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 MARCH 31, 2009





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)





P. O. Box
760


5300
Claus Road


Riverbank,
CA 95367


(Address
of principal executive offices)(Zip Code)





(209)
863-6200


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





680
Second Street, Suite 200 San Francisco, CA 94107


(Former
address of principal executive offices)




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 April
30, 2009 is 560,401,057.





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














ECO2 PLASTICS,
INC.


FORM
10-Q




TABLE OF
CONTENTS




PagePART
      I
            FINANCIAL
      INFORMATION
            3Item
      1
            Financial
      Statements
            3Item
      2
            Management's
      Discussion and Analysis of Financial Condition and Results of
      Operations
            18Item
      3
            Quantitative
      and Qualitative Disclosures About Market Risk
            23Item
      4
            Controls
      and Procedures
            24PART
      II
            OTHER
      INFORMATION
            25Item
      1
            Legal
      Proceedings
            25Item
      1A
            Risk
      Factors
            25Item
      2
            Unregistered
      Sales of Equity Securities and Use of Proceeds
            27Item
      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





Condensed
      Balance Sheets at March 31, 2009 (unaudited) and December 31,
      2008
            4Condensed
      Statements of  Operations for the three
      months  ended March 31, 2009 and  2008
      (unaudited)
            5Condensed
      Statement of Changes in Stockholders’ Equity for the three months ended
      March  31, 2009 (unaudited)
            6Condensed
      Statements of Cash Flows for the three months ended March 31, 2009
      and 2008 (unaudited)
            7Notes
      to Condensed Financial Statements (unaudited)
            8







- 3
-




ECO2
      Plastics, Inc.Condensed
      Balance Sheets(in
      thousands, except share and per share
data)
   March
      31,
              
              
              December
      31,2009
              
              
              2008Current
      assets:
              
              (unaudited)Cash
      and cash equivalents
              
              $
              2
              
              
              $
              1,577Accounts
      receivable, net of allowance of $10
              
              
              188
              
              
              
              318Inventories
              
              
              169
              
              
              
              48Total
      current assets
              
              
              359
              
              
              
              1,943Property
      and equipment, net
              
              
              9,125
              
              
              
              9,104Deferred
      debt issue costs, net
              
              
              43
              
              
              
              139Other
      assets
              
              
              70
              
              
              
              70Total
      assets
              
              $
              9,597
              
              
              $
              11,256Current
      liabilities:Accounts
      payable
              
              $
              1,962
              
              
              $
              1,481Accounts
      payable to related parties
              
              
              220
              
              
              
              132Accrued
      liabilities
              
              
              764
              
              
              
              651Notes
      payable and accrued interest, net of debt discountDue
      to related parties, net of debt discount of nil and $1,171
              
              
              2,848
              
              
              
              1,589Due
      to others, net of debt discount of nil and $597
              
              
              1,506
              
              
              
              857Current
      portion of note payable to California Integrated Waste Management Board
      (CIWMB)
              
              
              215
              
              
              
              209Participation
      Certificates obligations issued prior to 2004
              
              
              354
              
              
              
              354Total
      current liabilities
              
              
              7,869
              
              
              
              5,273Non-current
      liabilities:Note
      payable to CIWMB, net of current portion and debt discount
              
              
              1,223
              
              
              
              1,299Fair
      value liability relating to price adjustable warrants
              
              
              73
              
              
              
              -Convertible
      notes payable and accrued interest, net of debt discountDue
      to related parties, net of debt discount of $2,822 and
    $3,078
              
              
              370
              
              
              
              41Due
      to others, net of debt discount of $298 and $324
              
              
              39
              
              
              
              5Total
      non-current liabilities
              
              
              1,705
              
              
              
              1,345Total
      liabilities
              
              
              9,574
              
              
              
              6,618Commitments
      and contingencies (Note 10)Stockholders'
      equity:Preferred
      stock, $0.001 par value, 1,700,000,000 shares authorized,Series
      A convertible, 152,843,414 shares authorized, 149,995,655
    and152,843,414
      shares issued outstanding, preference in liquidation
$4,585
              
              
              150
              
              
              
              153Series
      B-1 convertible, 336,240,039 shares authorized, 328,630,238
      sharesissued
      and outstanding, preference in liquidation $6,573
              
              
              329
              
              
              
              329Series
      B-2 convertible, 140,000,000 shares authorized, none issued and
      outstanding
              
              
              
              
              
              
              -Series
      C convertible, 400,000,000 shares authorized, none issued and
      outstanding
              
              
              
              
              
              
              -Common
      stock, $0.001 par value, 2,500,000,000 shares authorized,560,401,057
      and 556,453,298 shares issued and outstanding
              
              
              561
              
              
              
              557Additional
      paid-in capital
              
              
              105,614
              
              
              
              106,351Accumulated
      deficit
              
              
              (106,631
              )
              
              
              (102,752
              )Total
      stockholders' equity
              
              
              23
              
              
              
              4,638Total
      liabilities and stockholders' equity
              
              $
              9,597
              
              
              $
              11,256
 See
accompanying notes to condensed financial statements




- 4
-




ECO2
      Plastics, Inc.Condensed
      Statements of Operations(in
      thousands, except per share data)(unaudited)
   Three
      months ended March 31,2009
              
              
              2008Revenue
              
              $
              525
              
              
              $
              1,510Cost
      of goods sold
              
              
              262
              
              
              
              1,593Gross
      margin
              
              
              263
              
              
              
              (83
              )Operating
      expensesPlant
      operations and technology development
              
              
              1,802
              
              
              
              1,864General
      and administrative, including stock-basedcompensation
      expense of $173 and $450
              
              
              779
              
              
              
              1,314Total
      operating expenses
              
              
              2,581
              
              
              
              3,178Loss  from
      operations
              
              
              (2,318
              )
              
              
              (3,261
              )Other
      income (expense)Interest
      expense, including amortization of debt discount anddebt
      issue costs of $2,148 and $4,250
              
              
              (2,381
              )
              
              
              (4,879
              )Change
      in fair value liability for price adjustable warrants
              
              
              73
              
              
              
              -Excess
      of fair value of common stock issued in exchangefor
      notes, interest and accounts payable and warrants
              
              
              -
              
              
              
              (3,458
              )Total
      other income (expense)
              
              
              (2,308
              )
              
              
              (8,337
              )Loss
      before income taxes
              
              
              (4,626
              )
              
              
              (11,598
              )Income
      taxes
              
              
              -
              
              
              
              -Net
      loss
              
              $
              (4,626
              )
              
              $
              (11,598
              )Net
      loss per common share, basic and diluted
              
              $
              (0.01
              )
              
              $
              (0.04
              )Weighted
      average shares used in computing net lossper
      share, basic and diluted
              
              
              558,079
              
              
              
              306,167
 See
accompanying notes to condensed financial statements.
  - 5
-


ECO2
      Plastics, Inc.Condensed
      Statement of Changes in Stockholders' EquityFor
      the Three Months Ended March 31, 2009(in
      thousands, except share data)
   Convertible
      Preferred Stock
              
              
              
              
              
              
              
              
              AdditionalSeries
      A
              
              
              Series
      B-1
              
              
              Common
      stock
              
              
              paid-in
              
              
              AccumulatedShares
              
              
              Amount
              
              
              Shares
              
              
              Amount
              
              
              Shares
              
              
              Amount
              
              
              capital
              
              
              deficit
              
              
              TotalBalance
      at December 31, 2008
              
              
              152,843,414
              
              
              $
              153
              
              
              
              328,630,238
              
              
              $
              329
              
              
              
              556,453,298
              
              
              $
              557
              
              
              $
              106,351
              
              
              $
              (102,752
              )
              
              $
              4,638Cumulative
      effect of adjustments resultingfrom
      adoption of EITF 07-5
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              $
              (893
              )
              
              
              747
              
              
              
              (146
              )Adjusted
      balance at January 1, 2009
              
              
              152,843,414
              
              
              
              153
              
              
              
              328,630,238
              
              
              
              329
              
              
              
              556,453,298
              
              
              
              557
              
              
              
              105,458
              
              
              
              (102,005
              )
              
              
              4,492Stock-based
      compensation expense
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              173
              
              
              
              
              
              
              
              173Shares
      vested for executive compensation
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              1,100,000
              
              
              
              1
              
              
              
              (1
              )
              
              
              
              
              
              
              -Stock
      issue costs
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              (16
              )
              
              
              
              
              
              
              (16
              )Series
      A preferred stock converted to common
              
              
              (2,847,759
              )
              
              
              (3
              )
              
              
              
              
              
              
              
              
              
              
              2,847,759
              
              
              
              3
              
              
              
              
              
              
              
              
              
              
              
              -Net
      loss
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              (4,626
              )
              
              
              (4,626
              )Balance
      at March 31, 2009
              
              
              149,995,655
              
              
              $
              150
              
              
              
              328,630,238
              
              
              $
              329
              
              
              
              560,401,057
              
              
              $
              561
              
              
              $
              105,614
              
              
              $
              (106,631
              )
              
              $
              23
 See
accompanying notes to condensed financial statements.







- 6
-




ECO2
      Plastics, Inc.Condensed
      Statements of Cash Flows(in
      thousands)(unaudited)
   Three
      months ended March 31,2009
              
              
              2008Cash
      flows from operating activities:Net
      loss
              
              $
              (4,626
              )
              
              $
              (9,362
              )Adjustments
      to reconcile net loss to net cash used by operating
      activities:Depreciation
      and amortization
              
              
              470
              
              
              
              360Excess
      of fair value of common stock issued and issuable in
    exchangefor
      accounts payable, notes payable, accrued interest and
    warrants
              
              
              -
              
              
              
              3,458Stock-based
      compensation
              
              
              173
              
              
              
              454Change
      in fair value of warrants
              
              
              (73
              )
              
              
              -Amortization
      of debt issue costs  and discount
              
              
              2,148
              
              
              
              2,261Changes
      in operating assets and liabilities:Accounts
      receivable
              
              
              130
              
              
              
              90Inventory
              
              
              (121
              )
              
              
              105Accounts
      payable
              
              
              570
              
              
              
              214Accrued
      liabilities, including accrued interest
              
              
              331
              
              
              
              315Other
              
              
              -
              
              
              
              1Net
      cash used by operating activities
              
              
              (998
              )
              
              
              (2,104
              )Cash
      flows from investing activities:Purchase
      of property, plant & equipment
              
              
              (491
              )
              
              
              (87
              )Net
      cash used by investing activities
              
              
              (491
              )
              
              
              (87
              )Cash
      flows from financing activities:Payments
      on CIWMB note payable
              
              
              (70
              )
              
              
              (67
              )Proceeds
      from issuance of notes payable
              
              
              -
              
              
              
              2,220Payments
      of stock issue costs
              
              
              (16
              )
              
              
              -Net
      cash provided (used) by financing activities
              
              
              (86
              )
              
              
              2,153Net
      decrease in cash and cash equivalents
              
              
              (1,575
              )
              
              
              (38
              )Cash
      and cash equivalents, beginning of year
              
              
              1,577
              
              
              
              101Cash
      and cash equivalents, end of period
              
              $
              2
              
              
              $
              63Supplemental
      disclosures of cash flow information:Cash
      paid for interest
              
              $
              16
              
              
              $
              18Cash
      paid for income taxes
              
              $
              -
              
              
              $
              -Supplemental
      disclosures of non-cash investing and financing
activities:Debt
      discount
              
              $
              -
              
              
              $
              540Deferred
      debt issue costs
              
              $
              -
              
              
              $
              82Common
      stock exchanged for notes payable, accrued interest and
      warrants
              
              $
              -
              
              
              $
              12,492Common
      stock exchanged for accounts payable and accrued
    liabilities
              
              $
              -
              
              
              $
              754
 See
accompanying notes to condensed financial statements.






- 7
-


ECO2 Plastics,
Inc.


Notes
to Condensed Financial Statements


As
of March 31, 2009


(unaudited)





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




Organization and
Business – ECO2 Plastics,
Inc., (“ECO2”) or the
(“Company”) was incorporated under the laws of the State of Delaware in 2000,
and formed for purposes of acquiring certain patented technology and development
of a worldwide market.  ECO2 has
developed a unique and revolutionary process 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 cost savings versus traditional methods (the “Process”). This Process is both
patented and patent-pending and 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 $4.6 million for the three months ended March 31, 2009
and $24.0 million for the year ended December 31, 2008, and operating activities
used cash of approximately $998,000 during the three months ended March 31, 2009
and $9.9 million during the year ended December 31, 2008.  At March
31, 2009, the Company had a working capital deficit of $7.5 million and
accumulated losses from inception of $106.6 million.




As a
result of our new production technology beginning to come online, and to reduce
plant operating costs and use of cash during the ramp-up period, we decided to
direct most production to the new technology equipment and accordingly reduced
operations of prior technology production equipment.  In the near
term, production volumes and revenues will decrease as the new technology comes
on line and then are expected to increase as throughput increases as a
percentage of capacity. In connection with reducing prior technology production
in mid-November 2008, we terminated approximately 85 employees at our Riverbank
plant, thus reducing our workforce to approximately 35 employees. As production
volume increases over the next several months, similarly, our workforce is
expected to increase.





At March
31, 2009, the Company has cash and cash equivalents of approximately $2,000 and
does not have sufficient cash to meets it needs for the next twelve
months.  In April 2009, the Company received $300,000 from existing
investors in exchange for convertible notes payable bearing interest at 8%, due
in May 2009 and in May 2009 received another $250,000 from existing investors
under the same terms.  The Company’s Board of Directors and Chief
Executive Officer continue to be actively involved in discussions and
negotiations with investors in order to convert outstanding convertible notes
payable and to raise additional funds to finance implementation of recently
acquired equipment and purchase additional new equipment, and to provide
adequate working capital for operations with a near-term goal of generating
positive cash flow from operations. There is no assurance that continued
financing proceeds will be obtained in sufficient amounts necessary to meet the
Company's needs. In view of these matters, continuation as a going concern is
dependent upon the Company's ability to meet its financing requirements, raise
additional capital, and the future success of its operations.  The
accompanying financial statements do not include any adjustments to reflect the
possible future effects on the recoverability and classification of assets or
the amounts and classifications of liabilities that may result from the possible
inability of the Company to continue as a going concern.


- 8
-





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 Company 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 March 31, 2009 interim period
are not necessarily indicative of the results to be expected for the entire
fiscal year ending December 31, 2009 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, 2008 Annual Report on Form
10-K.





Summary of Significant
Accounting Policies - Significant accounting policies used in preparation
of the Company’s financial statements are disclosed in notes to its audited
annual December 31, 2008 financial statements.  A condensed summary of
disclosures regarding certain of such policies are set forth below.





Use of estimates in the
preparation of financial statements - Preparation of financial statements
in conformity with generally accepted accounting principles requires management
to make estimates and assumptions that affect reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the financial statements and reported amounts of revenue and expenses during the
reporting 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 and impairment of long-lived assets, valuation of
accounts receivable and inventories, valuation and classification 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.




Fair value of financial
instruments - The Company measures its financial assets and liabilities
in accordance with generally accepted accounting principles. For certain of the
Company's financial instruments, including cash and cash equivalents,
receivables, accounts payable and accrued liabilities, the carrying amounts
approximate fair value due to their short maturities. Amounts recorded for notes
payable, net of discount, also approximate fair value because current interest
rates offered to the Company for debt of similar maturities are substantially
the same.





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.


- 9
-


Level
3: Unobservable inputs in which little or no market data exists, therefore
developed using estimates and  assumptions developed by us, which reflect
those that a market participant would use.




The
Company currently measures and reports at fair value cash and cash equivalents
and fair value liability for price adjustable warrants. The following table
summarizes our financial assets and liabilities measured at fair value on a
recurring basis in accordance with SFAS 157 as of March 31, 2009 (in
thousands):




Level
      1
            
            
            Level
      2
            
            
            Level
      3Quoted
      prices in
            
            
            Significant
            
            
            SignificantBalance
      at
            
            
            active
      markets for
            
            
            other
      observable
            
            
            UnobservableMarch
      31, 2009
            
            
            identical
      assets
            
            
            inputs
            
            
            inputsAssets:Cash
            
            $
            2
            
            
            $
            2
            
            
            $
            -
            
            
            $
            -Total
      financial assets
            
            $
            2
            
            
            $
            2
            
            
            $
            -
            
            
            $
            -Liabilities:Fair
      value liability for price adjustable warrants
            
            $
            73
            
            
            
            
            
            
            
            
            
            
            $
            73Total
      financial liabilities
            
            $
            73
            
            
            $
            -
            
            
            $
            -
            
            
            $
            73




As of
March 31, 2009 and December 31, 2008, our cash and cash equivalents
and restricted cash are recorded at fair value as determined through market,
observable and corroborated sources. The following table is a roll forward for
the three months ended March 31, 2009 of the fair value liability of price
adjustable warrants, as to which fair value is determined by Level 3 inputs (in
thousands):




Beginning
      balance at January 1, 2009
              
              $
              146Change
      in fair value included in net income
              
              
              (73
              )Ending
      balance at March 31, 2009
              
              $
              73


Accounting for
Derivatives – The Company evaluates its convertible debt, options,
warrants or other contracts to determine if those contracts or embedded
components of those contracts qualify as derivatives to be separately accounted
for under Statement of Financial Accounting Standards 133 “Accounting for Derivative
Instruments and Hedging Activities” and related interpretations including
EITF 00-19 “Accounting for
Derivative Financial Instruments Indexed to, and Potentially Settled in, a
Company’s Own Stock”.   The result of this accounting
treatment is that under certain circumstances the fair value of the derivative
is marked-to-market each balance sheet date and recorded as a
liability.  In the event that the fair value is recorded as a
liability, the change in fair value is recorded in the statement of operations
as other income or expense.  Upon conversion or exercise of a
derivative instrument, the instrument is marked to fair value at the conversion
date and then that fair value is reclassified to equity. Equity instruments that
are initially classified as equity that become subject to reclassification under
SFAS 133 are reclassified to liability at the fair value of the instrument on
the reclassification date.




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.





Basic and diluted net loss
per common 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 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 the three
months ended March 31, 2009, exclude 347,056,717 shares issuable upon exercise
of outstanding and issuable warrants to purchase common stock, 497,582,173
shares issuable upon conversion of outstanding convertible notes payable and
478,625,893 shares issuable upon conversion of outstanding convertible preferred
stock. Computations of net loss per share for the three months ended March 31,
2008, exclude 26,946,153 shares issuable upon exercise of outstanding and
issuable warrants to purchase common stock. These common stock equivalents could
have the effect of decreasing diluted net income per share in future
periods.






- 10
-




Recent accounting
pronouncements - 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
adopted SFAS 160 January 1, 2009, and there was no effect of
adoption.  In the absence of possible future investments, application
of SFAS 160 will have no effect on the Company’s financial
statements.




In March
2008, the FASB issued SFAS No. 161, Disclosures about Derivative
Instruments and Hedging Activities – an amendment of SFAS No. 133.
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. The Company does not use derivative financial instruments nor does it
engage in hedging activities.  SFAS No. 161 is effective for the
Company’s interim period beginning January 1, 2009. The Company adopted
SFAS 160 January 1, 2009, and there was no effect of adoption.




In June
2008, the Emerging Issues Task Force of the FASB issued EITF Issue No. 08-4,
Transition Guidance for
Conforming Changes to Issue No. 98-05(“EITF 08-4”), which is effective
for fiscal years ending after December 15, 2008, with earlier application
permitted.  EITF 08-4 provides for, among other things, revisions to
certain provisions of EITF 98-05, including nullification of guidance under EITF
98-05 that upon conversion, unamortized discounts for instruments with
beneficial conversion features should be included in the carrying value of the
convertible security that is transferred to equity at the date of
conversion.  This nullification was made to update guidance to
acknowledge the issuance of EITF Issue No. 00-27, which revised accounting
guidance to require immediate recognition of interest expense for the
unamortized discount.  In accordance with EITF 08-4 transition
guidance, the Company
has retrospectively applied the accounting guidance of EITF
00-27.  During 2008, certain convertible promissory notes payable were
exchanged for shares of Company common stock, and as a result of adoption of
EITF 00-27 accounting guidance the remaining unamortized debt discount of
approximately $2.2 million was recognized as interest expense.  There
was no cumulative effect for periods prior to 2008.




In June
2008, the Emerging Issues Task Force of the FASB issued EITF Issue
No. 07-5, “Determining Whether an Instrument (or Embedded Feature) Is
Indexed to an Entity’s Own Stock” (“EITF 07-5”), which is effective for fiscal
years ending after December 15, 2008, with earlier application not
permitted by entities that have previously adopted an alternative accounting
policy. The adoption of EITF 07-5’s requirements affects accounting for
convertible instruments and warrants with provisions that protect holders from
declines in the stock price (“down-round” provisions). Warrants with such
provisions will no longer be recorded in equity. EITF 07-5 guidance is to be
applied to outstanding instruments as of the beginning of the fiscal year in
which the EITF 07-5 is applied. The cumulative effect of the change in
accounting principle is recognized as an adjustment to the opening balance of
accumulated deficit for the year of adoption, presented separately. The
cumulative-effect adjustment is the difference between the amounts recognized in
the statement of financial position before initial application of EITF 07-5 and
the amounts recognized in the statement of financial position its initial
application. The amounts recognized in the statement of financial position as a
result of the initial application are determined based on the amounts that would
have been recognized if the guidance in EITF 07-5 had been applied from the
issuance date of the instrument. Effective January 1, 2009, the Company adopted
EITF 07-5.  In connection with warrants issued in prior years, the
financial reporting (non-cash) effect of initial adoption of this accounting
requirement for future financial statements resulted in a cumulative effect of
change in accounting principle of approximately $146,000, based on a per share
price of $0.02 at December 31, 2008, which decreased additional paid-in capital
by $893,000 and decreased accumulated deficit by $747,000 and recorded a fair
value liability for price adjustable warrants of $146,000. The fair value
liability is revalued quarterly utilizing Black-Scholes valuation model
computations with the increase or decrease in fair value being reported in the
statement of operations as other income (expense).  During the three
months ended March 31, 2009, the fair value decreased $73,000, based on a per
share price of $0.01 per share at March 31, 2009, which decreased
net loss. Weighted average assumptions used in Black Scholes calculation were
expected life equal to 1.5 to 8.5 years, volatility rates of 130% to 165%,
risk-free interest rates of .6% to 2.4% and dividend rate of 0%.




- 11
-




Note
2. Inventories





Inventories
consist of the following (in thousands):




March
      31,
              
              
              December
      31,2009
              
              
              2008Raw
      materials
              
              $
              90
              
              
              $
              13Finished
      Good
              
              
              79
              
              
              
              35Total
              
              $
              169
              
              
              $
              48
 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.
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
$200,000 for 2008 and $300,000 for 2009 and years
thereafter.  Honeywell may terminate this agreement in the event of,
among other things, the nationalization of the industry which encompasses any
products or services, any suspension of payments under the terms of the
agreement by government regulation, a substantial change in ownership of the
Company (whether resulting from merger, acquisition, consolidation or
otherwise), another company or person acquiring control of the Company, or the
existence of a state of war between the United States and any country where the
Company has a license to manufacture products or provide services.





Cash in excess of federally
insuredlimits - 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.  There were no
amounts on deposit in excess of federally insured limits at March 31,
2009.





Major Customers -
During the three months ended March 31, 2009, the Company had revenues of over
10% of total revenue from one individual customer, Customer A (65%), and during
the three months ended March 31, 2008 from customers C (48%), D (20%) and E
(13%).  As further described in Note 6, Customer A is an owner of
Company convertible notes and warrants.





Note
4.  Notes Payable and Convertible Notes Payable





The
Company is obligated to the California Integrated Waste Management Board
(“CIWMB”) pursuant to terms of a Promissory Note, which bears interest at 4.25%
per annum with principal and interest monthly payments of approximately $22,500
until fully paid in May 2015. Pursuant to terms of a Security Agreement, among
other things, the promissory note is collateralized by equipment purchased for
the recycling plant, and a secondary security interest in all other machinery
and equipment and other Company assets.





Convertible
notes payable and related accounts at March 31, 2009, consist of the following
(in thousands):




Convertible
                
                
                Unamortized
                
                
                Notes,
      net
                
                
                AccruedNotes
                
                
                debt
      discount
                
                
                of
      discount
                
                
                interest
                
                
                TotalConvertible
      promissory notes, due March 2009Due
      to related parties
                
                $
                2,626
                
                
                $
                -
                
                
                $
                2,626
                
                
                $
                222
                
                
                $
                2,848Due
      to others
                
                
                1,389
                
                
                
                -
                
                
                
                1,389
                
                
                
                117
                
                
                
                1,506Subtotal
                
                
                4,015
                
                
                
                -
                
                
                
                4,015
                
                
                
                339
                
                
                
                4,354Convertible
      promissory notes, due December 2011Due
      to related parties
                
                
                3,120
                
                
                
                (2,822
                )
                
                
                298
                
                
                
                72
                
                
                
                370Due
      to others
                
                
                329
                
                
                
                (298
                )
                
                
                31
                
                
                
                8
                
                
                
                39Subtotal
                
                
                3,449
                
                
                
                (3,120
                )
                
                
                329
                
                
                
                80
                
                
                
                409Total
                
                $
                7,464
                
                
                $
                (3,120
                )
                
                $
                4,344
                
                
                $
                419
                
                
                $
                4,763


- 12
-




Convertible Promissory
Notes, due March 2009 – During 2008, the Company received cash of
approximately $3.9 million and a promissory note with related accrued interest
totaling approximately $101,000 and in exchange issued convertible notes payable
due March 31, 2009 (the “Convertible Notes due March 2009”) of approximately
$4.0 million and warrants to purchase approximately 134 million shares of
Company common stock at a per share price of $0.015 that expire in April
2015.  The Convertible Notes due March 2009 bear interest at 15%, and
are convertible into shares of Company common stock, and upon written election
at the discretion of holders of 60% or more of the aggregate principal amount of
Convertible Notes due March 2009 then outstanding, the entire principal amount
of such notes, together with all accrued interest, which shall be computed as if
such notes were held until March 31, 2009, regardless of whether converted prior
to that date, shall be converted.  If the Company has raised $1
million in new equity, the conversion price would be the lesser of 80% of the
new equity price or $0.015 per share.  If such next equity financing
has not occurred, then the conversion securities shall consist of shares of a
newly created series of Series C Convertible Preferred Stock of the Company
having rights, preferences and privileges substantially similar to those of the
Company’s Series B Stock, except that the liquidation preference shall be senior
to the Series B Stock and the Company’s Series A Convertible Preferred Stock, at
a price per share equal to $0.015 (subject to appropriate adjustment for all
stock splits, subdivisions, combination, recapitalizations and the like) until
April 2015.  The Company has pledged as collateral pursuant to terms
of a Security Agreement relating to the Convertible Notes due March 2009, as
amended and restated, substantially all of its assets, subject only to a
security interest granted to CIWMB.  Debt discount relating to these
Convertible Notes approximated $4.0 million, of which approximately $2.2 million
was amortized to interest expense during 2008, with the remainder of $2.8
million amortized to interest expense during the three months ended March 31,
2009.  The fair value of warrants was computed using a Black-Scholes
option pricing model with the following assumptions:  expected term of
6.5 years (contractual term), volatility of 156% (based on historical
volatility), zero dividends and interest rate of approximately
3.1%.  In connection with a subsequent financing in 2008, upon written
election of holders of more than 65% of the aggregate principal amount of
Convertible Notes due March 2009 then outstanding, the Convertible Notes due
March 2009 are subordinated to Convertible Notes due December 2011 and no
payments of principal or interest will be made until the Convertible Notes due
December 2011 are retired.





Convertible Promissory
Notes, due December 2011- Additionally, in 2008, the Company received
cash of approximately $3.4 million and an amount due to an officer for deferred
compensation of $50,000 and in exchange issued convertible notes payable due in
December 2011(the “Convertible Notes due December 2011”) of approximately $3.45
million and warrants to purchase approximately 115 million shares of Company
common stock at a per share price of $0.015 that expire in April
2015.  The Convertible Notes bear interest at 8%.   The
Convertible Notes due December 2011 are convertible into shares of Company
Series C Convertible Preferred stock, and upon written election at the
discretion of holders of 70% or more of the aggregate principal amount of
Convertible Notes due December 2011 then outstanding, the entire principal
amount of such notes, together with all accrued interest shall be converted at a
price per share equal to $0.015 (subject to appropriate adjustment for all stock
splits, subdivisions, combination, recapitalizations and the
like).  The Company has pledged as collateral pursuant to terms of a
Security Agreement relating to the Convertible Notes, as amended and restated,
substantially all of its assets, subject only to a security interest granted to
CIWMB.  Debt discount relating to these Convertible Notes approximated
$3.4 million, of which approximately $46,000 was amortized to interest expense
during 2008, with the remainder to be amortized approximately $1.2 million in
each of 2009 and 2010 and $1.1 million in 2011.  During the three
months ended March 31, 2009, approximately $284,000 was amortized to interest
expense.  The fair value of warrants was computed using a
Black-Scholes option pricing model with the following
assumptions:  expected term of 6.3 years (contractual term),
volatility of 151% (based on historical volatility), zero dividends and interest
rate of approximately 1.5%.  Pursuant to terms of an Amended and
Restated Subordination and Intercreditor Agreement (the “Intercreditor
Agreement”) signed by purchasers of Convertible Notes due December 2011 and
certain purchasers of Convertible Notes due March 2009, Convertible Notes due
March 2009 are subordinate to $3.0 million of Convertible Notes due December
2011 held by certain investors (the “Senior Lenders”) (the “Senior Debt”);
provided that so long as at the time of and after giving effect to any such
payment of principal or interest due on subordinated debt, no Event of Default
(as defined) has occurred under the amended and restated notes, security
agreements and other
documents evidencing the Convertible Notes due December 2011, or would occur as
a result thereof, the Company may make regularly scheduled payments of principal
and interest on such subordinated debt.




Issuance of Common Stock in
exchange for Notes Payable and 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 then 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.  As a result of the adoption of EITF
00-27 in accordance with EITF 08-4 Transition Guidance for Conforming
Changes to Issue No. 98-05, the March 31, 2008 statement of operations
gives retrospective effect to recognition of the $2.2 million remaining
unamortized debt discount as interest expense.




- 13
-





Issuance of Convertible
Preferred Stock in exchangeforDirector Notes and
Short-term Notes - During the three months ended June 30, 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.





Note
5. Preferred Stock, Common Stock and Stock Warrants





Authorized
Shares – The Company has authorized Four Billion Two Hundred
Million (4,200,000,000) shares of capital stock, of which Two Billion Five
Hundred Million (2,500,000,000) shares are classified as common stock and One
Billion Seven Hundred Million (1,700,000,000) shares are classified as preferred
stock, of which the Company has designated and authorized 152,843,413 shares as
Series A Preferred Stock (the “Series A Preferred Stock”), 336,240,040
shares as Series B-1 Convertible Preferred Stock (the “Series B-1 Preferred
Stock”), 140,000,000 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”), and 400,000,000 shares as Series C Convertible
Preferred Stock (the “Series C Preferred Stock”).





Preferred Stock - A
summary of the significant rights and privileges of the Series A Preferred
Stock, Series B Preferred Stock and Series C Preferred Stock (together, the
Preferred Stock”) is as follows:





Dividends -Holders of
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 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 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 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 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 Preferred Stock.  As of March 31, 2009, 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 C 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 B Preferred Stock, Series A Preferred Stock,
or any other stock of the Company ranking junior to the Series C Preferred
Stock, an amount per share equal to the Original Issue Price of $0.015 per share
of Series C Preferred Stock, plus all declared and unpaid dividends on such
shares.  After payment of the full liquidation preference of the
Series C Preferred Stock, if assets or surplus funds remain, 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, of $0.0175 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 C
Preferred Stock and
Series B Preferred Stock, if assets or surplus funds remain, holders of Series A
Preferred 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 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, Series B Preferred Stock and Series C Preferred Stock, each
electing as separate groups, can require redemption of the respective series of
Preferred Stock, 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
(in the case of the Series A Preferred Stock and Series B Preferred Stock) or
(in the case of Series C Preferred Stock) by holders of a majority of the then
outstanding shares of Series C Preferred Stock.




- 14
-





Preferred Stock Issued for
Cash and Exchange of Debt and Other Securities – In June 2008, the
Company issued (i) 165,000,000 shares of its Series B-1 Preferred Stock for $3.3
million cash, (ii) 152,843,413 shares of its Series A Preferred Stock and
111,244,040 shares of its Series B-1 Preferred Stock in exchange for outstanding
Director Notes and Short-term 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.   The fair value of
shares of common stock that preferred shares are convertible into exceeded the
recorded value of notes and accrued interest exchanged and cash received by
approximately $9.0 million; this beneficial conversion feature is presented as a
constructive dividend, increasing the net loss in the computation of net loss
per share attributable to holders of common stock for the interim periods ended
in June, September and December 2008.  In connection with terms of the
First Amendment to Securities Subscription Agreement pertaining to the purchase
of Series A and B Convertible Preferred Stock, the Company granted to certain
purchasers rights to purchase up to an aggregate of 140 million shares of the
Company’s Series B-2 Convertible Preferred Stock on or prior to March 31, 2009
at a price of $0.0175 per share, subject to certain terms and conditions of
various related agreements, including the authorization of a sufficient number
of shares to be issued.  In January 2009, the Company received
notification from the state of Delaware of authorization of its amendments to
Articles of Incorporation authorizing 140 million shares of Series B-2
Convertible Preferred Stock.   The rights to purchase Series B-2
Convertible Preferred Stock were not exercised, and these rights have
expired.





Common Stock Issued for
Conversion of Series B-1 Convertible Preferred Stock – During the three
months ended March 31, 2009, there were 2,847,759 shares of Series A Convertible
Preferred Stock that were converted for that same number of shares of Company
common stock.





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





Additionally,
during the three months ended March 31, 2008, the Company made a special offer
to holders of warrants to purchase Company common stock  to exchange
all outstanding warrants into shares of Company common stock in a number of
shares equal to 60% to 75% (depending on the warrant) of the number of warrant
shares exchanged.  Holders of approximately 124.2 million warrants
accepted the offer and the Company issued approximately 81.9 million shares of
its common stock.  The shares were valued at approximately $536,000
based on the closing stock price on the exchange date, and the excess of fair
value issued over the fair value of securities received has been recorded as a
loss of approximately $556,000.





Warrants – In
connection with borrowings and other transactions, the Company issues warrants
to purchase its common stock.  The fair value of warrants issued
during 2008 was estimated using the Black-Scholes option-pricing model with the
following assumptions: dividend yield of 0%; expected volatility of
approximately 150% to 180% (based on historical volatility over the terms);
risk-free interest rates of approximately 3% to 5%; and contractual terms of 3.5
to 10 years.  The weighted-average fair value of warrants granted
during 2008 and 2007 was $0.03 and $0.19, respectively.




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





In 2008,
the Company and an individual agreed to terms of an offer of employment pursuant
to which, among other things, the individual will serve as its Senior Vice
President of Operations and in addition to cash compensation and other customary
employee related benefits received a warrant to purchase 15 million shares of
Company common stock, 25% of which vest at the end of one year and the remainder
vest equally on a monthly basis over the next three years.  The
warrants have a term of approximately 6.5 years and an exercise price of $0.015
per share and were valued at approximately $287,000 as determined utilizing the
Black-Scholes valuation model and will be expensed over the vesting
period.  The closing stock price at the issuable date was $0.02 per
share. During 2008, approximately $37,000 was recognized as
expense.




- 15
-





In 2008,
the Company and an individual agreed to terms of an offer of employment pursuant
to which, among other things, the individual will serve as its Chief Financial
Officer and in addition to cash compensation and other customary employee
related benefits received a warrant to purchase 20 million shares of Company
common stock, 25% of which vest at the end of one year and the remainder vest
equally on a monthly basis over the next three years.  The warrants
have a term of approximately 6.5 years and an exercise price of $0.015 per share
and were valued at approximately $382,000 as determined utilizing the
Black-Scholes valuation model and will be expensed over the vesting period. The
closing stock price at the issuable date was $0.02 per share. During 2008,
approximately $8,000 was recognized as expense.





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.





There
were no changes in warrants outstanding during the three months ended March 31,
2009.





Note
6. Related Party Transactions




As
summarized in Note 5, certain of the Company’s Directors, Officers and their
affiliates are holders of the Company’s notes payable in the aggregate amount of
approximately $5.7 million at March 31, 2009 and December 31,
2008.  Accrued interest payable on the notes approximated $294,000 and
$134,000 at March 31, 2009 and December 31, 2008,
respectively.  Included in accounts payable to related parties at
March 31, 2009 and December 31, 2008 is approximately $102,000 and $36,000 due
to the Company Chief Executive Officer relating to deferred
compensation.





As
disclosed further in Note 10, in November 2008, the Company entered into a
supply agreement with a company (the “Purchaser”), which holds approximately
$1.5 million of Convertible Notes due December 2011 and warrants to purchase
approximately 50 million shares of Company common stock, and which has the right
to and has designated a person to be a member of the Company’s Board of
Directors.  Pursuant to terms of the Supply Agreement, among other
things, if the Purchaser is in need of at least 1.5 million pounds of Products
(as defined) for any calendar month during the three year term, then the
Purchaser shall order its requirements for 1.5 million pounds from the Company,
and the Company has agreed to sell Products to the Purchaser in accordance to a
contractual pricing formula.  During the three months ended March 31,
2009, sales of Product to Purchaser approximated $341,000.  Accounts
receivable from Purchaser at March 31, 2009 approximated $62,000.





The
Company incurs legal fees pursuant to an agreement for legal services with a law
firm, the managing partner of which was until December 2008 one of the Company’s
Directors. During the three months ended March 31, 2009 and 2008, the Company
incurred fees for legal services from this firm of approximately $49,000 and
$69,000, respectively.    At March 31, 2009, accounts payable due
to the firm for services of $118,000 are included in accounts payable to related
party.





Note
7. Commitments and Contingencies




Legal – The Company
is subject to various lawsuits and other claims in the normal course of
business.  In February 2009, a former vendor filed a Complaint for
Breach of Negotiable Instrument, Breach of Contract and Demand for Jury Trial
against the Company in the United States District Court for the District of
Minnesota, and in April 2009, the Company was served.  The former
vendor has, among other things, prayed for judgments against the Company of
approximately $626,000.  The Company intends to vigorously defend this
action, and cannot, at this time, reasonably predict the ultimate outcome of the
proceedings, if any, that will occur.  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 in these accompanying financial statements with respect to legal
matters. Company management does not expect that the ultimate resolution of
pending legal matters in future periods, including the matter described above
will have a material effect on the Company’s financial condition or results of
operations.




- 16
-





Leases – The Company
leases space for its recycling plant and offices in Riverbank,
California.   In 2008, the Company entered into amendments of its
lease agreement, as amended, exercising its option to extend the expiration of
the lease from May 2009 through March 2010 and to rent additional
space.  The Company has an option to extend the lease for an
additional five years.





Supply Agreement – In
November 2008, the Company entered into a supply agreement with a company (the
“Purchaser”), which holds approximately $1.5 million of Convertible Notes due
December 2011 and warrants to purchase approximately 50 million shares of
Company common stock, and which has the right to and has designated a person to
be a member of the Company’s Board of Directors.  The Supply Agreement
was entered into prior to the Purchaser’s acquisition of
securities.  Pursuant to terms of the Supply Agreement, among other
things, if the Purchaser is in need of at least 1.5 million pounds of Products
(as defined) for any calendar month during the three year term, then the
Purchaser shall order its requirements for 1.5 million pounds from the Company,
and the Company has agreed to sell Products to the Purchaser in accordance to a
contractual pricing formula.





Note
8. Subsequent Events through May 11, 2009





In April
2009, the Company received $300,000 from existing investors in exchange for
convertible notes payable bearing interest at 8%, due in May 2009.  In
May 2009, the Company received an additional $250,000 from existing investors
under the same terms as the April 2009 agreement.






- 17
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Item
2. Management’s Discussion and Analysis of Financial Condition and Results of
Operations.




FORWARD
LOOKING STATEMENTS CAUTIONARY





This
Item 2 and this March 31, 2009 Quarterly Report on Form 10-Q (the “Quarterly
Report”) may contain "forward-looking statements." In some cases, you can
identify forward-looking statements by terminology such as "may," "will,"
"should," "could," "expects," "plans," "intends," "anticipates," "believes,"
"estimates," "predicts," "potential" or "continue" or the negative of such terms
and other comparable terminology. These forward-looking statements include,
without limitation, statements about our market opportunity, our strategies,
competition, expected activities and expenditures as we pursue our business
plan, and the adequacy of our available cash resources. Although we believe that
the expectations reflected in any forward-looking statements are reasonable, we
cannot guarantee future results, levels of activity, performance or
achievements. Actual results may differ materially from the predictions
discussed in these forward-looking statements. Changes in the circumstances upon
which we base our predictions and/or forward-looking statements could materially
affect our actual results. Additional factors that could materially affect these
forward-looking statements and/or predictions include, among other things: (1)
our limited operating history; (2) the risks inherent in the investigation,
involvement and acquisition of a new business opportunity; (3) unforeseen costs
and expenses; (4) our ability to comply with federal, state and local government
regulations; and (5) 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 Item 1A. Risk Factors included
elsewhere in this Quarterly Report and the factors described in our audited
financial statements and elsewhere in the Company’s December 31, 2008 Annual
Report on Form 10-K.





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 financial statements included
in this March  31, 2009 Quarterly Report on form 10-Q and the annual
audited Company’s financial statements included in our December 31, 2008 Annual
Report on Form 10-K (the “Annual Report”).





Background





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.  Wehave
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 our inception, wehave
invested in the development of the technology and equipment comprising the
ECO2Environmental System, which includes a patent issued in 2007. Our first
full scale production facility was constructed in Riverbank, California and is
now producing saleable product and ramping up, but has not yet achieved
full-scale operations as it further develops the process. Our goal is to build
and operate plastic recycling plants in the USA that utilize the ECO2Environmental System and to expand the ECO2Environmental System worldwide. Our growth strategy includes organic
growth, strategic acquisitions and licensing or partnership agreements, where
appropriate.





We
operate in the evolving field of plastics materials recycling. New developments
could both significantly and adversely affect existing and emerging technologies
in the field. Our success in developing marketable products and processes
and achieving a competitive position will depend on our 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
we will be successful in accomplishing our goals.






- 18
-




As a
result of our new production technology beginning to come online, and to reduce
plant operating costs and use of cash during the ramp-up period, we decided in
November 2008 to direct most production to the new technology equipment and
accordingly reduced operations of prior technology production
equipment.  Production volumes and revenues have decreased and in the
near term will remain at the reduced levels.  New technology, some
still under development, is expected to increase throughput as a
percentage of capacity. In connection with reducing prior technology production
in mid-November 2008, we terminated approximately 85 employees at our Riverbank
plant, thus reducing our workforce to approximately 35 employees. As projected
production volume increases over the next several months, similarly, our
workforce is expected to increase.





The
Company has been utilizing its second-generation liquid-CO2 cleansing equipment,
referred to as “Next Gen” in prior public filings, in operations since November
2008.  The Next Gen system required significant amounts of capital for
design, purchase, implementation and initial operations.  The Company to
date has not been able to demonstrate that Next Gen can operate at sufficiently
high throughput and efficiency to achieve sustained profitable operations.
Accordingly, the Company has purchased and installed alternative equipment,
using other technologies, which has demonstrated promise in limited operations
since April 2009.  The Company has also recently implemented a number of
additional process improvements, and will continue to do so.  In this
regard, the Company has been investigating acquisition of an entirely new wash
line (which will utilize a number of components of equipment currently utilized)
to further enhance production processes. This additional wash line could require
significant additional financing. All of these efforts represent our overall
effort towards our goal of achieving sustainable profitable
operations.





We have
incurred recurring losses from operations and operating activities have used
cash, and have a net working capital deficit and have had net capital
deficiencies. The Report of Independent Registered Public Accounting Firm
included in this Annual Report stated that these conditions, among others, raise
substantial doubt about the our ability to continue as a going
concern.





At March
31, 2009, the Company has cash and cash equivalents of approximately $2,000 and
does not have sufficient cash to meets it needs for the next twelve
months.  In April 2009, the Company received $300,000 from existing
investors in exchange for convertible notes payable bearing interest at 8%, due
in May 2009.  In May 2009, the Company received an additional $250,000
from existing investors under the same terms as the April 2009
agreement.  The Company’s Board of Directors and Chief Executive
Officer continue to be actively involved in discussions and negotiations with
investors in order to convert outstanding convertible notes payable and to raise
additional funds to finance next generation processing and other equipment, and
to provide adequate working capital for operations with a near-term goal of
generating positive cash flow from operations. There is no assurance that
continued financing proceeds will be obtained in sufficient amounts necessary to
meet the Company's needs. In view of these matters, continuation as a going
concern is dependent upon the Company's ability to meet its financing
requirements, raise additional capital, and the future success of its
operations.  The accompanying financial statements do not include any
adjustments to reflect the possible future effects on the recoverability and
classification of assets or the amounts and classifications of liabilities that
may result from the possible inability of the Company to continue as a going
concern.





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. During 2008, we received approximately
$15.5 million from issuances of notes payable and preferred stock, and notes,
interest and accounts payable of approximately $14.1 million were converted into
shares of our common stock.  Management and the Board of Directors continue
to be active in discussions and negotiations with investors in order to raise
additional funds.  Significant additional financing will be necessary to
fund working capital needs as the Company continues to lose money and to finance
new production equipment and processes intended to help achieve our goal of
sustainable, profitable operations.  There is no assurance that such
financing will be obtained, that, if obtained, it will be available on
reasonable terms, or that such financing will be sufficient to reach
profitability.





In view
of these matters, continuation as a going concern is dependent upon our ability
to meet its financing requirements, raise additional capital, and the future
success of its operations.  The accompanying financial statements do
not include any adjustments to reflect the possible future effects on the
recoverability and classification of assets or the amounts and classifications
of liabilities that may result from the possible inability to continue as a
going concern.





Critical
Accounting Policies and Estimates





The
preparation of financial statements included in this Quarterly Report requires
our 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 our 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 Quarterly Report and in our December 31,
2008 Annual Report on Form 10-K.




- 19
-





We
believe that the following discussion addresses our most critical accounting
policies and estimates, which are those that we believe are most important to
the portrayal of our financial condition and results of operations and which
require our most difficult and subjective judgments, often as a result of the
need to make estimates about the effect of matters that are inherently
uncertain. We also have other policies that we consider key accounting policies;
however, these policies do not meet the definition of critical accounting
estimates because they do not generally require us to make estimates or
judgments that are difficult or subjective.





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, we have reported losses and operating activities
have used cash, have reported net working capital deficiencies and have had net
capital deficiencies, which raises substantial doubt about our ability to
continue as a going concern. The Report of Independent Registered Public
Accounting Firm included in our Annual Report on Form 10-K stated that these
conditions, among others, raise substantial doubt about the Company’s ability to
continue as a going concern. Our Board of Directors and management intend 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 our 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 – We recognize 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. We
recognize 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.




Income
taxes – We account for income taxes in accordance with 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. We continue to provide a
full valuation allowance to reduce our net deferred tax asset to zero, inasmuch
as management has not determined that realization of deferred tax assets is more
likely than not.





Stock-based
compensation– We account for stock-based compensation in accordance with
Statement of Financial
Accounting Standard (“SFAS”) No. 123(R), Accounting for Stock-Based Compensation(“FAS 123(R)”), which requires recording an expense over the requisite
service period for the fair value of options or warrants granted. We use
the Black-Scholes option pricing model as our method of valuation for
stock-based awards.  Our determination of the fair value of
stock-based awards on the date of grant using an option pricing model is
affected by our stock price as well as assumptions regarding a number of highly
complex and subjective variables.  These variables include, but are
not limited to, the expected stock price volatility over the term of the
award.  Although the fair value of stock-based awards is determined in
accordance with SFAS 123(R), the Black-Scholes option pricing model requires the
input of highly subjective assumptions, and other reasonable assumptions could
provide differing results.





Impairment
of long-lived assets – Our management evaluates the recoverability of our
long-lived assets in accordance with SFAS No. 144, “Accounting for the
Impairment or Disposal of Long-lived Assets,” which generally requires the
assessment of these assets for recoverability when events or circumstances
indicate a potential impairment exists. Events and circumstances considered by
management in determining whether the carrying value of long-lived assets may
not be recoverable include, but are not limited to: significant changes in
performance relative to expected operating results, significant changes in the
use of the assets, significant negative industry or economic trends, a
significant decline in the Company’s stock price for a sustained period of time,
and changes in our business strategy. In determining if impairment exists,
management estimates the undiscounted cash flows to be generated from the use
and ultimate disposition of these assets. If impairment is indicated based on a
comparison of the assets’ carrying values and the undiscounted cash flows, the
impairment loss is measured as the amount by which the carrying amount of the
assets exceeds the fair market value of the assets.


- 20
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Accounting
for Derivatives – Management evaluates our convertible debt, options,
warrants or other contracts to determine if those contracts or embedded
components of those contracts qualify as derivatives to be separately accounted
for under Statement of Financial Accounting Standards No. 133 “Accounting for Derivative
Instruments and Hedging Activities” and related interpretations including
EITF 00-19 “Accounting for
Derivative Financial Instruments Indexed to, and Potentially Settled in, a
Company’s Own Stock”.   The result of this accounting
treatment is that under certain circumstances the fair value of the derivative
is marked-to-market each balance sheet date and recorded as a
liability.  In the event that the fair value is recorded as a
liability, the change in fair value is recorded in the statement of operations
as other income or expense.  Upon conversion or exercise of a
derivative instrument, the instrument is marked to fair value at the conversion
date and then that fair value is reclassified to equity. Equity instruments that
are initially classified as equity that become subject to reclassification under
SFAS 133 are reclassified to liability at the fair value of the instrument on
the reclassification date.





Recent
accounting pronouncements - Effective January 1, 2008, we 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 in which little or no market data exists, therefore
developed using estimates developed by us, which reflect those that a market
participant would use.




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. Effective January 1, 2009, we adopted SFAS No. 161. We do not use
derivative financial instruments nor engage in hedging activities, and the
adoption of SFAS No. 161 did not have an effect on our financial position,
results of operations or cash flows.




In June
2008, the Emerging Issues Task Force of the FASB issued EITF Issue
No. 07-5, “Determining Whether an Instrument (or Embedded Feature) Is
Indexed to an Entity’s Own Stock” (“EITF 07-5”), which is effective for fiscal
years ending after December 15, 2008, with earlier application not
permitted by entities that have previously adopted an alternative accounting
policy. The adoption of EITF 07-5’s requirements affects accounting for
convertible instruments and warrants with provisions that protect holders from
declines in the stock price (“down-round” provisions). Warrants with such
provisions will no longer be recorded in equity. EITF 07-5 guidance is to be
applied to outstanding instruments as of the beginning of the fiscal year in
which the EITF 07-5 is applied. The cumulative effect of the change in
accounting principle is recognized as an adjustment to the opening balance of
accumulated deficit for the year of adoption, presented separately. The
cumulative-effect adjustment is the difference between the amounts recognized in
the statement of financial position before initial application of EITF 07-5 and
the amounts recognized in the statement of financial position its initial
application. The amounts recognized in the statement of financial position as a
result of the initial application are determined based on the amounts that would
have been recognized if the guidance in EITF 07-5 had been applied from the
issuance date of the instrument. Effective January 1, 2009, the Company adopted
EITF 07-5.  In connection with warrants issued in prior years, the
financial reporting (non-cash) effect of initial adoption of this accounting
requirement for future financial statements resulted in a cumulative effect of
change in accounting principle of approximately $146,000, based on a per share
price of $0.02 at December 31, 2008, which decreased additional paid-in capital
by $893,000 and decreased accumulated deficit by $747,000 and recorded a fair
value liability for price adjustable warrants of $146,000. The fair value
liability is revalued quarterly utilizing Black-Scholes valuation model
computations with the increase or decrease in fair value being reported in the
statement of operations as other income (expense).  During the three
months ended March 31,
2009, the fair value decreased $73,000, based on a per share price of $0.01 per
share at March 31, 2009, which decreased net loss.




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Results
of Operations





Comparison
of Three months ended March 31, 2009 and 2008





Revenues
were approximately $525,000 during the three months ended March 31, 2009 as
compared to $1.5 million in the comparative prior year period. Revenues
decreased due primarily to decreased production volumes resulting from ceasing
prior technology production in mid-November 2008.   During the first
quarter, production volumes and revenues decreased as new technology was
installed. Once the new technology comes on line, volumes and revenues are
expected to increase as throughput increases as a percentage of
capacity.





The
Company derives its revenues from certain major customers.  The loss
of major customers could potentially create a significant financial hardship for
the Company.  During the three months ended March 31, 2009, the
Company had revenues of over 10% of total revenue from one customer, Customer A
at 65%. Customer A is the Purchaser as described below.




In
November 2008, we entered into a supply agreement with a company (the
“Purchaser”), which holds approximately $1.5 million of our Convertible Notes
due December 2011 and warrants to purchase approximately 50 million shares of
our common stock, and which has the right to and has designated a person to be a
member of our Board of Directors.  Pursuant to terms of the Supply
Agreement, among other things, if the Purchaser is in need of at least 1.5
million pounds of Products (as defined) for any calendar month during the three
year term, then they shall order their requirements for 1.5 million pounds from
us, and we have agreed to sell Products in accordance to a contractual pricing
formula.  These orders are dependent on quality levels that are not
yet fully met, but are expected to be met from additional process
improvements.





Cost of
goods sold consists of the cost of raw materials processed and was approximately
$262,000 during the three months ended March 31, 2009 as compared to $1.6
million during the comparative prior year period. There was a gross profit of
$263,000 during the three months ended March 31, 2009 as compared to a negative
$83,000 in the comparative prior year period.  As a percent of
revenues, gross profit was 50% and (5)% during the three months ended March 31,
2009 and 2008, respectively.





Plant
operations and technology development expenses decreased to $1.8 million during
the three months ended March 31, 2009 as compared to $1.9 million during the
comparative prior year period due to decreased production.  Operating
expenses are comprised primarily of payroll and related, utilities, occupancy,
supplies, and repairs and maintenance expenses.  Payroll and related
costs decreased $435,000 to $326,000 during the 2009 period as compared to
$761,000 during the 2008 period, which was the primary reason for the decrease
overall.  The decrease in payroll and related costs were offset by
increases in depreciation expense of $99,000 to $423,000 during the 2009 period
as compared to $324,000 during the prior year period, and in property taxes
which approximated $289,000 during the 2009 period, most of which related to
prior periods.  As production volumes approach maximum capacity,
certain plant operating expenses will be included in cost of goods
sold.





General
and administrative expenses decreased to $779,000 during the three months ended
March 31, 2009 as compared to $1.3 million during the comparative prior year
period.  Payroll and related costs approximated $424,000, including
$173,000 of non-cash stock-based compensation during the 2009 period as compared
to $930,000, including $450,000 of stock-based compensation in the 2008
period.





As a
result of the above described increase in gross profit, decrease in plant
operations and technology development expenses, and decrease in general and
administrative expenses, loss from operations decreased to $2.3 million during
the three months ended March 31, 2009, from $3.3 million during the comparative
prior year period.





We
recorded interest expense of approximately $2.4 million during the three months
ended March 31, 2009 as compared to $4.9 million during the comparative prior
year period.  Interest expense includes amortization of debt issue costs
and debt discount of approximately $2.1 million during the 2009 period and $4.6
million during the 2008 period.  The decrease in interest expense for
2009 as compared to 2008 was primarily due to note conversions in
2008.




Our net
loss decreased to approximately $4.6 million for the three months ended March
31, 2009 from $11.6 million for the comparative prior year period, due to the
$943,000 decrease in loss from operations, a $2.5 million decrease in interest
expense, and $3.5 million of other expense recorded during the 2008 period
representing the excess of fair value of common stock issued in exchange for
accounts payable, notes payable, accrued interest and warrants.


- 22
-




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.





Liquidity
and Capital Resources





Sources
of Cash





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. During 2008, we received
approximately $15.5 million from issuances of notes payable and preferred stock,
and notes, interest and accounts payable of approximately $14.1 million were
converted into shares of our common stock.    Our Board of
Directors and Chief Executive Officer continue to be actively involved in
discussions and negotiations with investors in order to raise additional funds
to finance new equipment, and to provide adequate working capital for operations
with a near-term goal of generating positive cash flow from operations. No
additional funds have been raised since December 2008 and, at this point, we do
not have enough cash to operate for the next 12 months.





Cash
Provided (Used) by Operating, Investing and Financing Activities





During
the three months ended March 31, 2009 cash used by operating activities
decreased to approximately $998,000 from $2.1 million during the comparative
prior year period, due primarily to the decrease in loss from operations of
approximately $943,000.





During
the three months ended March 31, 2009, cash used by investing activities
increased to $491,000 relating to capital expenditures on the recycling plant as
compared to $87,000 during the comparative prior year
period.  Expenditures during 2009 have related primarily to process
improvements.





During
the three months ended March 31, 2009, cash used by financing activities was
approximately $86,000 as compared to cash provided of $2.2 million during the
comparative prior year period.





Liquidity





At March
31, 2009, the Company has cash and cash equivalents of approximately $2,000 and
does not have sufficient cash to meets it needs for the next twelve
months.  In April 2009, the Company received $300,000 from existing
investors in exchange for convertible notes payable bearing interest at 8%, due
in May 2009. In May 2009, the Company received an additional $250,000 from
existing investors under the same terms as the April 2009
agreement.





The
Company’s Board of Directors and Chief Executive Officer continue to be actively
involved in discussions and negotiations with investors in order to convert
outstanding convertible notes payable and to raise additional funds to finance
next generation processing and other equipment, and to provide adequate working
capital for operations with a near-term goal of generating positive cash flow
from operations. There is no assurance that continued financing proceeds
will be obtained in sufficient amounts necessary to meet the Company's needs. In
view of these matters, continuation as a going concern is dependent upon the
Company's ability to meet its financing requirements, raise additional capital,
and the future success of its operations.




Item 3.  Quantitative and
Qualitative Disclosures about Market Risk.





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





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


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-


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.  At March 31, 2009,
there were no amounts on deposit in excess of federally insured
limits.





Item
4. 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.





Management
evaluated the effectiveness of our internal control over financial reporting as
of December 31, 2008 based on the control criteria established in a report
entitled Internal Control –
Integrated Framework,issued by the Committee of Sponsoring Organizations
of the Treadway Commission (“ COSO"), and this
assessment identified the following material weaknesses in the Company’s
internal control over financial reporting.





·
            Inadequate
      or ineffective policies for documenting policies, processes and
      transactions; and


·
            Inadequate
      or ineffective internal control environment related to segregation of
      duties.





Because
of the above described material weaknesses, management believes that, as of
December 31, 2008, the Company’s internal control over financial reporting was
not effective based on those criteria. As a result, we have put an
implementation plan in place whereby in 2009 additional resources will be
directed to documentation of processes and segregation of duties to satisfy COSO
requirements.  Despite material weaknesses noted, we believe that our
financial statements contained in our 2008 Annual Report on form 10-K filed with
the SEC and this quarterly report on form 10-Q fairly present our financial
position, results of operations and cash flows as of and for the periods
presented in all material respects.





The
annual report did not include an attestation report of the Company’s registered
public accounting firm regarding internal control over financial
reporting.  Management’s report was not subject to attestation by the
Company’s registered public accounting
firm pursuant to temporary rules of the Securities and Exchange Commission that
permit the Company to provide only management’s report in this Annual
Report.




- 24
-




PART II - OTHER INFORMATION





Item
1. Legal Proceedings





On
February 27, 2009, Cool Clean Technologies, Inc. (“Cool Clean”) filed a
complaint against the Company in the United States District Court, District of
Minnesota.  Cool Clean is alleging breach of negotiable instrument and
breach of contract and that it is due in excess of $626,000.  The
Company was served on April 2, 2009.





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




Our production
process has not yet, and may not achieve expected production volumes or
production costs.





ECO2’s
proprietary patented and patent-pending process has yet to achieve expected
production volumes, and there are no assurances that these volumes will be
attained.  Moreover, the Company has not been able to produce output
in volume at a cost low enough to be profitable under current market
conditions.  The Company is working to overcome the technical
obstacles posed by our unique technology, to improve production processes and
lower production costs.  The Company has identified additional
equipment that may help achieve operational goals and continues to evaluate
additional technologies.  The operational enhancements currently in
process may not deliver desired results, and the Company may never be able to
improve operations to the point where the Company can operate profitably on a
sustained basis. Actual results may differ materially from those predicted and
changes in the circumstances on which we base our predictions could materially
affect our actual results.





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.





We
need to raise additional capital to continue to operate.  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.





ECO2 needs to
raise additional capital to continue to operate, tom purchase new equipment, and
to improve production processes in the hopes of achieving sustainable,
profitable operations.  Such financing may not be available, or may
not be available on reasonable terms.





Salberg
& Company, P.A., in its report of independent registered public accounting
firm for the years ended December 31, 2008 and 2007, has expressed “substantial
doubt” as to our ability to continue as a going concern based on net losses and
negative cash flows in 2008, and a working capital deficit at December 31, 2008.
Our financial statements do not include any adjustments that might result from
the outcome of that uncertainty.





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.




- 25
-




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




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





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





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





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





Our
ability to generate revenue depends upon our ability to secure raw plastic (PET
and HDPE).  There is a world-wide market for these materials, and the
Company faces competition from China and other low-cost users.  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.




The
Company is susceptible to commodity pricing for both raw material and final
product sales, which could result in margins that will not allow the Company to
operate profitably.





The
Company purchases PET bales in an open market and sells the finished product in
an open market.  In order to generate a profit, the Company must
process material at a cost, which is lower than the spread between buying and
selling prices.  There may be times when competitive pricing changes
the spread and such changes are outside of the control of the
Company.  For example, aggressive buying by firms in China could
result in an increase in bale prices, while at the same time, excess production
capacity for virgin PET supply could result in a decrease in selling prices of
the finished product.





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.


- 26
-


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





We
will need to hire additional employees as we grow.





We will
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.





Not
applicable.





Item
3. Defaults Upon Senior Securities





Not
applicable.





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





In
connection with the contemplated financing agreements and pursuant to the
Preliminary Schedule 14C filed by the Company on May 4, 2009, the Company was
seeking to amend its Certificate of Incorporation again with the state of
Delaware (the “Amendment”) to increase the amount of authorized shares of
capital stock.  In April 2009, 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 Seven Billion (7,000,000,000) shares of
capital stock (the “Amended Authorized Amount”).  Of the Amended
Authorized Amount, Four Billion (4,000,000,000) shares shall be classified as
common stock and Three Billion (3,000,000,000) shares shall be classified as
preferred stock. The Definitive Schedule 14C was due for filing on May 8,
2009, but was not filed as the Company’s board of directors has decided not to
go forward with the Amendment to increase the amount of authorized shares of
capital stock. Definitive Schedule 14C was not filed.


- 27
-


Item
5.   Other Information





See Item
4 above.





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






/s/ Raymond M.
Salomon





Raymond
M. Salomon


Chief
Financial Officer








DATE





May 13,
2009








- 29
-


EXHIBIT
INDEX





Exhibit
      No.
            Description3.1(i)
            Amendment
      to Restated Certificate of Incorporation
            Incorporated
      by reference to Exhibit A to the DEF-14C filed by the Company on November
      30, 2005.3.2(i)
            Restated
      Certificate of Incorporation
            Incorporated
      by reference to Exhibit B to the DEF-14C filed by the Company on September
      9, 2002.3.3(i)
            Certificate
      of Incorporation
            Incorporated
      by reference to the Form S-18 Registration Statement filed by the Company
      File No. 33-31-67.3.4(i)
            Amendment
      to Restated Certificate of Incorporation
            Incorporated
      by reference to the DEF-14C filed by the Company on February 22,
      2007.3.5(i)
            Amendment
      to Restated Certificate of Incorporation
            Incorporated
      by reference to the DEF-14C filed by the Company on May 15,
      2008.3.6(i)
            Amendment
      to Restated Certificate of Incorporation
            Incorporated
      by reference to the DEF-14C filed by the Company on August 1,
      2008.3.7(i)
            Second
      Amended and Restated Certificate of Incorporation
            Attached.3.7(ii)
            Bylaws
            Incorporated
      by reference to Exhibit B to the DEF-14C filed by the Company on September
      9, 2002.31.1
            Certification
      of CEO pursuant to Section 302 of the Sarbanes-Oxley Act
            Attached31.2
            Certification
      of CFO pursuant to Section 302 of the Sarbanes-Oxley Act
            Attached32.1
            Certification
      of CEO pursuant to Section 906 of the Sarbanes-Oxley Act
            Attached32.2
            Certification
      of CFO pursuant to Section 906 of the Sarbanes-Oxley Act
            Attached