007, the FASB issued SFAS No. 160, “Noncontrolling Interests in
Consolidated Financial Statements – an amendment of Accounting Research Bulletin
No. 51”(“SFAS 160”), which establishes accounting and reporting
standards for ownership interests in subsidiaries held by parties other than the
parent, the amount of consolidated net income attributable to the parent and to
the noncontrolling interest, changes in a parent’s ownership interest and the
valuation of retained non-controlling equity investments when a subsidiary is
deconsolidated. The Statement also establishes reporting requirements that
provide sufficient disclosures that clearly identify and distinguish between the
interests of the parent and the interests of the non-controlling owners. SFAS
160 is effective for fiscal years beginning after December 15, 2008. The Company
has not determined the effect that the application of SFAS 160 will have on its
financial statements.
  In March
2008, the FASB issued SFAS No. 161, Disclosures about Derivative
Instruments and Hedging Activities – an amendment of SFAS No. 133.
This statement changes the disclosure requirements for derivative instruments
and hedging activities. SFAS No. 161 requires enhanced disclosures about
(a) how and why an entity uses derivative instruments, (b) how
derivative instruments and related hedged items are accounted for under SFAS
No. 133, Accounting for
Derivative Instruments and Hedging Activities, and its related
interpretations, and (c) how derivative instruments and related hedged
items affect an entity’s financial position, financial performance, and cash
flows. SFAS No. 161 is effective for the Company’s interim period beginning
January 1, 2009. The Company does not use derivative financial instruments
nor does it engage in hedging activities.  The Company is currently
evaluating the impact of implementation of SFAS No. 161 on its financial
position, results of operations and cash flows.
  9
  In June
2008, the FASB issued SFAS No. 162, The Hierarchy of Generally Accepted
Accounting Principles. This statement identifies the sources of generally
accepted accounting principles and provides a framework, or hierarchy, for
selecting the principles to be used in preparing U.S. GAAP financial statements
for nongovernmental entities.  This statement makes the GAAP hierarchy
explicitly and directly applicable to preparers of financial
statements.  The hierarchy of authoritative accounting guidance is not
expected to change current practice but is expected to facilitate the FASB ‘s
plan to designate as authoritative its forthcoming codification of accounting
standards.  This statement is effective 60 days following the SEC’s
approval of the PCAOB’s related amendments to remove the GAAP hierarchy from its
auditing standards.
 
 Note
2.                      Inventories
 
 Inventories
at June 30, 2008, consist of the following (in thousands):
  Raw
      materials
                
                $
                100Finished
      goods
                
                
                128Total
                
                $
                228
 Note 3.Concentrations and Major
Customers
 
 Technology License -
The Company’s business is reliant on its licensing of technology from
Honeywell.  Pursuant to terms of a license agreement entered into by
the Company and Honeywell, as amended, the Company obtained an exclusive,
nontransferable, worldwide license rights for the life of the underlying patent
to practice the methods and to make, use, and sell the products and/or services
and to certain sublicense rights, which are covered by the proprietary rights,
limited to the field of use of separating and recovering motor oil from high
density polyethylene plastic. Under this agreement, the Company is required to
pay royalties at a rate of $0.005 per pound of recycled plastics sold, with
minimum annual royalties of $100,000 for 2007, $200,000 for 2008 and $300,000
for 2009 and for years thereafter.  Honeywell may terminate this
agreement in the event of, among other things, the nationalization of the
industry which encompasses any products or services, any suspension of payments
under the terms of the agreement by government regulation, a substantial
change in ownership of the Company (whether resulting from merger, acquisition,
consolidation or otherwise), another company or person acquiring control of the
Company, or the existence of a state of war between the United States and
any country where the Company has a license to manufacture products or provide
services.
 
 Cash and
cash equivalents are maintained at financial institutions and, at times,
balances may exceed federally insured limits.  The Company has never
experienced any losses related to these balances.  Such amounts on
deposit in excess of federally insured limits at June 30, 2008 approximated $1
million.
 
 Major Customers -
During the six months ended June 30, 2008, the Company had revenues of over 10%
of total revenue from individual customers and related accounts receivable over
10% of total accounts receivable at June 30, 2008 as follows (“*” means <
10%):
 Revenues                                           Accounts
Receivable
 Customer
1                                        32%                                                      *
 Customer
2                                        22%                                                      34%
 Customer
3                                        16%                                                      36%
 Customer
4                                        14%                                                      *
 Customer
5                                         *                                                          19%
 
 
 Amounts
for the comparative 2007 interim period were insignificant.
 
 Note
4.  Notes Payable
 
 Convertiblepromissory
notes – During the three months ended March 31, 2008, the Company
issued approximately 243.9 million shares of its common stock in exchange for
full satisfaction of all outstanding convertible notes payable, which
approximated $13.2 million and related accrued interest of approximately $1.7
million, and the return of outstanding warrants to purchase approximately 38.6
million shares of Company common stock having an exercise price of $0.06 per
share and expiring in April 2015, which such warrants were acquired when the
notes were issued.  The total number of shares issued was in excess of
what would have been received had the notes been converted according to original
terms.  The Company has accounted for this transaction pursuant to
Statement of Financial Accounting Standards No. 84 “Induced Conversions of Convertible
Debt—an amendment of APB Opinion No. 26 “, and accordingly, the
excess of fair value of consideration issued by the Company over the fair value
of what would have been received has been recorded as a loss of approximately
$2.8 million.  The remaining unamortized debt discount and deferred
debt issue costs of approximately $2.2 million and $198,000, respectively, were
written off with the offset decreasing additional paid-in
capital.
  10
  
 Director
Notes – During 2007, the Company received cash proceeds of
approximately $2.7 million from various members of the Company’s Board of
Directors (the “Director Notes”).  In accordance with the Director
Notes, each lender received a promissory note with an interest rate of 15% per
annum (the “Note”).  All or any portion of the Note, any accrued
interest thereon and all other sums due under the Note, is due and payable on
demand within 90 days of the Note.  In connection with these notes,
lenders received common stock purchase warrants to purchase 22,657,000 shares of
Company common stock with an exercise price of $0.06 per share that expire in
April 2015.  The shares underlying the warrants are subject to piggy
back registration rights.  The exercise price of the warrants is
subject to anti-dilution downward adjustments in the event the Company sells
common stock at a price below the exercise price.  Debt discount
relating to the value of warrants issued of approximately $2.7 million was
recorded and amortized to interest expense during the third and fourth quarters
of 2007.   The fair value of warrants was computed using a
Black-Scholes option pricing model with the following assumptions: expected term
of 7.8 years (based on the contractual term), volatility of approximately 180%
(based on historical volatility), zero dividends and interest rate of
approximately 4.6%.
 
 Short-term Notes-
During 2007, the Company received cash proceeds of approximately $2.2 million
from new and existing investors and issued to each lender a promissory note
with an interest rate of 15% per annum, due and payable on demand within 180
days (the “Short-Term Notes”), and warrants to purchase approximately 15 million
shares of Company common stock with an exercise price of $0.06 per share that
expire in April 2015.  During the six months ended June 30, 2008, the
Company received cash of approximately $3.1 million and issued to each lender
Short-Term Notes, and issued to certain lenders warrants to purchase
approximately 9.2 million shares of Company common stock with an exercise price
of $0.06 per share that expire in April 2015.   The shares
underlying the warrants are subject to piggy back registration
rights.  The exercise price of the warrants is subject to
anti-dilution downward adjustments in the event the Company sells common stock
at a price below the exercise price.  Debt discount relating to the
value of warrants issued in 2007 and 2008 of approximately $1.1 million and
$539,000 was recorded, of which approximately $1.2 million was amortized to
interest expense during the six months ended June 30, 2008.  The fair
value of warrants was computed using a Black-Scholes option pricing model with
the following assumptions: expected term of approximately 7.7 years (based on
the contractual term), volatility of approximately 166% - 180% (based on
historical volatility), zero dividends and interest rate of approximately
4.6%.
 
 Exchange of Director Notes
and Short-term Notesfor Convertible Preferred
Stock - In June 2008, holders of outstanding Director Notes and
Short-term notes, which had an outstanding principal amount of approximately
$2.9 million and $4.6 million and related accrued interest payable of $318,000
and $206,000, respectively, exchanged all such notes and accrued interest for
152,843,413 shares of the Company’s Series A Convertible Preferred Stock and
111,240,040 shares of the Company’s Series B-1 Convertible Preferred
Stock.  The unamortized balance of deferred debt discount relating to
a portion of the notes was $201,000 and was written off upon the transaction
with the offset decreasing additional paid in-capital.
 
 Other Notes Payable -
In January 2008, the Company received $300,000 cash from a new investor and
issued a $300,000 promissory note bearing interest at 15% and due in sixty
days.  In May 2008, the note and related accrued interest was paid in
full.
 
 During
the six months ended June 30, 2008, one of the Company’s Executive Officers
loaned the Company $270,000 pursuant to terms of short-term notes payable
bearing interest at 15%, and repaid $175,000 of the loan, including interest
thereon.  At June 30, 2008, there is $95,000 still outstanding as
notes payable and related accrued interest is approximately $2,000.
 
 Note
5. Preferred Stock, Common Stock and Stock Warrants
 
 Authorized Shares -
On April 25, 2008, ECO2’s board of directors and on April 28, 2008 the holders
of a majority of the outstanding shares of common stock of the Company, approved
an amendment of the Company’s Certificate of Incorporation, as amended, to
change the number of authorized shares to Two Billion shares of all classes of
capital stock (the “Authorized Amount”).  Of the Authorized Amount,
One Billion Five Hundred Million (1,500,000,000) shares shall be classified as
common stock, and Five Hundred Million Shares (500,000,000) shares shall be
classified as preferred stock.  Pursuant to the Definitive Schedule
14C filed by the Company on May 15, 2008, effective May 12, 2008, the Company
amended its Certificate of Incorporation with the state of Delaware (the
“Amendment”).  On June 2, 2008, the Company received notice from the
state of Delaware confirming the effectiveness of the Amendment.  The
Articles of Incorporation, as amended, authorize a maximum of 1,500,000,000
shares of $0.001 par value common stock, and 700,000,000 shares of $0.001 par
value preferred stock, of which the Company has designated and authorized
152,843,413 shares as Series A Convertible Preferred Stock (the “Series A
Preferred Stock”), 336,240,040 shares as Series B-1 Convertible Preferred Stock
(the “Series B-1 Preferred Stock”), and 10,916,546 shares as Series B-2
Convertible Preferred Stock (the “Series B-2 Preferred Stock”, and together with
the Series B-1 Preferred Stock, the “Series B Preferred Stock”).  Each
share of common stock is entitled to one voting right, the right to share in
earnings and the right to share in assets upon liquidation.  A summary
of the significant rights and privileges of the Series A Preferred Stock and
Series B Preferred Stock (together, the Senior Preferred Stock”) is as
follows:
  11
  Voting – Each share of
Senior Preferred Stock entitles the holder thereof to vote on all matters except
as required by law, voted on by holders of the Company’s common stock on an
as-converted basis.  For as long as any shares of Series A Preferred
Stock remain outstanding, the affirmative vote of the holders of a majority of
the outstanding shares of Series A Preferred Stock, voting separately as a
single class, shall be necessary to amend the rights, preferences or privileges
of the Series A Preferred Stock, however effected, whether by amendment, merger,
consolidation, recapitalization or otherwise, provided that no such separate
consent of the Series A Preferred Stock shall be required with respect to
any such amendment if a similar amendment is contemporaneously effect with
respect to the rights, preferences or privileges of the Series B Preferred Stock
and the amendment is approved by holders of a majority of the Series B Preferred
Stock then outstanding.  For as long as any shares of Series B
Preferred Stock remain outstanding, the affirmative vote of the holders of a
majority of the outstanding shares of Series B Preferred Stock, voting
separately as a single class, shall be necessary to take certain described
actions, however effected, whether by amendment, merger, consolidation,
recapitalization or otherwise, which include, among others, transactions with
affiliates, except on an arms-length basis, authorization, creation or issuance
of any class of capital stock of the Company ranking senior to or on a parity
with the Series B Preferred Stock, authorizing any increase or decrease in the
total authorized shares or any amendment to the rights, preferences or
privileges of the Series A Preferred Stock or Series B Preferred Stock, and
paying any dividend or distribution on any shares of capital stock of the
Company (other than dividends paid on Preferred Stock).  For so long
as 134,496,016 shares of Series B Preferred Stock (as adjusted for stock
dividends, splits or the like) remain outstanding, holders of Series B Preferred
Stock, voting separately as a single class, shall have the right to elect three
Directors (3 of 7) to the Company’s Board of Directors.
 
 Conversion -Each share of
Senior Preferred Stock is convertible at the option of the holder into fully
paid and non-assessable shares of the Company’s common stock on a one-for-one
basis.  Upon election by holders of a majority of the then outstanding
shares of Series B Preferred Stock, all issued and outstanding shares of Senior
Preferred Stock shall automatically be converted into shares of common stock at
the conversion rate in effect upon conversion, as potentially adjusted for any
dividends or distributions, stock dividends, combinations, splits, and the like
with respect to such shares.  Pursuant to conversion terms, the
Company shall at all times reserve and keep available out of its authorized but
unissued shares of common stock, solely for the purpose of effecting the
conversion of the shares of Senior Preferred Stock, such number of shares as
shall be sufficient to effect the conversion of all such outstanding
shares.
 
 Dividends -Holders of Senior
Preferred Stock shall be entitled to receive, on a pari passu basis, when, as
and if declared by the Board of Directors, out of any assets of the Company
legally available therefore, dividends at a  rate of 5% of the
Original Issue Price of such share of Senior Preferred Stock (in each case, as
adjusted for any stock dividends, combinations, splits, recapitalizations and
the like with respect to such shares) per annum prior and in preference to the
holders of the Company’s common stock, and in preference to the holders of any
other equity securities of the Company that may from time to time come into
existence to which the Senior Preferred Stock ranks senior (such junior
securities, together with the Company’s common stock, “Junior
Securities”).  No dividends will be paid on Junior Securities in any
year unless such dividends of the Senior Preferred Stock are paid in full or
declared and set apart.  Additionally, whenever the Company shall pay
a dividend on its common stock, each holder of a share of Senior Preferred Stock
shall be entitled to receive, at the same time the dividend is paid on the
common stock, a dividend equal to the amount that would have been paid in
respect of the common stock issuable upon conversion of such share of Senior
Preferred Stock.  As of June 30, 2008, no dividends have been
declared.
 
 Liquidation -In the event of
a voluntary or involuntary liquidation, dissolution, or winding up of the
Company, holders of Series B Preferred Stock are entitled to be paid out first,
prior and in preference to any distribution of any of the assets of the Company
to holders of common stock, Series A Preferred Stock, or any other stock of the
Company ranking junior to the Series B Preferred Stock, an amount per share
equal to the Original Issue Price of $0.02 per share of Series B-1 Preferred
Stock and of $0.025 per share of Series B-2 Preferred Stock, plus all declared
and unpaid dividends on such shares. After payment of the full liquidation
preference of the Series B Preferred Stock, if assets or surplus funds remain,
holders of Series A Preferred Stock and common stock shall be entitled to be
paid out first, prior and in preference to any distribution of any of the assets
of the Company to holders of common stock,  or any other stock of the
Company ranking junior to the Series A Preferred Stock, an amount per share
equal to the Original Issue Price of $0.03 per share, plus all declared and
unpaid dividends on such shares.
 
 Redemption – The Series
A Preferred Stock and Series B Preferred Stock are not redeemable, except that,
in the event of a Change of Control (as defined), holders of a majority of the
then outstanding shares of Series A Preferred Stock and/or Series B Preferred
Stock, separately as two groups, can require redemption of the Series A
Preferred Stock and/or Series B Preferred Stock, as the case might be, at a
redemption price per share equal to the amount per share to which such holder
would be entitled upon a liquidation, dissolution or winding up of the
Company.  A “Change of Control”, as defined, means (i) the beneficial
acquisition by any person or group of 45% or more of the voting power of
the outstanding common stock of the Company, (ii) the occupancy of a majority of
Board seats by persons other than the directors occupying such seats as of the
date of the initial issuance of shares of Series B Preferred Stock (the “Current
Directors”) or persons nominated by Current Directors or their nominated
successors, or (iii) there shall occur a change in the Chief Executive Officer
of the Company without the consent of holders of a majority of the outstanding
shares of Series B Preferred Stock.  A Change of Control will be
treated as a liquidation, dissolution or winding up of the affairs of the
Company with respect to certain matters, except as otherwise agreed by holders
of a majority of the then outstanding Series B Preferred Stock.
  12
  Preferred Stock Issued for
Cash and Exchange of Debt and Other Securities – On June
4, 2008, the Company issued (i) 165,000,000 shares of its Series B-1
Preferred Stock for $3.3 million cash, (ii) 152,843,413 shares of its Series A
Preferred Stock and 111,244,040 shares of its Series B-1 Preferred Stock in
exchange for outstanding promissory notes having a principal balance of
approximately $7.5 million and related accrued interest payable of $525,000, and
(iii) 60,000,000 shares of its Series B-1 Preferred Stock in exchange for shares
of the Company’s “old” preferred series a preferred stock, which was issued in
exchange for $1.2 million cash received during April and May 2008, and which
such series was eliminated upon exchange.
 
 In
connection with the acquisition of the securities, the Company entered into an
Investor Rights Agreement with investors who acquired shares of Series A
Preferred Stock and Series B Preferred Stock (each an “Investor” and together
“Investors”).  Pursuant to terms of such agreement, among other
things, the Company has agreed to file with the Securities and Exchange
Commission a registration statement to enable the resale of common shares
issuable pursuant to conversion terms of Senior Preferred Stock and certain
warrants issued concurrently, upon written notice of at least 40% of the then
Registrable Securities, as defined, on or after the date that is 90 days after
June 4, 2008, and to use reasonable best efforts to file such registration
statement, and such additional registration statements as may be necessary, at
the earliest practicable date on which the Company is permitted by the SEC
guidance to file such additional registration statements, and to cause such
registration statement(s) to become effective and continue to be effective for
such period necessary to provide for, in general, the resale of such securities
with certain exceptions and limitations.  The Investor Rights
Agreement also provides Investors with certain piggy-back registration
rights.  Additionally, pursuant to terms of the Investor Rights
Agreement, for a three year period, each Investor holding at least 5,000,000
shares of common stock or Senior Preferred Stock (each a “Major Holder”), shall,
in general, have a pre-emptive right to receive from the Company prior notice of
any proposed or intended issuance or sale of securities and to purchase such
eligible purchaser’s pro rata percentage of the number of shares of common
stock, as converted and defined, on such same terms and
conditions.
 
 Common Stock Issued Upon
Induced Conversion of Debt and Exchange of Warrants- During the three
months ended March 31, 2008, the Company issued approximately 243.9 million
shares of its common stock in exchange for full satisfaction of all outstanding
convertible notes payable, which approximated $13.2 million and related accrued
interest of approximately $1.7 million, and the return of outstanding warrants
to purchase approximately 38.6 million shares of Company common stock having an
exercise price of $0.06 per share and expiring in April 2015, which such
warrants were acquired when the notes were issued.
 
 During
the three months ended March 31, 2008, the Company made a special offer to
holders of warrants to purchase Company common to exchange all outstanding
warrants into shares of Company common stock in a number of shares equal to 60%
to 75% (depending on the warrant) of the number of warrant shares
exchanged.  Holders of approximately 124.2 million warrants accepted
the offer and the Company issued approximately 81.9 million shares of its common
stock.
 
 Common Stock Issued in
Exchange for Accounts Payable and Accrued Liabilities - During the three
months ended March 31, 2008, the Company entered into agreements with certain
vendors that have provided services to the Company to issue shares of its common
stock in satisfaction of amounts owed, and in connection with these agreements
agreed to issue approximately 15.9 million shares of its common stock in
satisfaction of approximately $754,000 owed, which included approximately 12.0
million shares issued in exchange for $567,000 included in accounts payable –
related party at December 31, 2007.   The shares were valued at
$829,000 based on the quoted trading price on the agreement dates, resulting in
a loss on payment of approximately $75,000. The shares were issued subsequent to
March 31, 2008.
 
 Common Stock Issued for
Services - During 2006, the Company entered into an employment agreement
with an individual to serve as its Chief Executive Officer and a Director,
pursuant to which, among other things, the executive received 44,000,000 shares
of Company common stock, of which 26,400,000 were fully vested, and of which
11,000,000 shares vested in 2007, and the remaining vest at approximately
733,000 shares per month through September 2008.  The total value of
the shares based on the grant date quoted trading price of the Company’s common
stock was approximately $5.7 million.  The Company recognized
stock-based compensation expense of approximately $1.4 million and $3.9 million
in 2007 and 2006, respectively, and as of December 31, 2007, there was
approximately $405,000 of unrecognized compensation expense related to unvested
stock, which is expected to be recognized as expense in 2008.  During
the six months ended June 30, 2008, the Company recognized expense of
approximately $286,000.
 
 In
February 2007, the Company entered into an employment agreement with an
individual to serve as its Vice President of Sales & Marketing, pursuant to
which, among other things, the executive received 4.4 million shares of Company
common stock, 1.1 million of which were fully-vested and the remainder vesting
evenly over the next three years, and is entitled to receive warrants to
purchase 1.1 million shares of Company common stock at $0.30 per share on the
one year anniversary of the employment agreement and warrants to purchase 1.1
million shares of Company common stock at $0.40 per share on the second year
anniversary.  The warrants have a four-year term and vest ratably over
3 years.  The shares are valued at approximately $1.1 million based on
the quoted trading price of $0.25 on the effective date and the warrants are
valued at approximately $511,000 computed using a Black-Scholes option pricing
model with the following assumptions: contractual terms of 4 and 10 years,
volatility of 184% (based on historical volatility over the term), zero
dividends and interest rate of 4.5%.  In connection with this
agreement, the Company recorded compensation expense for fully-vested shares and
for a portion of the unvested shares amortized on a straight-line basis over the
vesting periods.  The Company recorded compensation expense of
approximately $792,000 during 2007.  As of December 31, 2007, there
was approximately $820,000 of unrecognized compensation expense related to
unvested stock and warrants, which is expected to be recognized as expense of
approximately $620,000 in 2008 and $185,000 in 2009, and $15,000 in
2010.  The Company recognized approximately $264,000 during the six
months ended June 30, 2008.
  13
  During
2007, the Company issued 5,070,411 shares of Company common stock to various
non-employee service providers and has recorded the fair value of shares issued
based on the closing market price of stock on the respective measurement dates
of approximately $899,000 as an increase in additional paid-in
capital.  Stock-based compensation expense is recognized over the
requisite service periods, all of which, except one relating to rent, expired in
2007.  At June 30, 2008, unrecognized expense of $15,000 is recorded
as deferred stock-based consulting, a component of stockholders’ deficit, which
is expected to be recognized as expense in years 2008 - 2010.
 
 Pursuant
to terms of a mutual settlement and release agreement, in early 2008, among
other things, the Company issued 5,000,000 shares of its common stock to a
former executive, and the former executive returned to the Company for
cancellation all previously issued warrants, which include vested warrants to
purchase approximately 17 million shares and forfeited all rights to acquire
additional shares under the employment agreement.  The Company
recorded the 5,000,000 shares issuable, net of the approximately $101,000 fair
value of warrants surrendered, as compensation expense of approximately $249,000
during 2007, based on the $0.07 quoted trading price of the Company’s
common stock and black-scholes fair value computations at year-end, when it was
determined that it was more likely than not that such an arrangement would be
agreed to.
 
 Common stock
issued – During June 2008, the Company issued 395,588 shares of its
common stock to investors, for which the  Company previously recorded
752,731 shares as issued in 2006, and obtained releases from such investors as
to any additional future liability or obligations, and as a result reported a
decrease in shares issuable previously recorded as issued in 2006 of 357,143
share in the accompanying condensed statement of changes in stockholders’ equity
for the six months ended June 30, 2008.
 
 Stock Warrantsissued for
services – During 2007, the Company issued warrants to a new
employee to purchase 2,000,000 shares of its common stock at an exercise price
of $0.0975 with a ten year term and recorded compensation expense of
approximately $204,000 based on the fair value as determined utilizing the
Black-Scholes valuation model. The closing stock price at the issuance date was
$0.19 per share.  As of December 31, 2007, there was approximately
$176,000 of unrecognized compensation expense related to unvested
warrants.  During the three months ended March 31, 2008, the employee
left the Company and was allowed to retain the warrants on a fully-vested basis
and the Company recorded the remaining $176,000 as expense.
 
 During
the three months ended June 30, 2008, the Company issued to certain of its
non-employee directors warrants to purchase 750,000 shares and 1,000,000 shares
of its common stock at an exercise price of $0.22 and $0.07, respectively, with
a term of approximately 6.8 years and recorded compensation expense of
approximately $77,000 based on the fair value as determined utilizing the
Black-Scholes valuation model. The closing stock price at the issuance date was
$0.04 per share.
 
 In
connection with, among other things, consummation of the June 4, 2008 financing
transactions resulting in exchanges of outstanding notes payable and receipt of
cash in consideration of the issuance of shares of the Company’s Series A and
Series B-1 Convertible Preferred Stock, the Company issued to each of two of the
Company’s new Directors warrants to purchase 10,918,072 shares of its common
stock at a per share price of $0.02 with a ten-year term.  The
Black-Scholes determined fair value of the warrants of approximately $1.0
million has been accounted for as stock issue costs, which results in an
increase and decrease in additional paid in capital, for no net effect on
stockholders’ equity.
 
 Certain
of the Company’s outstanding warrants have exercise prices that are subject to
downward adjustments in the event the Company sells certain of its equity
securities at per share prices less that originally established exercise
prices.  Additionally, certain of such warrants also contain
provisions providing for an increase in the number of shares warrants that may
be exercised.  The following schedules of warrants outstanding and
activity give effect to such adjustments.
 
 The
intrinsic value of stock warrants is calculated by aggregating the difference
between the closing market price of the Company’s common stock at the reporting
period end and the exercise price of warrants which have an exercise price less
than the closing price.
 
 The
following summarizes activity for stock warrants issued to lenders for
borrowings, all of which are exercisable:
 
 Outstanding
              
              
              Weighted
      average exercise price
              
              
              Weighted
      average remaining contractual life in years
              
              
              Aggregate
      instrinsic value (in thousands)Balance
      at December 31, 2007
              123,406,817
              
              
              $
              0.09
              
              
              
              6.2
              
              
              $
              962Issued
              
              
              10,840,991
              
              
              
              0.06Increase
      for price adjustment
              
              
              2,750,000
              
              
              
              0.02Exchanged
              
              
              (129,691,141
              )Balance
      at June 30, 2008
              
              
              7,306,667
              
              
              $
              0.04
              
              
              
              6.4
              
              
              $
              470
  14
  The
following summarizes activity for stock warrants issued to consultants for
services, all of which are exercisable:
  Outstanding
                
                
                Weighted
      average exercise price
                
                
                Weighted
      average remaining contractual life in years
                
                
                Aggregate
      instrinsic value (in thousands)Balance
      at December 31, 2007
                
                
                31,715,179
                
                
                $
                0.08
                
                
                
                5.6
                
                
                $
                220Issued
                
                
                21,836,144
                
                
                
                0.02Exchanged
                
                
                (9,325,693
                )Balance
      at June 30, 2008
                
                
                44,225,630
                
                
                $
                0.04
                
                
                
                8.0
                
                
                $
                703
  The
following summarizes activity for stock warrants issued to employees and
directors, all of which are exercisable:
  Outstanding
              
              
              Weighted
      average exercise price
              
              
              Weighted
      average remaining contractual life in years
              
              
              Aggregate
      instrinsic value (in thousands)Balance
      at December 31, 2007
              27,575,000
              
              
              $
              0.09
              
              
              
              5.6
              
              
              $
              151Issued
              
              
              1,750,000
              
              
              
              0.13Issuable
              
              
              1,100,000
              
              
              
              0.30Exchanged
              
              
              (23,825,000
              )
              
              
              0.08Forfeited
              
              
              ( 
      3,750,000
              )
              
              
              0.11Balance
      at June 30, 2008
              
              
              2,850,000
              
              
              $
              0.20
              
              
              
              6.8
              
              
              $
              -
 
 The
following summarizes activity for all stock warrants:
  Outstanding
              
              
              Weighted
      average exercise price
              
              
              Weighted
      average remaining contractual life in years
              
              
              Aggregate
      instrinsic value (in thousands)Balance
      at December 31, 2007
              182,696,996
              
              
              $
              0.09
              
              
              
              6.1
              
              
              $
              1,333Issued
              
              
              34,427,135
              
              
              
              0.06Issuable
              
              
              1,100,000
              
              
              
              0.30Increase
      for price adjustment
              
              
              2,750,000
              
              
              
              0.02Exchanged
              
              
              (162,841,834
              )Forfeited
              
              
              ( 
      3,750,000
              )
              
              
              0.10Balance
      at June 30, 2008
              
              
              54,382,297
              
              
              $
              0.05
              
              
              
              7.7
              
              
              $
              793
  Additional
information regarding all warrants outstanding as of June 30, 2008, is as
follows:
 
 Weighted
average
 Exercise
prices                                                      Shares                           remaining
life
 $  0.001                                                               60,000                                        2.9
years
 $   0.02                                                        30,392,667                                        8.2
years
 $   0.05                                                          1,100,000                                        2.0
years
 $   0.06                                                        18,979,630                                        6.8
years
 $   0.07                                                          1,000,000                                        6.8
years
 $   0.12                                                          1,000,000                                        7.7
years
 $   0.22                                                             750,000                                        6.8
years
 $   0.30                                                      1,100,000                                        6.8
years
 Total                         54,382,297                                        7.7
years
 
 Note
6.   Related Party Transactions
  Certain
of the Company’s Directors and family members were holders of the Company’s
notes payable, all of which have been exchanged for shares of the Company’s
common and/or preferred stock during the six months ended June 30,
2008.
 
 Pursuant
to an agreement for legal services with a law firm, the managing partner of
which is one of the Company’s Directors, the Company incurs legal fees for
services provided.  During the six months ended June 30, 2008 and
2007, the Company incurred legal fees from the firm of approximately
$177,000 and $223,000, respectively.   In March 2008, the Company
issued approximately 12.0 million shares of its common stock in exchange for
satisfaction of accounts payable to the firm of approximately
$567,000.  At June 30, 2008, accounts payable due to the firm for
services of $121,000 are included in accounts payable to related
party.
 
 Accounts
payable to related parties at June 30, 2008 includes $5,000 relating to expense
reimbursements due to Company officers.
  15
  
 Note
7.  Commitments and Contingencies
  Legal proceeding –
The Company is subject to various lawsuits and other claims in the normal course
of business.  The Company establishes accruals for specific
liabilities in connection with legal actions deemed to be probable and
reasonably estimable.  No material amounts have been accrued as of
June 30, 2008 in these accompanying financial statements with respect to any
legal matters. Company management does not expect that the ultimate resolution
of pending legal matters in future periods, including the matter described below
will have a material effect on the Company’s financial condition or results of
operations.
 
 In
October 2007, a former vendor filed a claim against the Company and its former
Chief Executive Officer, now Chief Technology Officer, in Tuolumne County
Superior Court in the state of California.  The claim alleges breach
of contract and that the plaintiff is due fees for services provided in excess
of $68,000, of which $7,500 is alleged to be due from the
Company.   The Company is in the process of entering into a
settlement agreement and expects that terms of the settlement will not have a
material effect on the Company’s financial condition or results of
operations.
 
 Note
8.  Subsequent Events
 
 In
connection with the financing agreements executed by the Company on June 4,
2008, and pursuant to the Preliminary Schedule 14C filed by the Company on July
17, 2008, the Company seeks to amend its Certificate of Incorporation again with
the state of Delaware (the “Subsequent Amendment”) to increase the amount of
authorized shares of capital stock.  In July 2008, ECO2’s board of
directors approved an amendment of the Company’s Certificate of Incorporation,
as amended, to change the number of authorized shares to Two Billion Two Hundred
Million (2,200,000,000) shares of capital stock (the “Amended Authorized
Amount”).  Of the Amended Authorized Amount, One Billion Five Hundred
Million (1,500,000,000) shares shall continue to be classified as common stock
and Seven Hundred Million (700,000,000) shares shall be classified as preferred
stock.
  16
  Item
2.                      Management’s Discussion and Analysis
or Plan of Operations
 
 FORWARD
LOOKING STATEMENTS CAUTIONARY
 This
Item 2 and the June 30, 2008 Quarterly Report on Form 10-Q may contain
"forward-looking statements." In some cases, you can identify forward-looking
statements by terminology such as "may," "will," "should," "could," "expects,"
"plans," "intends," "anticipates," "believes," "estimates," "predicts,"
"potential" or "continue" or the negative of such terms and other comparable
terminology. These forward-looking statements include, without limitation,
statements about our market opportunity, our strategies, competition, expected
activities and expenditures as we pursue our business plan, and the adequacy of
our available cash resources. Although we believe that the expectations
reflected in any forward-looking statements are reasonable, we cannot guarantee
future results, levels of activity, performance or achievements. Actual results
may differ materially from the predictions discussed in these forward-looking
statements. Changes in the circumstances upon which we base our predictions
and/or forward-looking statements could materially affect our actual results.
Additional factors that could materially affect these forward-looking statements
and/or predictions include, among other things: (1) our limited operating
history; (2) the risks inherent in the investigation, involvement and
acquisition of a new business opportunity; (3) unforeseen costs and expenses;
(4) potential litigation with our shareholders, creditors and/or former or
current investors; (5) the Company's ability to comply with federal, state and
local government regulations; and (6) other factors over which we have little or
no control.
 
 We
do not undertake any obligation to publicly update any forward-looking
statement, whether as a result of new information, future events, or otherwise,
except as required by law. Such forward-looking statements involve known and
unknown risks, uncertainties and other factors which may cause our actual
results or achievements to be materially different from any future results or
achievements expressed or implied by such forward-looking statements. Such
factors include the factors described in our audited financial statements and
elsewhere in the Company’s December 31, 2007 Annual Report on Form 10-KSB and in
Part II Item 1A in this Quarterly Report on Form 10-Q.
 
 Further,
in connection with, and because we desire to take advantage of, the "safe
harbor" provisions of the Private Securities Litigation Reform Act of 1995, we
caution readers regarding certain forward looking statements in the following
discussion and elsewhere in this report and in any other statement made by, or
on our behalf, whether or not in future filings with the Securities and Exchange
Commission. Forward looking statements are statements not based on historical
information and which relate to future operations, strategies, financial results
or other developments. Forward looking statements are necessarily based upon
estimates and assumptions that are inherently subject to significant business,
economic and competitive uncertainties and contingencies, many of which are
beyond our control and many of which, with respect to future business decisions,
are subject to change. These uncertainties and contingencies can affect actual
results and could cause actual results to differ materially from those expressed
in any forward looking statements made by, or on our behalf.
 
 The
following should be read in conjunction with the annual audited Company’s
financial statements included in our December 31, 2007 Annual Report on Form
10-KSB (the “Annual Report”) and with the interim unaudited condensed financial
statements included in this Quarterly Report on Form 10-Q.
 
 Business– 
ECO2Plastics, Inc., “ECO2” or the
“Company”, was incorporated under the laws of the State of Delaware in 2000, and
formed for the purpose of acquiring certain patented technology and the
development of a worldwide market for its usage.  ECO2has
developed a unique and revolutionary cleaning process, referred to as the
ECO2Environmental System (the “ECO2Environmental System”). The ECO2Environmental System cleans post-consumer plastics, without the use of
water, at a substantial cost savings versus traditional methods (the “Process”).
This Process is licensed from Honeywell and the Department of Energy on an
exclusive basis for the life of the patent. Since its inception, ECO2has
invested in the development of the technology and equipment comprising the
ECO2Environmental System, which includes a patent issued in 2007. This
included building several scaled up versions of the Prototype ECO2Environmental System (the “Prototype”), testing of the Prototypes,
building a pilot plant, evaluating the product produced by the Prototype and
real-time testing. The Company’s first full scale production facility was
constructed in Riverbank, California and is now producing saleable product and
ramping up to full scale operations as it further develops the process. ECO2’s goal is
to build and operate plastic recycling plants in the USA that utilize the
ECO2Environmental System and to expand the ECO2Environmental System worldwide. ECO2’s growth
strategy includes organic growth, strategic acquisitions and licensing or
partnership agreements, where appropriate.
 
 The
Company operates in the evolving field of plastics materials recycling. New
developments could both significantly and adversely affect existing and emerging
technologies in the field. The Company's success in developing additional
marketable products and processes and achieving a competitive position will
depend on its ability to attract and retain qualified management personnel and
to raise sufficient capital to meet its operating and development
needs.
 
 Liquidity
and Capital Resources- At June 30,
2008, we had cash and cash equivalents of approximately $1.2 million, a working
capital deficiency of approximately $1.0 million, compared to a working capital
deficit of $18.6 million at December 31, 2007.  At June 30, 2008, we had
total stockholders’ equity of approximately $5.4 million compared with total
stockholder's deficit of approximately $11.8 million at December 31,
2007.  While our financial position and condition is much improved and
we are well positioned for operational and financial successes in the future, at
June 30, 2008, the Company does not have sufficient cash to meet its needs for
the next twelve months.
  17
  The
Company has incurred recurring losses from operations and has a net working
capital deficiency and net capital deficiency that raises substantial doubt
about its ability to continue as a going concern. The Report of Independent
Registered Public Accounting Firm included in the Company’s December 31, 2007
Annual Report stated that these conditions, among others, raise substantial
doubt about the Company’s ability to continue as a going concern. Historically,
our cash needs have been met primarily through proceeds from private
placements of our equity securities and debt instruments including debt
instruments convertible into our equity securities. Company management intends
to raise additional cash to fund future operations and to provide additional
working capital. However, there is no assurance that such financing will be
obtained.  We expect to continue to raise capital in the future, but cannot
guarantee that such financing activities will be sufficient to fund our current
and future projects and our ability to meet our cash and working capital
needs.
  The
Company’s Board of Directors and Chief Executive Officer continue to be actively
involved in discussions and negotiations with creditors and holders of Company
notes payable regarding conversion of amounts owed and warrants into shares of
Company common stock, and in continued fund-raising activities with new and
existing investors with respect to raising additional cash. During the six
months ended June 30, 2008:
 
 ·
              The
      Company received cash of approximately $3.4 million pursuant to issuance
      of short-term notes payable to new and existing
  investors;
 ·
              Holders
      of all convertible notes payable outstanding having a total principal
      amount outstanding of approximately $13.2 million, together with accrued
      interest of approximately $1.7 million, converted such notes and returned
      to the Company warrants to purchase approximately 38.6 million shares
      of common stock  at $0.06 per share and in exchange received
      approximately 243.9 million shares of the Company’s common
      stock;
 ·
              Pursuant
      to terms of a special offer made to all holders of warrants to purchase
      common stock, approximately 124.2 million warrants were exchanged 
      for approximately 81.9 million shares of Company common
    stock;
 ·
              The
      Company entered into agreements with certain service providers pursuant to
      which the Company issued approximately 15.9 million shares of its common
      stock as payment for amounts owed for services of approximately
      $754,000;
 ·
              Holders
      of promissory notes having a principal amount of approximately $6.5
      million, together with related accrued interest of $525,000, exchanged
      such notes for 152,000,000 shares of the Company’s Series A Preferred
      Stock and 111,240,040 shares of the Company’s Series B-1 Preferred Stock;
      and
 ·
              The
      Company received cash of approximately $4.5 million relating to the sale
      and issuance of 225,000,000 shares of its Series B-1 Preferred
      Stock.
  The focus
of these efforts is to sufficiently capitalize the Company with a goal of paying
down excessively late accounts payable balances, fund the development of the
Company’s next generation liquid carbon dioxide processing equipment, provide
adequate working capital necessary to move the Company to generating positive
cash flow from operations, eliminate all short term debt obligations, which will
result in a positive equity balance.
  Results
of Operations–
 
 Three
months ended June 30, 2008 and 2007
 
 Revenues
were approximately $1.4 million during the three months ended June 30, 2008 as
compared to $418,000 during the comparative prior year period. Revenues
decreased from approximately $1.5 million during the immediately preceding
quarter, which was due primarily to decreased production volumes resulting from
making process changes as well as selling recycled products at earlier stages of
recycling, which results in lower sales prices.
 
 The
Company derives its revenues from certain major customers.  The loss
of major customers could create a significant financial hardship for the
Company.  During the three months ended June 30, 2008, revenues from
three customers represented approximately 74% of total revenues.
 
 Cost of
goods sold consists of the cost of raw materials processed and was approximately
$1.4 million during the three months ended June 30, 2008 as compared to $430,000
during the comparative prior year period. There was a gross profit of $44,000
for the three months ended June 30, 2008 as compared to a gross profit deficit
of $12,000 in the comparative prior year period, and a gross profit deficit of
$83,000 during the immediately preceding quarter.  The plant has begun
ramping towards full-scale operation and as a result, significant volumes of
inventory are consumed for quality testing during these periods. Most of the
tested material is shipped out of the plant at prices significantly lower than
market standard, which resulted in relatively low gross margins. Additionally,
costs of goods sold include write-downs for scrap and
waste.
  18
  Plant
operations and technology development expenses increased to approximately $2.0
million for the three months ended June 30, 2008 as compared to $1.5 million for
the comparative prior year period.  As the Company ramps up the
Riverbank Plant, operating expenses are increasing commensurate with the
increase in operating activity, comprised primarily of payroll and related,
utilities, occupancy, supplies, and repairs and maintenance
expenses.  Payroll and related costs approximated $669,000 in during
the three months ended June 30, 2008 as compared to $364,000 during the
comparative prior year period, and depreciation expense approximated $360,000
during the three months ended June 30, 2008 as compared to $234,000 in the prior
year period.  Other plant operating expenses approximated $643,000
during the three months ended June 30, 2008 as compared to $917,000 during the
comparative prior year period.  As production increases to closer to
capacity volumes, certain plant operations expenses will be included in cost of
goods sold.
 
 General
and administrative expenses decreased to $1.1 million for the three months ended
June 30, 2008 as compared to $2.4 million for the comparative prior year
period.  Payroll and related costs approximated $665,000 during the
three months ended June 30, 2008 as compared to $1.7 million in the comparative
prior year period.  The decrease in 2008 payroll and related was
primarily due to higher non-cash stock-based compensation in the comparative
prior year period of $1.6 million as compared to $356,000 during the comparative
2008 period relating to employment agreements equity awards with certain
executive officers and related recruiter fees payable in equity
securities.  Consulting and legal fees expenses approximated $168,000
during the three months ended June 30, 2008 as compared to $164,000 during the
comparative prior year period.
 
 The
Company’s loss from operations decreased from approximately $4.6 million for the
three months ended June 30, 2007 to $3.0 million for the three months ended June
30, 2008, due primarily to the $1.3 million decrease in general and
administrative expenses, largely due to a $1.2 million decrease in stock-based
compensation expense, offset by a $445,000 increase in plant operations and
technology development, and the absence of settlement expense paid in shares of
common stock, which was $740,000 during the 2007 period.
 
 The
Company recorded interest expense of approximately $691,000 for the three months
ended June 30, 2008 as compared to $3.7 million during the prior year period.
 Interest expense includes amortization of debt issue costs and debt
discount of approximately $260,000 during the three months ended June 30, 2008
and $3.4 million during the prior year period.  The decrease in
interest expense for 2008 as compared to the prior year was primarily due to
note conversions in 2008 and the last half of 2007.
 
 The
Company’s net loss decreased from approximately $8.4 million for the three
months ended June 30, 2007, to $3.7 million for the three months ended June 30,
2008, due to the $1.6 million decrease in loss from operations and $3.1 million
decrease in interest expense.
 
 Six
months ended June 30, 2008 and 2007
 
 Revenues
were approximately $2.9 million during the six months ended June 30, 2008 as
compared to $517,000 during the comparative prior year period. Revenues
decreased from approximately $3.8 million during the immediately preceding six
months (the six months ended December 31, 2007), which was due primarily to
decreased production volumes resulting from making process changes as well as
selling recycled products at earlier stages of recycling, which results in lower
sales prices.
 
 The
Company derives its revenues from certain major customers.  The loss
of major customers could create a significant financial hardship for the
Company.  During the six months ended June 30, 2008, revenues from
three customers represented approximately 84% of total revenues.
 
 Cost of
goods sold consists of the cost of raw materials processed and was approximately
$3.0 million during the six months ended June 30, 2008 as compared to $604,000
during the comparative prior year period. There was a gross profit deficit of
$39,000 for the six months ended June 30, 2008 as compared to a gross profit
deficit of $87,000 in the comparative prior year period, and a gross profit of
$205,000 during the immediately preceding six months.  The plant has
begun ramping towards full-scale operation and as a result, significant volumes
of inventory are consumed for quality testing during these periods. Most of the
tested material is shipped out of the plant at prices significantly lower than
market standard, which resulted in relatively low gross margins. Additionally,
costs of goods sold include write-downs for scrap and
waste.
 
 Plant
operations and technology development expenses increased to $3.8 million for the
six months ended June 30, 2008 as compared to $2.6 million for the comparative
prior year period.  As the Company ramps up the Riverbank Plant,
operating expenses are increasing commensurate with the increase in operating
activity, comprised primarily of payroll and related, utilities, occupancy,
supplies, and repairs and maintenance expenses.  Payroll and related
costs approximated $1.4 million during the six months ended June 30, 2008 as
compared to $710,000 during the comparative prior year period, and depreciation
expense approximated $720,000 during the six months ended June 30, 2008 as
compared to $443,000 in the prior year period.  Other plant operating
expenses approximated $1.4 million during the both of the six months ended June
30, 2008 and 2007. As production increases to closer to capacity volumes,
certain plant operations expenses will be included in cost of goods
sold.
  19
  General
and administrative expenses decreased to $2.4 million for the six months ended
June 30, 2008 as compared to $4.7 million for the comparative prior year
period.  Payroll and related costs approximated $1.6 million during
the six months ended June 30, 2008 as compared to $3.4 million in the
comparative prior year period.  The decrease in 2008 payroll and
related was primarily due to higher non-cash stock-based compensation in the
comparative prior year period of $2.8 million as compared to $812,000 during the
comparative 2008 period relating to employment agreements equity awards with
certain executive officers and related recruiter fees payable in equity
securities.  Consulting and legal fees expenses approximated $332,000
during the six months ended June 30, 2008 as compared to $478,000 during the
comparative prior year period.   The decrease in consulting and
legal fees was primarily due to having fewer consulting contracts in 2008 as
compared to the prior year.
 
 The
Company’s loss from operations decreased from approximately $8.0 million for the
six months ended June 30, 2007 to $6.3 million for the six months ended June 30,
2008, due primarily to the $2.3 million decrease in general and administrative
expenses, largely due to a $2.0 million decrease in stock-based compensation
expense, offset by a $1.3 million increase in plant operations and technology
development, and the absence of settlement expense paid in shares of common
stock, which was $740,000 during the 2007 period.
 
 The
Company recorded interest expense of approximately $3.3 million for the six
months ended June 30, 2008 as compared to $7.1 million during the prior year
period.  Interest expense includes amortization of debt issue costs and
debt discount of approximately $2.8 million during the six months ended June 30,
2008 and $6.4 million during the prior year period.  The decrease in
interest expense for 2008 as compared to the prior year was primarily due to
note conversions in 2008 and the last half of 2007.
  The
Company’s net loss decreased from approximately $15.2 million for the six months
ended June 30, 2007 to $13.1 million for the six months ended June 30, 2008, due
primarily to the $1.7 million decrease in loss from operations and $3.8 million
decrease in interest expense, offset by a $3.5 million loss recorded in 2008
representing the excess of fair value of common stock issued in exchange for
accounts payable, notes payable, accrued interest and warrants.
 
 Inflation -Although our
operations are influenced by general economic conditions, we do not believe that
inflation had a material effect on our results of operations.
 
 Cash
Provided (Used) by Operating, Investing and Financing Activities -During the six
months ended June 30, 2008 cash used by operating activities increased to
approximately $5.6 million from $3.5 million during the comparative prior year
period, due primarily to the increase in net loss before depreciation and
amortization, stock-based compensation, amortization of debt issue costs and
discount and excess of fair value of common stock issued, which is approximately
$5.3 million in the 2008 period as compared to $4.7 million during the prior
year period, as well as decreases in accounts payable due to payments in June
2008.
 
 During
the six months ended June 30, 2008, cash used by investing activities decreased
to $548,000 relating to capital expenditures on the recycling plant as compared
to $2.2 million during the prior year period, since the plant is substantially
complete.  Expenditures have been primarily related to additional
capacity and process improvements.
 
 During
the six months ended June 30, 2008, cash provided by financing activities was
approximately $7.3 million as compared to $5.5 million during the comparative
prior year period. During 2008, the Company received cash of approximately $3.6
million pursuant to issuance of short-term notes payable to new and existing
investors and $4.5 million pursuant to issuances of preferred
stock.  During the 2008 period, the Company repaid $475,000 of
short-term notes payable and incurred stock issue costs of
$242,000.  During the 2007 period, the Company received proceeds of
approximately $5.8 million (including approximately $1.2 million receivable for
cash in escrow for securities sold in 2006) from sales of private placement
units comprised of convertible promissory notes and warrants.
 
 Critical
Accounting Policies and Estimates – The preparation of
financial statements included in this Quarterly Report requires management to
make estimates and assumptions that affect the reported amounts of assets and
liabilities at the date of the financial statements and the reported amounts of
revenues and expenses during the reporting period.  On an on-going basis,
management evaluates its estimates and judgments. Management bases its estimates
and judgments on historical experiences and on various other factors that are
believed to be reasonable under the circumstances, the results of which form the
basis for making judgments about the carrying value of assets and liabilities
that are not readily apparent from other sources.  Actual results may
differ from these estimates under different assumptions or conditions.  The
more significant accounting estimates inherent in the preparation of the
Company's financial statements include estimates as to the depreciable lives of
property and equipment, valuation of equity related instruments issued, and the
valuation allowance for deferred income tax assets. Our accounting policies
are described in the notes to financial statements included in this Annual
Report. The more critical accounting policies are as described
below.
   20
  Going
concern presentation - The accompanying financial statements have
been prepared in conformity with accounting principles generally accepted in the
United States of America, which contemplate continuation of the Company as a
going concern. Since inception, the Company has reported losses and operating
activities have used cash, and has net working capital deficiencies and net
capital deficiencies, which raises substantial doubt about its ability to
continue as a going concern. The Report of Independent Registered Public
Accounting Firm included in the Company’s Annual Report on Form 10-KSB stated
that these conditions, among others, raise substantial doubt about the Company’s
ability to continue as a going concern. Company management intends to raise
additional financing to fund future operations and to provide additional working
capital. However, there is no assurance that such financing will be obtained in
sufficient amounts necessary to meet the Company’s needs. The accompanying
financial statements do not include any adjustments to reflect the possible
future effects on the recoverability and classification of assets or the amounts
and classifications of liabilities that may result from the outcome of this
uncertainty.
 
 Revenue
recognition - The Company recognizes revenue when there is
persuasive evidence of an arrangement, the product has been delivered to the
customer, the sales price is fixed or determinable, and collectability is
reasonably assured. The Company recognizes revenues from sales of recycled
products upon shipment to customers. Amounts received in advance of when
products are delivered are recorded as liabilities until earned. Research or
other types of grants from governmental agencies or private organizations are
recognized as revenues if evidence of an arrangement exists, the amounts are
determinable and collectability is reasonably assured with no further
obligations or contingencies remaining.
  In April
2007 the Company was granted $84,000 for research from a private
consortium.  The Company will receive payments based on achievement of
milestones as defined in the grant.  No payments were received and no
revenues were recognized in 2007 as the milestones were not yet met.  In
2008 certain milestones were met and the Company recognized approximately
$161,000 of revenue.
  Income
taxes - The Company utilizes SFAS No. 109, “Accounting for Income
Taxes,” which requires recognition of deferred tax assets and liabilities for
the expected future tax consequences of events that have been included in the
financial statements or tax returns. Under this method, deferred income taxes
are recognized for the tax consequences in future years of differences between
the tax bases of assets and liabilities and their financial reporting amounts at
each period end based on enacted tax laws and statutory tax rates applicable to
the periods in which the differences are expected to affect taxable income.
Valuation allowances are established, when necessary, to reduce deferred tax
assets to amounts expected to be realized. The Company continues to provide a
full valuation allowance to reduce its net deferred tax asset to zero, inasmuch
as Company management has not determined that realization of deferred tax assets
is more likely than not. The provision for income taxes represents the tax
payable for the period and change during the period in net deferred tax assets
and liabilities.
  Stock-based
compensation– The Company accounts for all options and warrant grants to
employees and consultants in accordance with SFAS 123R, which requires recording
an expense over the requisite service period for the fair value of all options
or warrants granted employees and consultants.
  Recent
accounting pronouncements - Effective January 1, 2008, the Company
adopted SFAS No. 157, “Fair Value Measurements” (“SFAS 157”), for financial
assets and liabilities. Adoption of SFAS 157 did not have a material impact on
the Company’s results of operations, financial position or liquidity. This
standard defines fair value, provides guidance for measuring fair value and
requires certain disclosures. This standard does not require any new fair value
measurements, but rather applies to all other accounting pronouncements that
require or permit fair value measurements. This standard does not apply
measurements related to share-based payments. SFAS 157 discusses valuation
techniques, such as the market approach (comparable market prices), the income
approach (present value of future income or cash flow), and the cost approach
(cost to replace the service capacity of an asset or replacement cost). The
statement utilizes a fair value hierarchy that prioritizes the inputs to
valuation techniques used to measure fair value into three broad levels. The
following is a brief description of those three levels:
  Level
1: Observable inputs such as quoted prices (unadjusted) in active
markets for identical assets or liabilities.
  Level
2: Inputs other than quoted prices that are observable for the asset or
liability, either directly or indirectly. These include quoted prices for
similar assets or liabilities in active markets and quoted prices for identical
or similar assets or liabilities in markets that are not active.
  Level
3: Unobservable inputs that reflect the reporting entity’s own
assumptions.
  The
Company’s financial assets subject to fair value measurements are comprised of
cash and cash equivalents of $1,165,000 all of which are valued using Level 1
observable inputs.
  In
February 2008, the Financial Accounting Standards Board, or FASB, issued FASB
Staff Position No. FAS 157-2, “Effective Date of FASB Statement No. 157”,
which provides a one year deferral of the effective date of SFAS 157 for
non-financial assets and non-financial liabilities, except those that are
recognized or disclosed in the financial statements at fair value at least
annually. Therefore, the Company adopted the provisions of SFAS 157 with respect
to its financial assets and liabilities only.
  21
  In
February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial
Assets and Financial Liabilities (“SFAS 159”), which is effective for
fiscal years beginning after November 15, 2007.  Adoption of SFAS 159
did not have a material impact on the Company’s results of operations, financial
position or liquidity.
 
 In June
2007, the Emerging Issues Task Force of the FASB issued EITF Issue No. 07-3,
Accounting for Nonrefundable
Advance Payments for Goods or Services to be Used in Future Research and
Development Activities, (“EITF 07-3”) which is effective for fiscal years
beginning after December 15, 2007. EITF 07-3 requires that nonrefundable advance
payments for future research and development activities be deferred and
capitalized. Such amounts will be recognized as an expense as goods are
delivered or services are performed. Adoption of EITF 07-3 did not have a
material impact on the Company’s results of operations, financial position or
liquidity.
  In
December 2007, the FASB issued SFAS No. 141(R), “Business Combinations”(“SFAS 141(R)”), which replaces SFAS No. 141. SFAS No. 141(R) establishes
principles and requirements for how an acquirer recognizes and measures in its
financial statements the identifiable assets acquired, the liabilities assumed,
any non-controlling interest in the acquiree and the goodwill acquired. The
Statement also establishes disclosure requirements which will enable users to
evaluate the nature and financial effects of the business combination. SFAS
141(R) is effective for fiscal years beginning after December 15, 2008. The
adoption of SFAS 141(R) will have an impact on accounting for future business
combinations once adopted.
  In
December 2007, the FASB issued SFAS No. 160, “Noncontrolling Interests in
Consolidated Financial Statements – an amendment of Accounting Research Bulletin
No. 51”(“SFAS 160”), which establishes accounting and reporting
standards for ownership interests in subsidiaries held by parties other than the
parent, the amount of consolidated net income attributable to the parent and to
the noncontrolling interest, changes in a parent’s ownership interest and the
valuation of retained non-controlling equity investments when a subsidiary is
deconsolidated. The Statement also establishes reporting requirements that
provide sufficient disclosures that clearly identify and distinguish between the
interests of the parent and the interests of the non-controlling owners. SFAS
160 is effective for fiscal years beginning after December 15, 2008. The Company
has not determined the effect that the application of SFAS 160 will have on its
financial statements.
  In March
2008, the FASB issued SFAS No. 161, Disclosures about Derivative
Instruments and Hedging Activities – an amendment of SFAS No. 133.
This statement changes the disclosure requirements for derivative instruments
and hedging activities. SFAS No. 161 requires enhanced disclosures about
(a) how and why an entity uses derivative instruments, (b) how
derivative instruments and related hedged items are accounted for under SFAS
No. 133, Accounting for
Derivative Instruments and Hedging Activities, and its related
interpretations, and (c) how derivative instruments and related hedged
items affect an entity’s financial position, financial performance, and cash
flows. SFAS No. 161 is effective for the Company’s interim period beginning
January 1, 2009. The Company does not use derivative financial instruments
nor does it engage in hedging activities.  The Company is currently
evaluating the impact of implementation of SFAS No. 161 on its financial
position, results of operations and cash flows.
  In June
2008, the FASB issued SFAS No. 162, The Hierarchy of Generally Accepted
Accounting Principles. This statement identifies the sources of generally
accepted accounting principles and provides a framework, or hierarchy, for
selecting the principles to be used in preparing U.S. GAAP financial statements
for nongovernmental entities.  This statement makes the GAAP hierarchy
explicitly and directly applicable to preparers of financial
statements.  The hierarchy of authoritative accounting guidance is not
expected to change current practice but is expected to facilitate the FASB ‘s
plan to designate as authoritative its forthcoming codification of accounting
standards.  This statement is effective 60 days following the SEC’s
approval of the PCAOB’s related amendments to remove the GAAP hierarchy from its
auditing standards.
 
 Item
3.                                  Quantitative
and Qualitative Disclosures about Market Risk.
 
 We do not
use derivative financial instruments. Our financial instruments consist of cash
and cash equivalents, trade accounts receivable, accounts payable and short and
long-term borrowing obligations. Investments in highly liquid instruments
purchased with a remaining maturity of 90 days or less at the date of purchase
are considered to be cash equivalents.
 
 Our
exposure to market risk for changes in interest rates relates primarily to our
cash and cash equivalents and short and long-term obligations, all of which have
fixed interest rates. Thus, fluctuations in interest rates would not have a
material impact on the fair value of these securities.  Based on our
cash and cash equivalents balances at June 30, 2008, a 100 basis point increase
or decrease in interest rates would result in an immaterial increase or decrease
in interest income on an annual basis.
 
 Cash and
cash equivalents are maintained at financial institutions and, at times,
balances may exceed federally insured limits.  The Company has never
experienced any losses related to these balances.  Such amounts on
deposit in excess of federally insured limits at June 30, 2008 approximated $1
million.
  22
  Item
4.                                  Controls
and Procedures
 
 (a)
Disclosure controls and procedures.
 
 The
Company maintains disclosure controls and procedures that are designed to ensure
that information required to be disclosed in the Company’s Exchange Act reports
is recorded, processed, summarized and reported within the time periods
specified in the SEC’s rules and forms, and that such information is accumulated
and communicated to the Company’s management, including its Chief Executive
Officer and Chief Financial Officer, as appropriate, to allow timely decisions
in accordance with the required "disclosure controls and  procedures"
as defined in Rule 13a-15(e).  The Company’s disclosure and control
procedures are designed to provide reasonable assurance of achieving their
objectives, and the principal executive officer and principal financial officer
of the Company concluded that the Company’s disclosure controls and procedures
were effective at the reasonable assurance level.
 
 Our
management is responsible for establishing and maintaining adequate internal
control over financial reporting. Internal control over financial reporting is
defined in Rules 13a-15(f) and 15d-15(f) under the Securities Exchange Act, as
amended, as a process designed by, or under the supervision of, a company’s
principal executive and principal financial officers and effected by a company’s
board of directors, management and other personnel to provide reasonable
assurance regarding the reliability of financial reporting and the preparation
of financial statements for external purposes in accordance with generally
accepted accounting principles. Our internal control over financial reporting
includes those policies and procedures that:
  ·
              pertain
      to the maintenance of records that, in reasonable detail, accurately and
      fairly reflect the transactions and dispositions of our
      assets;
 ·
              provide
      reasonable assurance that transactions are recorded as necessary to permit
      preparation of financial statements in accordance with generally accepted
      accounting principles, and that our receipts and expenditures are being
      made only in accordance with authorizations of our management and
      directors; and
 ·
              and
      provide reasonable assurance regarding prevention or timely detection of
      unauthorized acquisition, use or disposition of our assets that could have
      a material effect on the financial
  statements.
  Internal
control over financial reporting cannot provide absolute assurance of achieving
financial reporting objectives because of its inherent limitations. 
Internal control over financial reporting is a process that involves human
diligence and compliance and is subject to lapses in judgment and breakdowns
resulting from human failures. Internal control over financial reporting also
can be circumvented by collusion or improper management override.  Because
of such limitations, there is a risk that material misstatements may not be
prevented or detected on a timely basis by internal control over financial
reporting. However, these inherent limitations are known features of the
financial reporting process.  Therefore, it is possible to design into the
process safeguards to reduce, though not eliminate, this risk.  In
addition, projections of any evaluation of effectiveness to future periods are
subject to the risk that controls may become inadequate because of changes in
conditions or that the degree of compliance with the policies or procedures may
deteriorate.
  In order
to evaluate the effectiveness of our internal control over financial reporting
as of December 31, 2007, as required by Sections 404 of the Sarbanes-Oxley Act
of 2002, our management commenced an assessment, based on the criteria set forth
in Internal Control--Integrated Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission (the "COSO Framework"). A
material weakness is a control deficiency, or a combination of control
deficiencies, that results in more than a remote likelihood that a material
misstatement of our annual or interim financial statements will not be prevented
or detected on a timely basis. In assessing the effectiveness of our internal
control over financial reporting, our management, including the chief executive
officer and interim chief financial officer, could not conclude that our
internal controls and procedures were sufficient to ensure that we maintained
appropriate internal control over financial reporting at December 31, 2007, as
while we considered the criteria established in the COSO Framework, we did not
perform a complete assessment as outlined in Commission Guidance Regarding
Management’s Report on Internal Control Over Financial Reporting Under Section
13(a) or 15(d) of the Exchange Act. In summary, the Company did not conduct
sufficient testing of internal controls in 2007 to satisfy COSO requirements. As
a result, we have put an implementation plan in place whereby in 2008 sufficient
testing to satisfy COSO requirements will be performed. The absence of the
ability to conclude as to the sufficiency of internal controls, is a material
weakness.
 
 Despite
the insufficient testing, we believe that our financial statements contained in
our Annual Report on Form 10-KSB filed with the SEC fairly present our financial
position, results of operations and cash flows for the fiscal year ended
December 31, 2007 in all material respects. Our Annual Report does not include
an attestation report of our independent registered public accounting firm
regarding internal control over financial reporting. Our internal controls were
not subject to attestation by our independent registered public accounting firm
pursuant to temporary rules of the Securities and Exchange Commission that
permit us to provide only management’s report in this annual
report.
   23
  Our
management, with the participation of our Chief Executive Officer and Interim
Chief Financial Officer, assessed the effectiveness of the Company’s disclosure
controls and procedures (as defined in the rules and regulations of the SEC
under the Exchange Act) as of June 30, 2008 (the “Evaluation
Date”).   For those reasons noted above with respect to the
assessment of control effectiveness at December 31, 2007, Management determined
that its controls were ineffective, and accordingly, has concluded that the
Company’s disclosure controls over financial reporting were not effective as of
the Evaluation Date.
 
 (b)
Changes in internal control over financial reporting.
 
 We are
assessing the effectiveness of our internal controls over financial reporting on
an account by account basis as a part of our on-going accounting and financial
reporting review process in order to comply with Section 404 of the
Sarbanes-Oxley Act of 2002, which requires our management to assess the
effectiveness of our existing internal controls.  This effort includes
documenting, evaluating the design of and testing the effectiveness of our
internal controls over financial reporting.  We intend to continue to
refine and improve our internal controls on an ongoing basis.  During
this process, we may identify items for review or deficiencies in our system of
internal controls over financial reporting that may require strengthening or
remediation.
  There
have been no changes in our internal controls over financial reporting during
our most recent fiscal quarter that have materially affected, or are reasonably
likely to materially affect, our internal controls over financial
reporting.
 
 
 PART II - OTHER INFORMATION
 
 Item
1.                                Legal
Proceedings
 
 On
October 16, 2007, Robert Trotter, dba Bob Trotter’s Welding (“Trotter”), a
former vendor, filed a claim against ECO2and its
Director and CTO, Gary De Laurentiis in Tuolumne County Superior Court in the
state of California.  Trotter is alleging breach of contract and that
he is due fees for services provided in excess of $68,000, of which $7,500 is
alleged to be due from the Company.    Following two of
three non-binding arbitrations that were both decided in favor of the Company,
the parties agreed to settle all suits out of court for
$10,000.  Although the Company maintains that the claims were not
justified, the settlement minimized additional legal expenses that would have
been incurred by going to trial.
 
 The
Company is unaware of any other threatened or pending litigation against it not
in the ordinary course of business and that has not previously been
disclosed.
 
 
 Item
1A.                        Risk
Factors
  Risks Related to Our Business
  We
have had losses since our inception. We expect losses to continue in the near
future and there is a risk we may never become profitable.
 
 We have
incurred losses and experienced negative operating cash flows since inception.
While we cannot guarantee future results, levels of activity, performance or
achievements, we expect our revenues to continue to grow in the coming quarters,
which will produce gross profits in such amounts so as to more than cover our
operating expenses.  Actual results may differ materially from those
predicted and changes in the circumstances upon which we base our predictions
could materially affect our actual results.
 
 Our
independent registered public accounting firm, Salberg & Company,
P.A., has expressed doubt about our ability to continue as a going concern,
which may hinder our ability to obtain future financing.
 
 Salberg
& Company, P.A., in its report of independent registered public accounting
firm for the years ended December 31, 2007 and 2006, has expressed “substantial
doubt” as to our ability to continue as a going concern based on significant
operating losses that we incurred. Our financial statements do not include any
adjustments that might result from the outcome of that uncertainty. As a result
of the going concern qualification, we may find it much more difficult to obtain
financing in the future, if required. Further, any financing we do obtain may be
on less favorable terms.
 
 We
have few proprietary rights, the lack of which may make it easier for our
competitors to compete against us.
 
 The
exclusive Patent License Agreement being granted to the Company, as amended,
(the “License
Agreement”) for our technology with Honeywell FM&T for the system is
for the life of the patent, or until terminated by Honeywell FM&T in the
event of (i) the bankruptcy of the Company; (ii) an assignment for the benefit
of creditors of the Company, (iii) the nationalization of the industry which
encompasses any of the products and/or services, limited only within the
nationalizing country; (iv) any suspension of payments hereunder by governmental
regulation, (v)  the Company’s failure to commercialize the licensed
technology under this License Agreement; (vi) or the existence of a state of war
between the United States of America and any country where the Company has a
License to manufacture products and/or services.
  24
  If
we are unable to manage our growth, our growth prospects may be limited and our
future profitability may be adversely affected.
  We intend
to expand our sales and marketing programs and our manufacturing capability.
Rapid expansion may strain our managerial, financial and other resources. If we
are unable to manage our growth, our business, operating results and financial
condition could be adversely affected. Our systems, procedures, controls and
management resources also may not be adequate to support our future operations.
We will need to continually improve our operational, financial and other
internal systems to manage our growth effectively, and any failure to do so may
lead to inefficiencies and redundancies, and result in reduced growth prospects
and profitability.
 
 We
are subject to intellectual property infringement claims, which may cause us to
incur litigation costs and divert management attention from our
business.
 
 Any
intellectual property infringement claims against us, with or without merit,
could be costly and time-consuming to defend and divert our management’s
attention from our business. If our products were found to infringe a third
party’s proprietary rights, we could be required to enter into royalty or
licensing agreements in order to be able to sell our products. Royalty and
licensing agreements, if required, may not be available on terms acceptable to
us or at all.
 
 The
success of our business is heavily dependent upon our ability to secure raw
plastic.
 
 We intend
to expand our sales and marketing programs and our manufacturing
capability.  Our ability to generate revenue depends upon our ability
to secure raw plastic (PET and HDPE flake), which we then clean through the
System and sell through H. Muehlstein.  To the extent that we are
unable to secure enough raw plastic, our business, financial condition and
results of operations will be materially adversely affected.
  If
we were to lose the services of our Chief Executive Officer our business would
suffer.
 
 We are
substantially dependent upon the continued services of Rodney S. Rougelot, our
Chief Executive Officer. The loss of the services of Mr. Rougelot through
incapacity or otherwise would have a material adverse effect upon our business
and prospects. To the extent that his services become unavailable, we will be
required to retain other qualified personnel, and there can be no assurance that
we will be able to recruit and hire qualified persons upon acceptable
terms.
 
 Should a
change in the Chief Executive Officer occur, without the consent of holders of a
majority of the outstanding shares of Series B Preferred Stock, holders of a
majority of the then outstanding shares of Series B Preferred Stock could
require redemption of the Series B Preferred Stock.
 
 Penny
stock regulations.
 
 The
Securities Enforcement Penny Stock Act of 1990 requires specific disclosure to
be made available in connection with trades in the stock of companies defined as
“penny stocks.” The Commission has adopted regulations that generally define a
penny stock to be any equity security that has a market price of less than $5.00
per share, subject to certain exceptions. Such exceptions include any equity
security listed on NASDAQ and any equity security issued by an issuer that has
(i) net tangible assets of at least $2,000,000, if such issuer has been in
continuous operation for three years; (ii) net tangible assets of at least
$5,000,000, if such issuer has been in continuous operation for less than three
years; or (iii) average annual revenue of at least $6,000,000, if such issuer
has been in continuous operation for less than three years. Unless an exception
is available, the regulations require the delivery, prior to any transaction
involving a penny stock, of a disclosure schedule explaining the penny stock
market and the risks associated therewith as well as the written consent of the
purchaser of such security prior to engaging in a penny stock transaction. The
regulations on penny stocks may limit the ability of the purchasers of our
securities to sell their securities in the secondary marketplace. Our common
stock is currently considered a penny stock.
  We
may encounter potential environmental liability which our insurance may not
cover.
 
 We may,
in the future, receive citations or notices from governmental authorities that
our operations are not in compliance with our permits or certain applicable
regulations, including various transportation, environmental or land use laws
and regulations. Should we receive such citations or notices, we would generally
seek to work with the authorities to resolve the issues raised by such citations
or notices. There can be no assurance, however, that we will always be
successful in this regard, and the failure to resolve a significant issue could
result in adverse consequences to us.
 
 While we
maintain insurance, such insurance is subject to various deductible and coverage
limits and certain policies exclude coverage for damages resulting from
environmental contamination. There can be no assurance that insurance will
continue to be available to us on commercially reasonable terms, that the
possible types of liabilities that may be incurred by us will be covered by its
insurance, that our insurance carriers will be able to meet their obligations
under their policies or that the dollar amount of such liabilities will not
exceed our policy limits. An uninsured claim, if successful and of significant
magnitude, could have a material adverse effect on our business, results of
operations and financial condition.
  25
  We
may need to hire additional employees as we grow.
 
 We may
need to hire additional employees to implement our business plan. In order to
continue to grow effectively and efficiently, we will need to implement and
improve our operational, financial and management information systems and
controls and to train, motivate and manage our employees. We intend to review
continually and upgrade our management information systems and to hire
additional management and other personnel in order to maintain the adequacy of
its operational, financial and management controls. There can be no assurance,
however, that we will be able to meet these objectives.
 
 We
may be unable to obtain and maintain licenses or permits, zoning, environmental
and/or other land use approvals that we need to use a landfill and operate our
plants.
 
 These
licenses or permits and approvals are difficult and time-consuming to obtain and
renew, and elected officials and citizens’ groups frequently oppose them.
Failure to obtain and maintain the permits and approvals we need to own or
operate our plants, including increasing their capacity, could materially and
adversely affect our business and financial condition.
 
 Changes
in environmental regulations and enforcement policies could subject us to
additional liability and adversely affect our ability to continue certain
operations.
 
 Because
the environmental industry continues to develop rapidly, we cannot predict the
extent to which our operations may be affected by future enforcement policies as
applied to existing laws, by changes to current environmental laws and
regulations, or by the enactment of new environmental laws and
regulations.  Any predictions regarding possible liability under such
laws are complicated further by current environmental laws which provide that we
could be liable, jointly and severally, for certain activities of third parties
over whom we have limited or no control.
 
 If
environmental regulation enforcement is relaxed, the demand for our products may
decrease.
 
 The
demand for our services is substantially dependent upon the public’s concern
with, and the continuation and proliferation of, the laws and regulations
governing the recycling of plastic. A decrease in the level of public concern,
the repeal or modification of these laws, or any significant relaxation of
regulations relating to the recycling of plastic would significantly reduce the
demand for our services and could have a material adverse effect on our
operations and financial condition.
 
 
 Item
2.                                Unregistered
Sales of Equity Securities and Use of Proceeds.
 
 During
the three months ended March 31, 2008, the Company (i) received approximately
$2.2 million from loans from new and existing investors, (ii) entered into
agreements with holders of certain notes payable pursuant to which the Company
issued (subsequent to March 31, shares were issuable as of March 31)
approximately 243.9 million shares of Company common stock in consideration
for conversion of all convertible notes payable of approximately $13.2 million
together with related accrued interest of approximately $1.7 million and the
surrender of outstanding warrants to purchase approximately 38.6 million shares
of Company common stock, (iii) entered into agreements with related party and
non-related party creditors providing for issuance of  approximately
15.9 million shares of Company common stock as payment for accounts payable or
accrued amounts owed of $754,000, and (iv) entered into agreements with holders
of warrants to purchase Company common stock pursuant to which the Company will
issue 81.9 million shares of its common stock in exchange for the cancellation
of warrants to purchase approximately 124.2 million shares.  All
securities have been issued as of June 30, 2008.
 
 During
the period covered by this 10-Q, the Company sold the following securities which
were not registered under the Securities Act of 1933 (the “Act”):
 
 Short Term Notes -
During 2007, the Company received cash proceeds of approximately $2.2 million
from new and existing investors and issued to each lender a promissory note
with an interest rate of 15% per annum, due and payable on demand within 180
days (the “Short-Term Notes”), and warrants to purchase approximately 15 million
shares of Company common stock with an exercise price of $0.06 per share that
expire in April 2015.  During the six months ended June 30, 2008, the
Company received cash of approximately $3.1 million and issued to each lender
Short-Term Notes, and issued to certain lenders warrants to purchase
approximately 9.2 million shares of Company common stock with an exercise price
of $0.06 per share that expire in April 2015.   The shares
underlying the warrants are subject to piggy back registration
rights.  The exercise price of the warrants is subject to
anti-dilution downward adjustments in the event the Company sells common stock
at a price below the exercise price.
 
 Exchange of Director Notes
and Short-term Notesfor Convertible Preferred
Stock - During 2007, the Company received cash proceeds of
approximately $2.7 million from various members of the Company’s Board of
Directors (the “Director Notes”).  In June 2008, holders of
outstanding Director Notes and Short-term Notes (defined above), which had an
outstanding principal amount of approximately $2.9 million and $4.6 million and
related accrued interest payable of $318,000 and $206,000, respectively,
exchanged all such notes and accrued interest for 152,843,413 shares of the
Company’s Series A Convertible Preferred Stock and 111,240,040 shares of the
Company’s Series B-1 Convertible Preferred Stock.
  26
  Other Notes Payable -
In January 2008, the Company received $300,000 cash from a new investor and
issued a $300,000 promissory note bearing interest at 15% and due in sixty
days.  In May 2008, the note and related accrued interest was paid in
full.
 
 During
the six months ended June 30, 2008, one of the Company’s Executive Officers
loaned the Company $270,000 pursuant to terms of short-term notes payable
bearing interest at 15%, and repaid $175,000 of the loan, including interest
thereon.  At June 30, 2008, there is $95,000 still outstanding as
notes payable.
 
 Preferred Stock Issued for
Cash and Exchange of Debt andOther
Securities – On June 4, 2008, the Company issued (i) 336,244,040
shares of Series B-1 Preferred Stock, 165,000,000 shares of its Series B-1
Preferred Stock for $3.3 million cash, (ii) 152,843,413 shares of its Series A
(referenced above) and a total of 336,244,040 shares of its Series B-1 Preferred
Stock (of which 111,240,040 shares referenced above) in exchange for outstanding
promissory notes having a principal balance of approximately $7.5 million and
related accrued interest payable of $525,000, and (iii), of the 336,244,040
shares of Series B-1 Preferred Stock, 60,000,000 shares of its Series B-1
Preferred Stock in exchange for shares of the Company’s “old” preferred series a
preferred stock, which was issued in exchange for $1.2 million cash received
during April and May 2008, and which such series was eliminated upon
exchange.
 
 Common Stock Purchase
Warrants - During the three months ended June 30, 2008, the Company
issued to certain of its non-employee directors warrants to purchase 750,000
shares and 1,000,000 shares of its common stock at an exercise price of $0.22
and $0.07, respectively, each expiring in April 2015.
 
 In
connection with, among other things, consummation of the June 4 financing
transactions resulting in exchanges of outstanding notes payable and receipt of
cash in consideration of the issuance of shares of the Company’s Series A and
Series B-1 Convertible Preferred Stock, the Company issued to each of two of the
Company’s new Directors warrants to purchase 10,918,072 shares of its common
stock at a per share price of $0.02 with a ten-year term.
 
 Common Stock Issued forAccounts
Payable - In March 2008, the Company issued approximately 15.9 million
shares of its common stock for accounts payable or accrued amounts
owed.
 
 
 Item
3.                      Defaults
Upon Senior Securities
 
 Not
applicable.
 
  Item
4.  Submission of Matters to a Vote of Securities Holders
 
 Pursuant
to the Definitive Schedule 14C filed by the Company on May 15, 2008 (File No.
033-31067), effective May 12, 2008, the Company amended its Certificate of
Incorporation with the state of Delaware (the “Amendment”).
 
 On April
25, 2008, ECO2’s board of
directors and on April 28, 2008 the holders of a majority of the outstanding
shares of common stock of the Company, approved an amendment of the Company’s
Certificate of Incorporation, as amended, to change the number of authorized
shares to Two Billion shares of all classes of capital stock (the “Authorized
Amount”).  Of the Authorized Amount, One Billion Five Hundred Million
(1,500,000,000) shares shall be classified as common stock and Five Hundred
Million Shares (500,000,000) shares shall be classified as preferred
stock.  On June 2, 2008, the Company received notice from the state of
Delaware confirming the effectiveness of the Amendment.
 
 In
connection with the financing agreements executed by the Company on June 4,
2008, disclosed by the Company in a Form 8-K on June 10, 2008 (File No. 033-31067), and pursuant
to the Preliminary Schedule 14C filed by the Company on July 21, 2008 (File No.
033-31067), the Company seeks to amend its Certificate of Incorporation again
with the state of Delaware (the “Subsequent Amendment”) to increase the amount
of authorized shares of capital stock.
 
 Pursuant
to the Subsequent Amendment, on July 2, 2008, ECO2’s board of
directors approved an amendment of the Company’s Certificate of Incorporation,
as amended, to change the number of authorized shares to Two Billion Two Hundred
Million shares of capital stock (the “Amended Authorized Amount”).  Of
the Amended Authorized Amount, One Billion Five Hundred Million (1,500,000,000)
shares shall continue to be classified as common stock and Seven Hundred Million
Shares (700,000,000) shares shall be classified as preferred
stock.   On August 1, 2008, the Company filed a Definitive
Schedule 14C (File No. 033-31067).
  27
  Item
5.                      Other
Information
 
 None.
 
 Item
6.                      Exhibits
 
 [See
Exhibit Index below after signatures]
 
  28
  
 SIGNATURES
 
 
 Pursuant
to the requirements of the Securities Exchange Act of 1934, as amended, this
report has been signed by the following persons on behalf of the Registrant in
the capacities and on the dates indicated.
  ECO2 PLASTICS,
INC.
 
 
 /s/
Rodney S. Rougelot
 Rodney S.
Rougelot
 Director,
Chief Executive Officer and Interim Chief Financial Officer
 
 DATE
 
 August 5,
2008
 
 
  29
  EXHIBIT
INDEX
 
 Exhibit No.
              
              Description
              
              Location3.1(i)
              
              Amendment
      to Restated Certificate of Incorporation
              
              Incorporated
      by reference to Exhibit A to the DEFR14C filed by the Company on November
      30, 2005.3.2(i)
              
              Restated
      Certificate of Incorporation
              
              Incorporated
      by reference to Exhibit B to the DEF-14C filed by the Company on September
      9, 2002.3.3(i)
              
              Certificate
      of Incorporation
              
              Incorporated
      by reference to the Form S-18 Registration Statement filed by the Company
      File No. 33-31-67.3.4(i)
              
              Amendment
      to Restated Certificate of Incorporation
              
              Incorporated
      by reference to the DEF-14C filed by the Company on February 22,
      2007.3.5(i)
              
              Amendment
      to Restated Certificate of Incorporation
              
              Incorporated
      by reference to the DEF-14C filed by the Company on May 15,
      2008.3.6(ii)
              
              Bylaws
              
              Incorporated
      by reference to Exhibit B to the DEF-14C filed by the Company on September
      9, 2002.31.1
              
              Certification
      of CEO and Interim CFO pursuant to Section 302 of the Sarbanes-Oxley
      Act
              
              Attached32.1
              
              Certification
      of CEO and Interim CFO pursuant to Section 906 of the Sarbanes-Oxley
      Act
              
              Attached
 
  30