UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

______________

FORM 10-QSB

______________

ý

QUARTERLY REPORT UNDER SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2006

 ̈

TRANSITION REPORT UNDER SECTION 13 or 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM __________ TO __________

Commission file number000-25663

______________

ECOSPHERE TECHNOLOGIES, INC.

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

______________

|                                                               |                                     
|-------------------------------------------------------------- | ------------------------------------
|Delaware                                                       | 65-0841549                          
|(State or other jurisdiction of
incorporation or organization) | (I.R.S. Employer
Identification No.)

3515 S.E. Lionel Terrace
Stuart, Florida 34997

(Address of principal executive offices)

(772) 287-4846

(Issuers telephone number)

UltraStrip Systems, Inc

(Former name, former address and former fiscal year, if changed since last report)

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

APPLICABLE ONLY TO CORPORATE ISSUERS

Check whether the issuer (1) filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the past 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  ý    No   ̈.

State the number of shares outstanding of each of the issuers classes of common equity, as of the latest practicable date: 55,270,648 shares of common stock were outstanding as of November 7, 2006.

Transitional Small Business Disclosure Format (check one):  Yes   ̈    No  ý









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ECOSPHERE TECHNOLOGIES, INC.

FORM 10-QSB

TABLE OF CONTENTS

|                               |                                                             |     
|------------------------------ | ----------------------------------------------------------- | ----
|                               |                                                             | Page
|PART I - FINANCIAL INFORMATION |                                                            
|Item 1.                        | Consolidated Financial Statements (unaudited)               |     
|                               | Consolidated Balance Sheet                                  | 1   
|                               | Consolidated Statements of Operations.                      | 2   
|                               | Consolidated Statements of Cash Flows                       | 3   
|                               | Notes to Consolidated Financial Statements                  | 4   
|Item 2.                        | Managements Discussion or Analysis and Plan of Operation   | 18  
|Item 3.                        | Controls and Procedures                                     | 23  
|PART II - OTHER INFORMATION    |                                                            
|Item 1.                        | Legal Proceedings                                           | 24  
|Item 2.                        | Unregistered Sales of Equity Securities and Use of Proceeds | 24  
|Item 3.                        | Defaults Upon Senior Securities                             | 24  
|Item 4.                        | Submission of Matters to a Vote of Security Holders         | 24  
|Item 5.                        | Other Information                                           | 26  
|Item 6.                        | Exhibits                                                    | 26  





---





PART I - FINANCIAL INFORMATION

Item 1.

Consolidated Financial Statements.

ECOSPHERE TECHNOLOGIES, INC.

CONSOLIDATED BALANCE SHEET

|                                                                                                                                                  |  |                    |             |  
|------------------------------------------------------------------------------------------------------------------------------------------------- |  | ------------------ | ----------- | -
|                                                                                                                                                  |  | September 30,
2006 |            
|                                                                                                                                                  |  |                    | (unaudited) |  
|Current Assets                                                                                                                                    |  |                    |             |  
|Cash                                                                                                                                              |  | $                  | 1,970       |  
|Accounts receivable                                                                                                                               |  |                    | 161,346     |  
|Inventories                                                                                                                                       |  |                    | 143,630     |  
|Vendor deposits                                                                                                                                   |  |                    | 23,588      |  
|Prepaid expenses and other                                                                                                                        |  |                    | 87,314      |  
|Total current assets                                                                                                                              |  |                    | 417,848     |  
|Property and equipment, net                                                                                                                       |  |                    | 1,304,068   |  
|Patents, net                                                                                                                                      |  |                    | 70,825      |  
|Other Assets                                                                                                                                      |  |                    | 5,000       |  
|Total assets                                                                                                                                      |  | $                  | 1,797,741   |  
|Liabilities, Redeemable Convertible Cumulative Preferred Stock and Capital Deficit                                                                |  |                    |             |  
|Current Liabilities                                                                                                                               |  |                    |             |  
|Accounts payable                                                                                                                                  |  | $                  | 1,112,864   |  
|Accounts payable - related parties                                                                                                                |  |                    | 33,048      |  
|Accrued expenses                                                                                                                                  |  |                    | 1,150,242   |  
|Notes payable  related parties  - current portion (net of discount)                                                                              |  |                    | 2,446,107   |  
|Notes payable - current portion (net of discount)                                                                                                 |  |                    | 1,717,584   |  
|Total current liabilities                                                                                                                         |  |                    | 6,459,845   |  
|Notes payable  related parties, less current  portion                                                                                            |  |                    | 373,616     |  
|Notes payable  other, less current portion                                                                                                       |  |                    | 81,821      |  
|Total Liabilities                                                                                                                                 |  |                    | 6,915,282   |  
|Minority interest in consolidated affiliates                                                                                                      |  |                    |            |  
|Redeemable convertible cumulative preferred stock series A                                                                                        |  |                    |             |  
|250 shares authorized; 11 shares issued and outstanding as of September 30, 2006,
$25,000 per share redemption amount plus dividends in arrears   |  |                    | 1,135,702   |  
|Redeemable convertible cumulative preferred stock series B                                                                                        |  |                    |             |  
|4,000 shares authorized; 464 shares issued and outstanding as of September 30, 2006,
$2,500 per share redemption amount plus dividends in arrears |  |                    | 2,678,811   |  
|Commitments and Contingencies(Note 9)                                                                                                             |  |                    |             |  
|Capital Deficit                                                                                                                                   |  |                    |             |  
|Common stock,$0.01 par value; 150,000,000 shares authorized; 55,235,523
shares issued and outstanding at September 30, 2006                       |  |                    | 552,355     |  
|Additional paid-in capital                                                                                                                        |  |                    | 35,838,862  |  
|Accumulated deficit                                                                                                                               |  |                    | (45,323,272 | )
|Total capital deficit                                                                                                                             |  |                    | (8,932,055  | )
|Total liabilities, redeemable convertible cumulative preferred stock,  and capital deficit                                                        |  | $                  | 1,797,741   |  



See accompanying notes to the consolidated financial statements.



1



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ECOSPHERE TECHNOLOGIES, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

(UNAUDITED)

|                                                     |  |                                          |            |                                         |   |            |   |      |            |   |   |            |  
|---------------------------------------------------- |  | ---------------------------------------- | ---------- | --------------------------------------- | - | ---------- | - | ---- | ---------- | - | - | ---------- | -
|                                                     |  | For the three months ended
September 30, |            | For the nine months ended
September 30, |  
|                                                     |  | 2006                                     |            | 2005                                    |   | 2006       |   | 2005 |           
|Revenues                                             |  | $                                        | 1,382,368  |                                         | $ | 187,402    |   | $    | 2,075,324  |   | $ | 210,107    |  
|Cost of revenues                                     |  |                                          | 732,108    |                                         |   | 51,972     |   |      | 1,408,834  |   |   | 68,270     |  
|                                                     |  |                                          |            |                                         |   |            |   |      |            |   |   |            |  
|Gross profit                                         |  |                                          | 650,260    |                                         |   | 135,430    |   |      | 666,490    |   |   | 141,837    |  
|                                                     |  |                                          |            |                                         |   |            |   |      |            |   |   |            |  
|Operating expenses:                                  |  |                                          |            |                                         |   |            |   |      |            |   |   |            |  
|Selling, general and administrative                  |  |                                          | 1,133,743  |                                         |   | 1,130,148  |   |      | 3,463,145  |   |   | 3,357,739  |  
|Non-cash compensation expense                        |  |                                          | 129,294    |                                         |   | 544,586    |   |      | 322,546    |   |   | 629,387    |  
|Total operating expenses                             |  |                                          | 1,263,037  |                                         |   | 1,674,734  |   |      | 3,785,691  |   |   | 3,987,498  |  
|                                                     |  |                                          |            |                                         |   |            |   |      |            |   |   |            |  
|Loss from operations                                 |  |                                          | (612,777   | )                                       |   | (1,539,304 | ) |      | (3,119,201 | ) |   | (3,845,661 | )
|                                                     |  |                                          |            |                                         |   |            |   |      |            |   |   |            |  
|Other (income) expense:                              |  |                                          |            |                                         |   |            |   |      |            |   |   |            |  
|Other (income) expense                               |  |                                          | (1,732     | )                                       |   | (1,490     | ) |      | (8,286     | ) |   | (5,212     | )
|Interest expense                                     |  |                                          | 318,327    |                                         |   | 361,071    |   |      | 1,673,142  |   |   | 1,051,946  |  
|Total other expense                                  |  |                                          | 316,595    |                                         |   | 359,581    |   |      | 1,664,856  |   |   | 1,046,734  |  
|                                                     |  |                                          |            |                                         |   |            |   |      |            |   |   |            |  
|                                                     |  |                                          |            |                                         |   |            |   |      |            |   |   |            |  
|Minority Interest in net income (loss) of affiliates |  |                                          |           |                                         |   | (3,379     | ) |      | (40,951    | ) |   | (6,704     | )
|                                                     |  |                                          |            |                                         |   |            |   |      |            |   |   |            |  
|                                                     |  |                                          |            |                                         |   |            |   |      |            |   |   |            |  
|Net loss                                             |  |                                          | (929,372   | )                                       |   | (1,895,506 | ) |      | (4,743,106 | ) |   | (4,885,691 | )
|                                                     |  |                                          |            |                                         |   |            |   |      |            |   |   |            |  
|Preferred stock dividends                            |  |                                          | (39,312    | )                                       |   | (92,125    | ) |      | (159,390   | ) |   | (276,375   | )
|                                                     |  |                                          |            |                                         |   |            |   |      |            |   |   |            |  
|Net loss applicable to common stock                  |  | $                                        | (968,684   | )                                       | $ | (1,987,631 | ) | $    | (4,902,496 | ) | $ | (5,162,066 | )
|                                                     |  |                                          |            |                                         |   |            |   |      |            |   |   |            |  
|Net loss per common share (basic and diluted)        |  | $                                        | (0.02      | )                                       | $ | (0.04      | ) | $    | (0.09      | ) | $ | (0.11      | )
|                                                     |  |                                          |            |                                         |   |            |   |      |            |   |   |            |  
|Weighted average number of common shares outstanding |  |                                          | 54,985,523 |                                         |   | 49,360,746 |   |      | 54,203,563 |   |   | 48,174,914 |  





See accompanying notes to the consolidated financial statements.



2



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ECOSPHERE TECHNOLOGIES, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(UNAUDITED)

|                                                                            |  |                                        |            |      |   |            |  
|--------------------------------------------------------------------------- |  | -------------------------------------- | ---------- | ---- | - | ---------- | -
|                                                                            |  | For the nine months ended
September 30 |           
|                                                                            |  | 2006                                   |            | 2005 |  
|                                                                            |  |                                        |            |      |   |            |  
|Operating activities:                                                       |  |                                        |            |      |   |            |  
|Net loss                                                                    |  | $                                      | (4,743,106 | )    | $ | (4,885,691 | )
|                                                                            |  |                                        |            |      |   |            |  
|Adjustments to reconcile net loss to net cash used in operating activities: |  |                                        |            |      |   |            |  
|Depreciation and amortization                                               |  |                                        | 115,275    |      |   | 140,220    |  
|Provision for inventory impairment                                          |  |                                        | 50,000     |      |   |           |  
|Accretion of discount on notes payable                                      |  |                                        | 934,744    |      |   | 845,162    |  
|Non cast settlement of debt                                                 |  |                                        | 130,073    |      |   |           |  
|Non cash compensation expense                                               |  |                                        | 317,546    |      |   | 629,759    |  
|Non cash expense to renew loan                                              |  |                                        | 364,762    |      |   |           |  
|Minority interests in consolidated affiliates                               |  |                                        | (40,951    | )    |   | 6,704      |  
|Common stock issued for services                                            |  |                                        | 51,875     |      |   |           |  
|Change in operating assets and liabilities:                                 |  |                                        |            |      |   |            |  
|Accounts receivable                                                         |  |                                        | (141,145   | )    |   | (108,774   | )
|Inventories                                                                 |  |                                        | 654,516    |      |   | (933,103   | )
|Prepaid expenses                                                            |  |                                        | 76,305     |      |   | 14,591     |  
|Other assets                                                                |  |                                        | 21,239     |      |   | (58,065    | )
|Accounts payable                                                            |  |                                        | 632,904    |      |   | (221,427   | )
|Accounts payable - related parties                                          |  |                                        | (286,914   | )    |   | (292,082   | )
|Accrued expenses                                                            |  |                                        | 519,507    |      |   | 176,030    |  
|                                                                            |  |                                        |            |      |   |            |  
|Net cash used in operating activities                                       |  |                                        | (1,343,470 | )    |   | (4,686,676 | )
|                                                                            |  |                                        |            |      |   |            |  
|Investing activities:                                                       |  |                                        |            |      |   |            |  
|Purchase of equipment                                                       |  |                                        | (1,085,933 | )    |   | (61,641    | )
|                                                                            |  |                                        |            |      |   |            |  
|Net cash used in investing activities                                       |  |                                        | (1,085,933 | )    |   | (61,641    | )
|                                                                            |  |                                        |            |      |   |            |  
|Financing activities:                                                       |  |                                        |            |      |   |            |  
|Proceeds from issuance of notes payable and warrants to related parties     |  |                                        | 349,000    |      |   | 72,335     |  
|Repayments of notes payable                                                 |  |                                        | (26,551    | )    |   | (406,492   | )
|Repayment of notes payable to related parties                               |  |                                        | (931,237   | )    |   | (170,000   | )
|Proceeds from issuance of loans                                             |  |                                        | 2,793,000  |      |   | 4,975,550  |  
|Proceeds from sale of equity interests                                      |  |                                        |           |      |   | 612,607    |  
|Return of investment from affiliate                                         |  |                                        | 21,493     |      |   |           |  
|Proceeds from exercise of warrants                                          |  |                                        | 102,813    |      |   |           |  
|Distribution to partners of affiliate                                       |  |                                        | (45,201    | )    |   |           |  
|                                                                            |  |                                        |            |      |   |            |  
|Net cash provided by financing activities                                   |  |                                        | 2,263,317  |      |   | 5,084,000  |  
|                                                                            |  |                                        |            |      |   |            |  
|Net (decrease)/increase in cash                                             |  |                                        | (165,986   | )    |   | 335,683    |  
|                                                                            |  |                                        |            |      |   |            |  
|Cash, beginning of period                                                   |  |                                        | 167,956    |      |   | 183,405    |  
|                                                                            |  |                                        |            |      |   |            |  
|Cash, end of period                                                         |  | $                                      | 1,970      |      | $ | 519,088    |  





See accompanying notes to the consolidated financial statements.



3



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ECOSPHERE TECHNOLOGIES, INC.





For the three months and nine months ended September 30, 2006 and 2005



1.

SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Basis of Presentation

The accompanying unaudited consolidated financial statements include the accounts of Ecosphere Technologies, Inc., (Ecosphere or the Company), its wholly-owned subsidiaries, Ecosphere Systems, Inc. (ESI) and UltraStrip Envirobotic Solutions, Inc. (UES), and appropriate periods of its affiliates UltraStrip Japan, Ltd. (USJ) and Robotics Investment Group, LLC (RIG).  The Company changed its name from UltraStrip Systems, Inc. to Ecosphere Technologies, Inc. on August 10, 2006, upon approval of its stockholders.  ESI was formed during the first quarter of 2005 and markets the Companys water filtration technologies.  UES was formed in October 2005 to market, produce and service the maritime coating removal industry.  USJ was formed in April 2004 to market and service the maritime coating removal needs of the Japanese ports and RIG was formed to help finance the purchase of equipment to USJ.

The Company has been associated with two entities which have been consolidated into the Companys financial statements prior to this report in accordance with the provisions of Financial Accounting Standards Board Interpretation No. 46R, Consolidation of Variable Interest Entities.

The first entity, USJ was formed in April 2004 under Japanese law as a joint venture between the Company (49.9% ownership) and five Japanese companies (50.1% ownership):  Kamimura International Associates, LLC, Ihara Company, Ltd., Kyokuto Boeki Kaisha, Ltd., Shuwa Kaiun Kaisha, Ltd., and Chiba Marine Yokohama Co., Ltd.  The Company contributed $50,000 to the joint venture in 2004, provided a two year term loan of $32,000 during the first quarter of 2005, and provided an additional capital contribution of $44,222 in the third quarter of 2005.  On June 28, 2006, the Company sold all but 5% of its shares to the other partners in USJ.  Based upon this transaction and the lack of the Companys ability to control USJ, USJs financial statements will not be consolidated after June 28, 2006.

The second entity, RIG, was organized in December 2004.  The purpose of RIG was to purchase a M3500 robotic vehicle from the Company and lease the M3500 to USJ.  That lease is now terminated and the M3500 was sold to an unaffiliated Japanese joint venture in February 2006.  Given these transactions, the associated rationale for RIG being considered a variable interest entity no longer exists and RIGs financial statements have not been consolidated after March 31, 2006

The accompanying unaudited consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and with Item 310 of Regulation S-B. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States of America for complete financial statements. The consolidated financial statements reflect all normal recurring adjustments, which, in the opinion of management, are considered necessary for a fair presentation of the results for the periods shown.  The results of operations for the periods presented are not necessarily indicative of the results expected for the full fiscal year or for any future period. Certain prior period amounts have been reclassified to conform to the current period presentation. The information included in these unaudited consolidated financial statements should be read in conjunction with Management's Discussion and Analysis and Plan of Operation contained in this report and the audited financial statements and accompanying notes included in the Companys Annual Report on Form 10-KSB for the  year ended December 31, 2005.

Stock Based Compensation

As of January 1, 2006, the Company adopted the provisions of Statement of Financial Accounting Standards 123(Revised 2004), Share-Based Payment (SFAS 123(R)).  The Company had previously followed Accounting Principles Board (APB) Opinion 25, Accounting for Certain Transactions Involving Stock Compensation, and related interpretations in accounting for its employee stock options. Under APB No. 25, no compensation expense was recognized if the exercise price of the Companys employee stock options equaled or exceeded the market price of the underlying stock on the date of the grant.  Under SFAS 123(R), compensation expense is now recognized.  Stock-based compensation cost is measured at the date of grant, based on the fair value



4



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ECOSPHERE TECHNOLOGIES, INC.





of the award and is recognized over the directors and employees requisite service period.  The Company continues to use the Black-Scholes method to calculate the compensation expense of the options issued after the adoption date.  The Company has elected to use the modified prospective application method.  Under the modified prospective method, compensation cost, for all grants after the effective date, is recognized for the fair value of all share based award grants as those grants vest.  Additionally the portion of outstanding awards for which the requisite service has not been rendered, is recognized as compensation expense based upon the grant-date fair value of those awards as calculated under the original provisions of SFAS 123 Accounting for Stock-Based Compensation.

2.

GOING CONCERN

The accompanying consolidated financial statements were prepared assuming that the Company will continue as a going concern. This basis of accounting contemplates the realization of assets and the satisfaction of liabilities in the normal course of operations.  During the nine months ended September 30, 2006, the Company incurred losses applicable to common stock of approximately $4.9 million, has a working capital deficiency of approximately $6.0 million, and had outstanding convertible preferred stock that is redeemable under limited circumstances for approximately $3.8 million (including accrued dividends). The Company has not attained a level of revenues sufficient to support recurring expenses, and the Company does not presently have the resources to settle previously incurred obligations. These factors, among others, raise substantial doubt about the Companys ability to continue as a going concern.

The Companys continued existence is dependent upon its ability to resolve its liquidity problems, principally by obtaining additional debt financing and equity capital, and ultimately achieving profitable operations or realizing capital from the sale of its technologies.  While pursuing additional debt and equity funding, the Company must continue to operate on limited cash flow generated internally.

The unaudited consolidated financial statements do not include any adjustments to reflect the possible future effects on the recoverability and classification of assets or the amounts and classification of liabilities that may result from the inability of the Company to continue as a going concern. There are no assurances that the Company will be successful in achieving the above plans, or that such plans, if consummated, will enable the Company to obtain profitable operations or continue as a going concern.

3.

PROPERTY AND EQUIPMENT

The major components of property and equipment are summarized as follows:

|                                                  |  |                    |            |  
|------------------------------------------------- |  | ------------------ | ---------- | -
|                                                  |  | September 30,
2006 |           
|Computers and office equipment                    |  | $                  | 162,306    |  
|Plant and test equipment                          |  |                    | 717,954    |  
|Leasehold improvements                            |  |                    | 214,116    |  
|Furniture and fixtures                            |  |                    | 277,250    |  
|Robotic systems to provide services               |  |                    | 814,597    |  
|Tactical water filtration truck for demonstration |  |                    | 509,720    |  
|Vehicles                                          |  |                    | 41,233     |  
|Less:  Accumulated depreciation                   |  |                    | (1,433,108 | )
|                                                  |  |                    |            |  
|Total property and equipment                      |  | $                  | 1,304,068  |  



5



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ECOSPHERE TECHNOLOGIES, INC.





4.

ACCRUED EXPENSES

The major components of accrued expenses are summarized as follows:



|                                     |  |                    |           | 
|------------------------------------ |  | ------------------ | --------- | 
|                                     |  | September 30,
2006 |          
|Accrued payroll and related benefits |  | $                  | 484,331   | 
|Accrued interest                     |  |                    | 350,720   | 
|Accrued consulting                   |  |                    | 219,000   | 
|Accrued professional fees            |  |                    | 40,000    | 
|Other accrued expenses               |  |                    | 56,191    | 
|Total accrued expenses               |  | $                  | 1,150,242 | 

5.

NOTES PAYABLE

(a.)

Related Parties

Notes payable to related parties consist of the following:

|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |  |                    |           | 
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ------------------ | --------- | 
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |  | September 30, 2006 |          
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |  |                    |           | 
|1
Various notes payable to a former director who resigned in 2003 and  shareholder including (i) $1,000,000 note payable due on September 14, 2004, collateralized by all existing equipment and machinery utilized to manufacture the Companys products and (ii) $125,000 note payable, due on September 14, 2004, secured by all existing equipment and machinery utilized to manufacture the Companys products and (iii) $20,000 note payable, due upon demand.  During December 2005 and February 2006, the Company and the former director entered into note modifications and extension agreements which adjusted the principal amount to include the interest accrued to date.  The new note is payable $25,000 on January 15, 2006, $100,000 on February 15, 2006 and March 15, 2006, $87,500 due April 15, 2006, May 15, 2006, June 15, 2006, July 15, 2006 and the balance due on August 15, 2006, (plus interest accrued at 15% from December 1, 2005 through August 15, 2006.  Payments have been made per this schedule, excluding the July 15th payment, which was paid on August 31, 2006 and the final payment which is the current balance due.  As the amount was not paid in full at August 31, 2006, the interest charged on the outstanding balance increased to 18%. |  | $                  | 711,341   | 
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |  |                    |           | 
|2
Unsecured notes payable to a shareholder, net of unamortized discount, interest at prime plus 2% (10.25% at September 30, 2006), due as follows:  August 15, 2006 - $7,500, and $1,347,870 on February 13, 2007.  The August 15, 2006 payment has not been made as of the date of this report.  See Note B below regarding discount.  The principal amount of these notes as of September 30, 2006 is $1,355,370, reduced by unamortized loan discount of $136,333.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |  |                    | 1,219,037 | 
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |  |                    |           | 
|3
Unsecured notes payable to a group of stockholders, requiring 58 monthly payments of $15,067 at an interest rate of 26%.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   |  |                    | 446,345   | 
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |  |                    |           | 
|4
Unsecured notes payable to a director, interest at prime plus 2% (10.25% at September 30, 2006), due March 31, 2005.  The note has been extended through October 31, 2006 and is now due on demand.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |  |                    | 240,000   | 
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |  |                    |           | 
|5
Unsecured notes payable to Officer, interest at 12%, due on demand                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         |  |                    | 55,500    | 
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |  |                    |           | 



6



---

ECOSPHERE TECHNOLOGIES, INC.







|                                                                                                                                                                                                                                                                                                                                                        |  |   |           | 
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | - | --------- | 
|6
Notes payable to stockholders, interest at 18%, collateralized by certain machinery and equipment of the Company, due upon demand.                                                                                                                                                                                                                    |  |   | 50,000    | 
|                                                                                                                                                                                                                                                                                                                                                        |  |   |           | 
|7
secured note payable to a company owned by stockholders of the Company, interest at prime plus 2% (10.25% at September 30, 2006), due on demand.                                                                                                                                                                                                      |  |   | 40,000    | 
|                                                                                                                                                                                                                                                                                                                                                        |  |   |           | 
|8
Unsecured note payable to a shareholder and director of USJ, interest at 5%, due upon demand.                                                                                                                                                                                                                                                         |  |   | 47,500    | 
|                                                                                                                                                                                                                                                                                                                                                        |  |   |           | 
|9
Unsecured bridge finance notes payable of $10,000 to stockholders, net of discount,
convertible into common stock at the rate of $1.00 per share of common stock,
contains two detachable warrants for every dollar of principal to acquire shares of
common stock at an exercise price of $1.00 and $1.25 per share.  Interest at 5%,
due on demand. |  |   | 10,000    | 
|                                                                                                                                                                                                                                                                                                                                                        |  |   |           | 
|Total                                                                                                                                                                                                                                                                                                                                                   |  | $ | 2,819,723 | 
|                                                                                                                                                                                                                                                                                                                                                        |  |   |           | 
|Less:    current portion                                                                                                                                                                                                                                                                                                                                |  | $ | 2,446,107 | 
|                                                                                                                                                                                                                                                                                                                                                        |  |   |           | 
|Long-term debt                                                                                                                                                                                                                                                                                                                                          |  | $ | 373,616   | 



A.

On February 17, 2006, the Company and the holder renegotiated the payment terms for the notes in exchange for the granting of 100,000 warrants to purchase the Companys common stock at an exercise price of $1.00 per share. The estimated value of the warrants of $27,066 is being amortized to interest expense over the six month term remaining of the note.

B.

On February 13, 2006, the Company and holder renegotiated the payment terms for the notes, which were due on demand, in exchange for a forbearance fee of $371,000 included in the note and the granting of 1,000,000 warrants to purchase the Companys common stock at an exercise price of $1.00 per share. The estimated value of the warrants of $363,555 is being amortized to interest expense over the twelve month term of the note.



7



---

ECOSPHERE TECHNOLOGIES, INC.





(b.)

Other

Notes payable consist of the following:



|                                                                                                                                                                                                                                                                                                                                                                                                                    |  |                    |           | 
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ------------------ | --------- | 
|                                                                                                                                                                                                                                                                                                                                                                                                                    |  | September 30, 2006 |          
|                                                                                                                                                                                                                                                                                                                                                                                                                    |  |                    |           | 
|Unsecured convertible notes payable of $1,225,000, net of $77,712 discount, convertible into
common stock at the rate of $1.00 per share of common stock, contains two detachable warrants
for every dollar of principal to acquire shares of common stock at an exercise price of $1.00
and $1.25 per share.  Interest at 5%, due 12 months from respective issue dates ranging from
on demand through March 2007. |  | $                  | 1,147,288 | 
|                                                                                                                                                                                                                                                                                                                                                                                                                    |  |                    |           | 
|Unsecured convertible notes payable, convertible into common stock at a rate equal to the closing price the day before the investment was made.  Interest at 12%, due 12 months from the respective issues dates through August 2007.                                                                                                                                                                               |  |                    | 325,000   | 
|                                                                                                                                                                                                                                                                                                                                                                                                                    |  |                    |           | 
|Installment note, payable $3,319 monthly through December 2006, collateralized by equipment,
with no interest.                                                                                                                                                                                                                                                                                                      |  |                    | 13,275    | 
|                                                                                                                                                                                                                                                                                                                                                                                                                    |  |                    |           | 
|Installment note, payable $9,518 monthly through June 2008, collateralized by equipment, with
interest at 11.1%                                                                                                                                                                                                                                                                                                     |  |                    | 189,675   | 
|                                                                                                                                                                                                                                                                                                                                                                                                                    |  |                    |           | 
|Unsecured notes payable of $500,000,  interest at 8% per annum, due 12 months from respective
issue dates through September 2007.  These notes were issued with 1 share of restricted common
stock for each dollar invested in this note payable.  Discount relating to the restricted stock is
$375,833                                                                                                            |  |                    | 124,167   | 
|                                                                                                                                                                                                                                                                                                                                                                                                                    |  |                    |           | 
|Total                                                                                                                                                                                                                                                                                                                                                                                                               |  |                    | 1,799,405 | 
|                                                                                                                                                                                                                                                                                                                                                                                                                    |  |                    |           | 
|Less current portion                                                                                                                                                                                                                                                                                                                                                                                                |  | $                  | 1,717,584 | 
|                                                                                                                                                                                                                                                                                                                                                                                                                    |  |                    |           | 
|Long-term debt                                                                                                                                                                                                                                                                                                                                                                                                      |  | $                  | 81,821    | 

6.

COMMON STOCK

Shares issued

During the nine month period ended September 30, 2006, the Company issued 1,078,000 shares of common stock in connection with the conversion of the convertible notes payable to common stock; 408,000 shares of common stock issued in connection with the conversion of Preferred A shares; 492,650 shares of common stock were issued in connection with the conversion of Preferred B shares; and 182,000 shares were issued as a result of warrants exercised at no cost per warrant; 300,000 shares were issued as a result of the Company offering holders of warrants issued since November 2005 the right to exercise those warrants at the current market price of the share, 100,000 shares were issued to a consultant as partial compensation for services, 6,085 shares were issued as payment for interest expense, and 500,000 restricted shares were issued as part of a notes payable offering.

Shares reserved for issuance

As of September 30, 2006, 61,017,314 shares of common stock were reserved for issuance under the Companys three stock option plans, outstanding non-plan options, and warrants and upon conversion of the outstanding Series A and Series B Preferred Stock.



8



---

ECOSPHERE TECHNOLOGIES, INC.





7.

REDEEMABLE CONVERTIBLE CUMULATIVE PREFERRED STOCK

Series A

As of September 30, 2006 there were 11 shares of Series A Redeemable Convertible Cumulative Preferred Stock outstanding.  The shares are redeemable at the option of the Company at $27,500 per share plus accrued dividends, and the shares became redeemable at the option of the holder in June 2002 at $25,000 per share plus accrued dividends. Accrued dividends totaled $860,702 on September 30, 2006.  During the nine months ended September 30, 2006, various holders converted 17 shares of Series A Preferred Stock into common stock.

Series B

As of September 30, 2006 there were 464 shares of Series B Preferred Stock outstanding.  The shares are redeemable at the option of the Company at $3,000 per share plus accrued dividends, and the shares became redeemable at the option of the holder in June 2002 at $2,500 per share plus accrued dividends. Accrued dividends totaled $1,518,791 on September 30, 2006.  During the nine months ended September 30, 2006, various holders converted 590 shares of Series B Preferred Stock into common stock.

8.

LOSS PER SHARE

Basic loss per common share is computed on the basis of the weighted average number of common shares outstanding during each period presented.  Diluted loss per common share is computed on the basis of the weighted average number of common shares and dilutive securities outstanding.  Dilutive securities having an anti-dilutive effect on diluted loss per common share are excluded from the calculation.

The Companys outstanding options and warrants to acquire common stock and shares of common stock which may be issued upon conversion of outstanding redeemable convertible cumulative preferred stock (all aggregating 46,867,871 shares of common stock at September 30, 2006) are not included in the computation of loss per common share because the effects of inclusion would be anti-dilutive.

9.

STOCK-BASED COMPENSATION  PRO FORMA NET LOSS

SFAS 123(R) establishes standards surrounding the accounting for transactions in which an entity exchanges its equity instruments for goods or services. SFAS 123(R) focuses primarily on accounting for transactions in which an entity obtains employee services in share-based payment transactions, such as options issued under the Companys stock option plans. SFAS 123(R) provides for, and the Company has elected to adopt the modified prospective application under which compensation cost is recognized on or after the required effective date for the fair value of all future share based award grants and the portion of outstanding awards at the dated of adoption of this statement for which the requisite service has not been rendered, based on the grant-date fair value of those awards calculated under Statement 123 pro forma disclosures. The Companys stock option compensation expense was $104,898 and $199,826 for the three month and nine month periods ended September 30, 2006, respectively. This stock option expense is a non-cash item.

Prior to January 1, 2006, the Company accounted for its stock-based compensation using the intrinsic value method prescribed in Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees, and related interpretations. No stock-based employee compensation cost was reflected in net income, as all options granted under those plans had an exercise price equal to the market value of the underlying common stock on the date of grant.



9



---

ECOSPHERE TECHNOLOGIES, INC.





The application of SFAS 123(R) had the following effect on the reported amounts for the three month period ended September 30, 2006 relative to amounts that would have been reported using the intrinsic value method under previous accounting:

|                                    |  |                           |          |                        |   |             |   |   |          |  
|----------------------------------- |  | ------------------------- | -------- | ---------------------- | - | ----------- | - | - | -------- | -
|                                    |  | Using
Previous
Accounting |          | SFAS
123(R)
Adjustment |   | As Reported |  
|Operating Loss                      |  | $                         | (507,879 | )                      | $ | (104,898    | ) | $ | (612,777 | )
|Net Loss                            |  | $                         | (824,474 | )                      | $ | (104,898    | ) | $ | (929,372 | )
|Net loss applicable to common stock |  | $                         | (863,786 | )                      | $ | (104,898    | ) | $ | (968,684 | )
|Basic and Diluted                   |  | $                         | (0.02    | )                      | $ | (0.00       | ) | $ | (0.02    | )

Stock-based compensation for the three month period ended September 30, 2005 was determined using the intrinsic value method. The following table provides supplemental information for that period as if stock-based compensation had been computed under SFAS 123(R):

|                                                                                                                              |  |                                       |            |  
|----------------------------------------------------------------------------------------------------------------------------- |  | ------------------------------------- | ---------- | -
|                                                                                                                              |  | Three Months Ended
September 30,
2005 |           
|Net loss applicable to common stock, as reported                                                                              |  | $                                     | (1,987,631 | )
|Value of stock-based compensation expense determined under fair value-based method
for all awards, net of related tax effects |  |                                       | (546,541)  |  
|                                                                                                                              |  |                                       |            |  
|Pro forma net income                                                                                                          |  | $                                     | (2,534,172 | )
|                                                                                                                              |  |                                       |            |  
|(Loss) per share:                                                                                                             |  |                                       |            |  
|Basic and diluted net loss per common share  as reported                                                                    |  | $                                     | (0.04      | )
|Basic and diluted  net loss per common share  pro forma                                                                     |  | $                                     | (0.05      | )

The application of SFAS 123(R) had the following effect on the reported amounts for the nine month period ended September 30, 2006 relative to amounts that would have been reported using the intrinsic value method under previous accounting:

|                                    |  |                            |            |                        |   |             |   |   |            |  
|----------------------------------- |  | -------------------------- | ---------- | ---------------------- | - | ----------- | - | - | ---------- | -
|                                    |  | Using 
Previous
Accounting |            | SFAS
123(R)
Adjustment |   | As Reported |  
|Operating loss                      |  | $                          | (2,919,375 | )                      | $ | (199,826    | ) | $ | (3,119,201 | )
|Net loss                            |  | $                          | (4,543,280 | )                      | $ | (199,826    | ) | $ | (4,743,106 | )
|Net loss applicable to common stock |  | $                          | (4,702,670 | )                      | $ | (199,826    | ) | $ | (4,902,496 | )
|Basic and diluted                   |  | $                          | (0.09      | )                      | $ | (0.00       | ) | $ | (0.09      | )



10



---

ECOSPHERE TECHNOLOGIES, INC.





Stock-based compensation for the nine month period ended September 30, 2005 was determined using the intrinsic value method. The following table provides supplemental information for that period as if stock-based compensation had been computed under SFAS 123(R):

|                                                                                                                              |  |                                      |            |  
|----------------------------------------------------------------------------------------------------------------------------- |  | ------------------------------------ | ---------- | -
|                                                                                                                              |  | Nine Months Ended
September 30,
2005 |           
|Net loss applicable to common stock, as reported                                                                              |  | $                                    | (5,162,066 | )
|Value of stock-based compensation expense determined under fair value-based method
for all awards, net of related tax effects |  |                                      | (815,970   | )
|                                                                                                                              |  |                                      |            |  
|Pro forma net income                                                                                                          |  | $                                    | (5,978,036 | )
|                                                                                                                              |  |                                      |            |  
|(Loss) per share:                                                                                                             |  |                                      |            |  
|Basic and diluted net loss per common share  as reported                                                                    |  | $                                    | (0.11      | )
|Basic and diluted  net loss per common share  pro forma                                                                     |  | $                                    | (0.12      | )

The fair value of each option is estimated on the date of grant using the Black-Scholes option-pricing model. This model incorporates certain assumptions for inputs including a risk-free market interest rate, expected dividend yield of the underlying common stock, expected option life and expected volatility in the market value of the underlying common stock. We used the following assumptions for options issued in the following periods:

|                        |  |                                 |               |      |  |               | 
|----------------------- |  | ------------------------------- | ------------- | ---- |  | ------------- | 
|                        |  | Nine Months Ended
September 30, |              
|                        |  | 2006                            |               | 2005 | 
|Expected volatility     |  |                                 | 9.66  14.86% |      |  | 0%            | 
|Expected lives          |  |                                 | 5 -10 yrs.    |      |  | 10-20 yrs.    | 
|Risk-free interest rate |  |                                 | 4.36%-5.25%   |      |  | 4.22% - 4.50% | 
|Expected dividend yield |  |                                 | none          |      |  | None          | 

The Black-Scholes option-pricing model was developed for use in estimating the fair value of traded options, which have no vesting restrictions and are fully transferable. In addition, option valuation models require the input of highly subjective assumptions including the expected stock price volatility. Because the Companys stock options and warrants have characteristics different from those of its traded stock, and because changes in the subjective input assumptions can materially affect the fair value estimate, in managements opinion, the existing models do not necessarily provide a reliable single measure of the fair value of such stock options.  The risk free interest rate is based upon quoted market yields for United States Treasury debt securities. The expected dividend yield is based upon the Companys history of having never issued a dividend and managements current expectation of future action surrounding dividends.

As of September 30, 2006, there was $642,447 of total unrecognized compensation cost related to unvested options granted under the Companys option plans, $55,350 relates to options granted in 2005 and $587,097 relating to options granted in 2006. That cost is expected to be recognized over three years.



11



---

ECOSPHERE TECHNOLOGIES, INC.





A summary of the status of the Company's employee fixed plan options as of September 30, 2006 and 2005,  and changes during the nine months then ended is presented below:

|                                                                  |  |                                                |      |                                                |  |                                 |  |        |      |  |  |           | 
|----------------------------------------------------------------- |  | ---------------------------------------------- | ---- | ---------------------------------------------- |  | ------------------------------- |  | ------ | ---- |  |  | --------- | 
|                                                                  |  | September 30, 2006
Employee
Fixed Plan Options |      | September 30, 2005
Employee
Fixed Plan Options | 
|                                                                  |  | Weighted
Average
Exercise
Price                |      | Shares                                         |  | Weighted
Average
Exercise
Price |  | Shares |     
|Outstanding at beginning of period                                |  | $                                              | 1.22 |                                                |  | 3,580,497                       |  | $      | 2.19 |  |  | 722,163   | 
|                                                                  |  |                                                |      |                                                |  |                                 |  |        |      |  |  |           | 
|Granted                                                           |  |                                                | 0.65 |                                                |  | 155,000                         |  |        | 1.01 |  |  | 2,745,000 | 
|Exercised                                                         |  |                                                |     |                                                |  |                                |  |        |     |  |  |          | 
|Forfeited                                                         |  |                                                |     |                                                |  |                                |  |        |     |  |  |          | 
|Expired                                                           |  |                                                |     |                                                |  |                                |  |        |     |  |  | 25,000    | 
|                                                                  |  |                                                |      |                                                |  |                                 |  |        |      |  |  |           | 
|Outstanding at end of period                                      |  | $                                              | 1.19 |                                                |  | 3,735,497                       |  | $      | 1.22 |  |  | 3,442,163 | 
|                                                                  |  |                                                |      |                                                |  |                                 |  |        |      |  |  |           | 
|Exercisable at end of period                                      |  | $                                              | 1.18 |                                                |  | 3,404,763                       |  | $      | 1.22 |  |  | 3,132,996 | 
|                                                                  |  |                                                |      |                                                |  |                                 |  |        |      |  |  |           | 
|Weighted average fair value of 
options granted during the period |  | $                                              | .20  |                                                |  |                                 |  | $      | .34  |  |  |           | 
|                                                                  |  |                                                |      |                                                |  |                                 |  |        |      |  |  |           | 
|Weighted average remaining 
contractual life in years             |  |                                                | 8.3  |                                                |  |                                 |  |        | 6.0  |  |  |           | 

A summary of the status of the Companys employee fixed non-plan options as of September 30, 2006 and 2005 and changes during the nine months then ended is presented below:

|                                                                  |  |                                              |      |                                              |  |                                 |  |        |      |  |  |           | 
|----------------------------------------------------------------- |  | -------------------------------------------- | ---- | -------------------------------------------- |  | ------------------------------- |  | ------ | ---- |  |  | --------- | 
|                                                                  |  | September 30, 2006
Employee
Non-Plan Options |      | September 30, 2005
Employee
Non-Plan Options | 
|                                                                  |  | Weighted
Average
Exercise
Price              |      | Shares                                       |  | Weighted
Average
Exercise
Price |  | Shares |     
|Outstanding at beginning of period                                |  | $                                            | 1.75 |                                              |  | 8,910,003                       |  | $      | 2.61 |  |  | 4,210,003 | 
|                                                                  |  |                                              |      |                                              |  |                                 |  |        |      |  |  |           | 
|Granted                                                           |  |                                              | 0.87 |                                              |  | 4,100,000                       |  |        | 1.09 |  |  | 1,000,000 | 
|Exercised                                                         |  |                                              |     |                                              |  |                                |  |        |     |  |  |          | 
|Forfeited                                                         |  |                                              |     |                                              |  |                                |  |        |     |  |  |          | 
|Expired                                                           |  |                                              |     |                                              |  |                                |  |        |     |  |  |          | 
|                                                                  |  |                                              |      |                                              |  |                                 |  |        |      |  |  |           | 
|Outstanding at end of period                                      |  | $                                            | 1.46 |                                              |  | 13,010,003                      |  | $      | 2.22 |  |  | 5,210,003 | 
|                                                                  |  |                                              |      |                                              |  |                                 |  |        |      |  |  |           | 
|Exercisable at end of period                                      |  | $                                            | 1.72 |                                              |  | 8,910,003                       |  | $      | 2.41 |  |  | 4,793,331 | 
|                                                                  |  |                                              |      |                                              |  |                                 |  |        |      |  |  |           | 
|Weighted average fair value of 
options granted during the period |  | $                                            | 0.17 |                                              |  |                                 |  | $      | .27  |  |  |           | 
|                                                                  |  |                                              |      |                                              |  |                                 |  |        |      |  |  |           | 
|Weighted average remaining 
contractual life in years             |  |                                              | 7.0  |                                              |  |                                 |  |        | 5.3  |  |  |           | 





12



---

ECOSPHERE TECHNOLOGIES, INC.





A summary of the status of the Companys non-employee fixed non-plan options as of September 30, 2006 and 2005 and changes during the nine months then ended is presented below:



|                                                                  |  |                                                        |      |                                                        |  |                                 |  |        |      |  |  |           | 
|----------------------------------------------------------------- |  | ------------------------------------------------------ | ---- | ------------------------------------------------------ |  | ------------------------------- |  | ------ | ---- |  |  | --------- | 
|                                                                  |  | September 30, 2006
Non-Employee
Fixed Non-Plan Options |      | September 30, 2005
Non-Employee
Fixed Non-Plan Options | 
|                                                                  |  | Weighted
Average
Exercise
Price                        |      | Shares                                                 |  | Weighted
Average
Exercise
Price |  | Shares |     
|Outstanding at beginning of period                                |  | $                                                      | 1.18 |                                                        |  | 5,995,000                       |  | $      | 1.41 |  |  | 3,265,000 | 
|                                                                  |  |                                                        |      |                                                        |  |                                 |  |        |      |  |  |           | 
|Granted                                                           |  |                                                        |     |                                                        |  |                                |  |        | 1.00 |  |  | 1,800,000 | 
|Exercised                                                         |  |                                                        |     |                                                        |  |                                |  |        |     |  |  |          | 
|Forfeited                                                         |  | $                                                      | 1.00 |                                                        |  | 500,000                         |  |        |     |  |  |          | 
|Expired                                                           |  |                                                        |     |                                                        |  |                                |  |        | 2.00 |  |  | 200,000   | 
|                                                                  |  |                                                        |      |                                                        |  |                                 |  |        |      |  |  |           | 
|Outstanding at end of period                                      |  | $                                                      | 1.20 |                                                        |  | 5,495,000                       |  | $      | 1.22 |  |  | 4,865,000 | 
|                                                                  |  |                                                        |      |                                                        |  |                                 |  |        |      |  |  |           | 
|Exercisable at end of period                                      |  | $                                                      | 1.20 |                                                        |  | 5,411,667                       |  | $      | 1.48 |  |  | 3,740,000 | 
|                                                                  |  |                                                        |      |                                                        |  |                                 |  |        |      |  |  |           | 
|Weighted average fair value of 
options granted during the period |  | $                                                      |     |                                                        |  |                                 |  | $      | 0.10 |  |  |           | 
|                                                                  |  |                                                        |      |                                                        |  |                                 |  |        |      |  |  |           | 
|Weighted average remaining 
contractual life in years             |  |                                                        | 10.5 |                                                        |  |                                 |  |        | 15.8 |  |  |           | 

A summary of the status of the Company's non-employee variable non-plan options as of September 30, 2006 and 2005 and changes during the nine months then ended is presented below:

|                                                                  |  |                                                           |   |                                                           |  |                                 |  |        |      |  |  |           | 
|----------------------------------------------------------------- |  | --------------------------------------------------------- | - | --------------------------------------------------------- |  | ------------------------------- |  | ------ | ---- |  |  | --------- | 
|                                                                  |  | September 30, 2006
Non-Employee
Variable Non-Plan Options |   | September 30, 2005
Non-Employee
Variable Non-Plan Options | 
|                                                                  |  | Weighted
Average
Exercise
Price                           |   | Shares                                                    |  | Weighted
Average
Exercise
Price |  | Shares |     
|Outstanding at beginning of period                                |  | $                                                         |  |                                                           |  |                                |  | $      | 2.00 |  |  | 1,400,000 | 
|                                                                  |  |                                                           |   |                                                           |  |                                 |  |        |      |  |  |           | 
|Granted                                                           |  |                                                           |  |                                                           |  |                                |  |        |     |  |  |          | 
|Exercised                                                         |  |                                                           |  |                                                           |  |                                |  |        |     |  |  |          | 
|Forfeited                                                         |  |                                                           |  |                                                           |  |                                |  |        |     |  |  |          | 
|Expired                                                           |  |                                                           |  |                                                           |  |                                |  | $      | 2.00 |  |  | 1,400,000 | 
|                                                                  |  |                                                           |   |                                                           |  |                                 |  |        |      |  |  |           | 
|Outstanding at end of period                                      |  | $                                                         |  |                                                           |  |                                |  | $      |     |  |  |          | 
|                                                                  |  |                                                           |   |                                                           |  |                                 |  |        |      |  |  |           | 
|Exercisable at end of period                                      |  | $                                                         |  |                                                           |  |                                |  | $      |     |  |  |          | 
|                                                                  |  |                                                           |   |                                                           |  |                                 |  |        |      |  |  |           | 
|Weighted average fair value of 
options granted during the period |  | $                                                         |  |                                                           |  |                                 |  | $      |     |  |  |           | 
|                                                                  |  |                                                           |   |                                                           |  |                                 |  |        |      |  |  |           | 
|Weighted average remaining 
contractual life in years             |  |                                                           |  |                                                           |  |                                 |  |        | 0.0  |  |  |           | 







13



---

ECOSPHERE TECHNOLOGIES, INC.





A summary of the outstanding warrants issued for cash, financing, services and settlement as of September 30, 2006 is presented below:

|                                         |  |  |            | 
|---------------------------------------- |  |  | ---------- | 
|Description                              |  |  | Shares     | 
|                                         |  |  |            | 
|Warrants issued for cash                 |  |  | 1,585,010  | 
|Warrants issued for financing            |  |  | 21,649,221 | 
|Warrants issued for services             |  |  | 500,000    | 
|Warrants issued in settlement of lawsuit |  |  | 225,000    | 
|                                         |  |  |            | 
|Total shares                             |  |  | 23,959,231 | 

10.

COMMITMENT AND CONTINGENCIES

·

In December 2005, the Company entered into an agreement with a former officer and director relating to various notes payable and the accrued interest expense owed to the individual, the aggregate totaling $1,361,341. The repayment of this note included $50,000 due upon closing, $25,000 due on December 15, 2005 and January 15, 2006, $550,000 due on February 15, 2006, and $711,341 plus accrued interest due on August 15, 2006. On February 17, 2006, the Company and the individual renegotiated the payment terms of the amount due on February 15, 2006, providing for principal payments of $100,000 on February 19, 2006, $100,000 on March 15, 2006, and $87,500 due on April 15, 2006, May 15, 2006, June 15, 2006 and July 15, 2006.  All other provisions of the December 2005 agreements remain in place.  As of September 30, 2006, the principal outstanding balance of the note is $711,341.

·

On February 13, 2006, the Company renegotiated an agreement with a former officer and director regarding various amounts owed to the individual. This agreement re-established the payment terms under the following schedule:  $15,000 due immediately, $7,500 on May 20, 2006, $7,500 on August 8, 2006 and $1,347,870 due February 13, 2007.  The August 8th payment was not made as of September 30, 2006.  As of September 30, 2006, the principal outstanding balance of the note is $1,355,370.

·

The Company has had a relationship with Kamimura International Associates (KIA), a Washington D.C. based organization, whereby the principals at KIA agreed to assist the Company to develop the market in the Far East. The relationship resulted in the establishment of USJ, a company whose purpose was to market and deliver ship stripping services in Japan. The agreement with KIA was never formalized and the Company and KIA are in discussions regarding the amount of compensation which has been earned by KIA. The Company has accrued an amount it reasonably estimates may be required to resolve any outstanding issues between the Company and KIA.

·

On March 7, 2006, we entered into a Representation Agreement, effective for one year beginning July 1, 2005, with a corporation controlled by Mr. Thomas Von Essen, who was fire commissioner of the City of New York at the time of the September 11, 2001 terrorist attack.  Mr. Von Essen was vice president, special projects of ESI.As partial consideration,the corporation was granted options to purchase 500,000 shares of the Companys common stock at $1.00 per share.  The Representation Agreement was not renewed and in early August 2006, Mr. Von Essen resigned as an officer of ESI and cancelled the 500,000 vested options.

·

An April 11, 2006, we entered into an Investor Relations Consulting Agreement with Alliance Advisors, LLC.  Alliance Advisors provides the Company with advice and counsel relative to marketing the Company to the investor marketplace.  Under this agreement, the Company agreed to pay Alliance Advisors $7,500 per month for one year.  Additionally, the Company issued to Alliance Advisors 100,000 shares of its common stock.  Should Alliance Advisors not complete the term of the agreement, they must return to the Company a pro-rata share of 75% of the common stock.





14



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ECOSPHERE TECHNOLOGIES, INC.





·

Management Compensation Adjustment Plan.

In an effort to conserve cash outflow, the officers of the Company and subsidiaries listed below on May 26, 2006 entered into a Management Compensation Adjustment Plan (the “Plan”) and thereby amended their respective Employment Agreements. Under the Plan, they have agreed to reduce their aggregate annual salaries by approximately $400,000 and in return they received additional stock options and commissions based upon revenues of the Company and/or its subsidiaries as listed below. The options are exercisable at $0.83 per share over a five-year period and vest in equal increments every six months over a 24-month period subject to periodic performance reviews by the chief executive officer or the Compensation Committee at six month intervals. Additionally, the executives may be terminated after any six month review by the Board of Directors. The Management Adjustment Compensation Plan modified the Employment Agreements of these officers as follows:

|                                               |  |                   |           |                  |   |         |  |        |           |                       |  |                 |   |  |     |   |  |     |  
|---------------------------------------------- |  | ----------------- | --------- | ---------------- | - | ------- |  | ------ | --------- | --------------------- |  | --------------- | - |  | --- | - |  | --- | -
|Executives in the Program
And Principal Office |  | Current
Agreement |           | Revised
Pay Rate |   | Options |  | UES(2) |           | Commissions(1)
ESI(3) |  | Consolidated(4) |  
|Dennis McGuire                                 |  | $                 | 325,000   |                  | $ | 225,000 |  |        | 1,000,000 |                       |  |                |   |  |    |   |  | 3.0 | %
|James C. Rushing III                           |  |                   | 210,000   |                  |   | 185,000 |  |        | 600,000   |                       |  |                |   |  |    |   |  | 1.0 | %
|Stephen Johnson                                |  |                   | 250,000   |                  |   | 125,000 |  |        | 500,000   |                       |  | 2.0             | % |  |     |   |  | 1.0 | %
|Michael R. Donn, Sr.                           |  |                   | 137,000   |                  |   | 125,000 |  |        | 500,000   |                       |  |                 |   |  | 2.0 | % |  | 1.0 | %
|John  P. Odwazny                               |  |                   | 165,000   |                  |   | 100,000 |  |        | 250,000   |                       |  | 1.0             | % |  |     |   |  | 1.0 | %
|Jacqueline McGuire                             |  |                   | 125,000   |                  |   | 75,000  |  |        | 250,000   |                       |  | NA              |   |  | NA  |   |  |    |  
|Totals                                         |  | $                 | 1,212,000 |                  | $ | 835,000 |  | $      | 3,100,000 |                       |  | 3.0             | % |  | 2.0 | % |  | 7   | %



(1)

Commissions apply to any revenues whatsoever, including product or services sales as well as transactions to monetize technology portfolio inventory.

(2)

UES refers to UltraStrip Envirobotic Solutions, Inc., a wholly-owned subsidiary of the Company.

(3)

ESI refers to Ecosphere Systems, Inc., a wholly-owned subsidiary of the Company.

(4)

Consolidated means consolidated revenues of the Company, including UES and ESI.

11.

OPERATING SEGMENTS

Pursuant to FAS 131, the Company defines an operating segment as:

·

A business activity from which the Company may earn revenue and incur expenses;

·

Whose operating results are regularly reviewed by the chief operating decision maker to make decisions about resources to be allocated to the segment and assess its performance; and

·

For which discrete financial information is available.

In 2005, the Company expanded its business offerings to include the water filtration technology business. Recognizing that each business offering applied to different markets, the Company established two operating entities or segments, which are defined as each business line that it operates. This however, excludes corporate headquarters, which does not generate revenue.

Our operating entities are defined as follows:

·

ESI was formed during the first quarter of 2005 to market and produce the Companys water filtration technology.

·

UES was formed in October 2005 to continue marketing and development of the Companys patented robotic coasting removal technology.



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ECOSPHERE TECHNOLOGIES, INC.





·

The table below presents certain financial information by business segment for the three months ended September 30, 2006.

|                  |  |     |     |     |   |                |  |           |           |       |   |           |  |   |           |  
|----------------- |  | --- | --- | --- | - | -------------- |  | --------- | --------- | ----- | - | --------- |  | - | --------- | -
|                  |  | ESI |     | UES |   | Segment Totals |  | Corporate |           | Total |  
|Revenues          |  | $   |    |     | $ | 1,382,368      |  | $         | 1,382,368 |       | $ |          |  | $ | 1,382,368 |  
|Cost of revenues  |  |     |    |     |   | 732,108        |  |           | 732,108   |       |   |          |  |   | 732,108   |  
|Gross margin      |  |     |    |     |   | 650,260        |  |           | 650,260   |       |   |          |  |   | 650,260   |  
|Operating expense |  |     | n/a |     |   | n/a            |  |           | n/a       |       |   | 1,263,037 |  |   | 1,263,037 |  
|Other expense     |  |     | n/a |     |   | n/a            |  |           | n/a       |       |   | 316,595   |  |   | 316,595   |  
|Net loss          |  |     |     |     |   |                |  |           |           |       |   |           |  | $ | (929,372  | )

·

The table below presents certain financial information by business segment for the nine months ended September 30, 2006.

|                  |  |           |     |     |   |                |  |           |           |       |   |           |  |   |            |  
|----------------- |  | --------- | --- | --- | - | -------------- |  | --------- | --------- | ----- | - | --------- |  | - | ---------- | -
|                  |  | Ecosphere |     | UES |   | Segment Totals |  | Corporate |           | Total |  
|Revenues          |  | $         |    |     | $ | 2,075,324      |  | $         | 2,075,324 |       | $ |          |  | $ | 2,075,324  |  
|Cost of revenues  |  |           |    |     |   | 1,408,834      |  |           | 1,408,834 |       |   |          |  |   | 1,408,834  |  
|Gross margin      |  |           |    |     |   | 666,490        |  |           | 666,490   |       |   |          |  |   | 666,490    |  
|Operating expense |  |           | n/a |     |   | n/a            |  |           | n/a       |       |   | 3,785,691 |  |   | 3,785,691  |  
|Other expense     |  |           | n/a |     |   | n/a            |  |           | n/a       |       |   | 1,664,856 |  |   | 1,664,856  |  
|Net loss          |  |           |     |     |   |                |  |           |           |       |   |           |  | $ | (4,743,106 | )

The determination to establish the separate business segments was made in the last quarter of 2005. As such, management did not establish processes and procedures to capture costs by segment during the year, and it would be impracticable to do so. During 2006, management is establishing procedures to capture all of the required reporting information.

12.

SUPPLEMENTAL CASH FLOW INFORMATION

Supplemental disclosure is as follows:

|                                                                                     |  |                                         |           |      |   |           | 
|------------------------------------------------------------------------------------ |  | --------------------------------------- | --------- | ---- | - | --------- | 
|                                                                                     |  | For the Nine Months Ended
September 30, |          
|                                                                                     |  | 2006                                    |           | 2005 |  
|Cash paid for interest                                                               |  | $                                       | 92,129    |      | $ | 556       | 
|Non-cash investing and financing activities:                                         |  |                                         |           |      |   |           | 
|Accrued preferred stock dividends                                                    |  | $                                       | 159,390   |      | $ | 276,375   | 
|Warrants issued in connection with financing                                         |  | $                                       | 743,148   |      | $ |          | 
|Warrants issued for services                                                         |  | $                                       |          |      | $ | 629,759   | 
|Common stock issued to settle debt obligations                                       |  | $                                       | 1,078,000 |      | $ | 4,950,550 | 
|Note payable to former partner with Ultrastrip Japan, Ltd.                           |  | $                                       |          |      | $ | 47,500    | 
|Series A Redeemable Convertible Cumulative Preferred Stock converted to
common stock |  | $                                       | 425,000   |      | $ |          | 
|Series B Redeemable Convertible Cumulative Preferred Stock converted to
common stock |  | $                                       | 1,475,000 |      | $ |          | 
|Conversion of accounts payable and accrued expenses to debt                          |  | $                                       | 615,109   |      |   |          | 
|Cashless exercise of warrants into common stock                                      |  | $                                       | 182,000   |      |   |          | 



16



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ECOSPHERE TECHNOLOGIES, INC.







| |  |  |  |  |  |  | 
| |  |  |  |  |  |  | 

13.

SUBSEQUENT EVENTS

In October, the Company collected $234,000 from the City of Waveland in full payment for the water filtration services the Company provided to the city after Hurricane Katrina.

The Company raised $50,000 as part of its 8% Note offering.

The Company borrowed and repaid $5,000 from an officer. The Company also repaid $55,500 in full repayment of loans previously provided by the officer.

In December 2006, the Company borrowed $100,000 from an officer.







17



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Item 2.

Managements Discussion and Analysis and Plan of Operation.

Overview

The Company creates engineered and patented Clean Technology solutions. The Company has an intellectual property portfolio of registered and pending patents, trade secrets, trademarks, and copyrights for technologies that address pressing global environmental and humanitarian issues. Except as described below, all of our material intellectual property was invented or co-invented by our founder and Chief Executive Officer, Mr. Dennis McGuire, and assigned to us. Our intellectual property portfolio currently provides us with an opportunity to obtain 424 patent registrations throughout the world. Of these:

·

we hold 10 registered United States patents all relating to our robotic coating removal technology, airplane and automotive paint removal technology;

·

we effectively have 411 patent applications pending through either actual filings or reserved under the right to seek priority date filing covering our robotic coating removal technology and automotive paint removal technology in numerous countries, including Europe, Asia and the rest of the world; and

·

we have three United States patents pending relating to our water filtration system.

Presently, the Company owns several technologies that are completed and available for global marketing. While these technologies are beginning to produce revenues as we begin to market our products and services, our stockholders and other readers should understand that substantial revenues and profits will come from the licensing or sale of the Companys Clean Technologies. The Company will identify national/international companies who have an existing synergy or expansion interest in the markets that these technologies can exploit. To execute this model we are now in the process of engaging appropriate national representation to market the licensing or sale of these portfolio technologies. The fully-developed technologies as well as those that require additional development are the result of investment by the Company in research and development expenditures over the years that are required to be reflected as operating losses on the Companys consolidated financial statements. Our patents and other proprietary technology described in the paragraph above are the result of the over $44 million expended since inception of the Company as reported on the Companys financial statements as accumulated deficit.

As a result of this vision, we have developed a business model and related products to protect community water systems throughout the United States and the world through the only EPA verified portable high-volume water filtration system and we have developed products which reduce the discharge of contaminated residue into oceans, other water systems and the air.

We have two subsidiaries:

·

Ecosphere Systems, Inc. or ESI which we organized in April 2005 to operate our water filtration system business;

·

ltraStrip Envirobotic Solutions, Inc. or UES which we organized in October 2005 to operate our coating removal business; and

·

Ecosphere Energy Solutions, Inc. which we organized in November 2006. We expect that this new subsidiary will use our innovative Clean Technology in the field of renewable energy.

During the second quarter of 2006, we completed development of a new, less costly and more efficient, robotic coating removal system. In April 2006, we entered into an Exclusive Distribution and Purchase agreement with a distributor in Singapore,  for the purchase of two new robotic coating removal systems to begin the use of our new coating removal technology in Singapore.  We received payment and in July 2006 shipped those two robotic systems to Singapore.  In October 2006, this Singapore based company entered into a letter of intent with us to purchase eight additional robotic coating removal systems beginning in 2006. We have not received a purchase order for delivery of any of these systems. We also shipped two systems to BAEs San Francisco shipyard in August and commenced providing coating removal services to vessels in that shipyard.  Additionally, during the second quarter the manufacturing of the water filtration system was completed, integrated by Pierce Manufacturing Co. into Tactical Water Filtration Truck (TWFT) and delivered by Pierce to us in August 2006.  This TWFT is being used to demonstrate the capabilities of providing potable water to areas which have had their water systems disrupted.



18



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Critical Accounting Estimates

In response to the SEC's financial reporting release, FR-60, Cautionary Advice Regarding Disclosure About Critical Accounting Policies, the Company has selected its more subjective accounting estimation processes for purposes of explaining the methodology used in calculating the estimate, in addition to the inherent uncertainties pertaining to the estimate and the possible effects on the Company's financial condition. The three accounting estimates are discussed below. These estimates involve certain assumptions that if incorrect could create a material adverse impact on the Companys results of operations and financial condition.

Revenue Recognition

Revenues from sales of equipment are generally recognized when products are delivered to and accepted by the customer, economic risk of loss has passed to the customer, the price is fixed or determinable, collection is probable and any future obligations of the Company are insignificant. Revenues from water jetting service contracts are recognized ratably over the service period or as the services are rendered. Payments received in advance of the performance of services are deferred until the services are performed. The Company uses its judgment in assessing when revenues are realizable and earned, and records revenue based on the specific provisions of its contracts with third parties and its assessment of when collection is probable.

Determination of the Estimated Market Value of the Companys Common Stock

Effective January 25, 2006, the Companys common stock began trading on the Over-the-Counter Bulletin Board, under the symbol USTP.  With our name change on August 10, 2006 to Ecosphere Technologies, Inc., the symbol changed shortly thereafter to ESPH.  Prior to January 25, 2006, the Companys common stock was not listed on any national securities exchange or established trading market, and therefore there was no easily determined market value for the shares. As a result, our management made an estimate as to fair market value. The Company calculated the weighted average price per share using primary sales of common stock during each reporting period. This average was then used in assigning values to stock issued for services, as the market price of the underlying stock for options granted to employees and service providers and for purposes of computing stock appreciation for variable options. As a result, estimates were made as to the market value of the Companys common stock as of any given date for use in various non-cash equity transactions throughout a given reporting period. The Company believes this approach provided the most objective basis for assessing the market value of its common stock, prior to trading on the OTC Bulletin Board, and provided consistency among reporting periods.  After January 25, 2006, management utilizes the market value of its stock based upon the closing price for any particular day.

Useful Lives and Impairment of Machinery and Equipment and Patents

The Company capitalizes as machinery and equipment its automated water-jetting systems and its water filtration systems upon completion of all manufacturing and testing, if the unit is not being sold. The Company determines the useful lives of machinery and equipment based on the forecasted durability of the raw materials used in its manufacture and the technology utilized in the system. While some of the individual components of the Companys systems may individually have longer useful lives than the Companys estimate for the useful life of the entire system (i.e., 10 years or longer), the Company believes that the technological advancement in both the robotic system and water filtration system would be obsolete after five years. Accordingly, the Company has used five years to depreciate its robotic coating removal systems and its water filtration systems.

The Company determines the useful lives of its patents based on the remaining life of the patent issued by the U.S. Patent Office. Management believes the legal life of the patent is a reasonable period of time over which the Company expects to realize the benefits of its intellectual property rights because of the broad nature of the Companys patents and the Company's intent to protect its intellectual property rights over the lives of its patents.

The Company reviews for impairment its machinery and equipment used in its hydro jetting services, whenever events or changes in circumstances indicate that the carrying amount of its assets may not be recoverable. Such events or changes in circumstances might occur when a new version of a product is launched or when a major technological advancement in robotic operations or ultra high water pressure becomes available. During the quarter ended September 30, 2006 and 2005, the Company did not have any impairment write offs.



19



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Results of Operations

For the Three Months Ended September 30, 2006 Compared to the Three Months Ended September 30, 2005

The Companys net loss decreased significantly to approximately $969,000 during the quarter ended September 30, 2006 when compared to the year earlier period.  The primary causes of this decrease in losses is higher gross profits from the sale of two robotic systems.  Additionally, in 2005 the Company expensed, as non-cash compensation expense, the value of options granted to a former chairman, since the former chairman no longer has any relationship with the Company.

Revenues

Revenues were $1,382,368 for the three months ended September 30, 2006 as compared to $187,402 for the three months ended September 30, 2005.  The increase resulted primarily from the delivery of two robotic systems and related spare parts to an overseas customer for $1,280,000.  Additionally, the Company generated nearly $80,000 of service revenues by providing coating removal services to a customer at the Port of San Francisco.  In the same quarter of 2005, the Company recognized $125,000 of revenues in support of the Hurricane Katrina recovery project, had spare part sales of $51,000, and generated commissions of 11,000.

Cost of Revenues

Cost of revenues was $732,108 for the three months ended September 30, 2006, as compared to $51,972 for the three months ended September 30, 2005.  Gross profits increased during the quarter as compared to 2005 due to the higher sales volume on the robotic system sales during 2006.

Operating Expenses

Operating expenses for the three months ended September 30, 2006 were $1,263,037 compared to $1,674,734 for the three months ended September 30, 2005. This comparative decrease resulted from the Companys expensing of options granted in 2005 to a former chairman.

Loss from Operations

Loss from operations for the three months ended September 30, 2006 was $612,777 compared to $1,539,304 loss for the three months ended September 30, 2005.  The decrease in loss from operations in 2006 versus 2005 was due to the increase in revenues from the robotic system sales with higher gross margins and the reduction of non-cash charges compared to 2005, which included an option grant in 2005 to a former chairman.

Interest Expense

Interest expense was $318,327 and $361,071 for the three months ended September 30, 2006 and 2005, respectively. This primary component consisted of the valuation of warrants issued in connection with 2006 convertible debt associated with the Companys private placement offering as compared to the valuation of similarly issued warrants in 2005. Because we raised less money in the third quarter of 2006 as compared to the same quarter of 2005, the actual non-cash interest charge was lower in 2006.  For further information on this charge, see the discussion under Interest Expense for the comparison of the nine months ended September 30, 2006 and 2005.

Preferred Stock Dividends

Preferred stock dividends were $39,312 for the three months ended September 30, 2006 and $92,125 for the three months ended September 30, 2005. These dividends reflect Company obligations to preferred stockholders that have not been paid and decreased from 2005 because a significant number of holders chose to convert their preferred stock into common stock



20



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Net Loss Applicable to Common Stock

Net loss applicable to common stock was $968,684 for the three months ended September 30, 2006, compared to a net loss of $1,987,631 for the three months ended September 30, 2005. Net loss per common share was $0.02 for the three months ended September 30, 2006 and $0.04 for the three months ended June 30, 2005.  The primary cause of the decrease in net loss applicable to common stock was the sale of two robotic systems with higher gross margins and a reduction of non-cash accounting charges discussed above.

For the Nine Months Ended September 30, 2006 Compared to the Three Months Ended September 30, 2005

The Companys net loss decreased to approximately $4,903,000 during the nine months ended September 30, 2006 when compared to the year earlier period.  The primary cause of this decrease is higher revenues and gross profits, offset by higher interest charges the Company incurred as part of its financing activities.

Revenues

Revenues were $2,075,324 for the nine months ended September 30, 2006 as compared to $210,107 for the nine months ended September 30, 2005.  The increase resulted from the sale of three of the Companys robotic system to overseas customers. The Company also had spare part sales of $83,414 and $72,115 during the nine months ended September 30, 2006 and 2005, respectively. The Company had royalty revenues of $14,316 and $13,020 for the nine months ended September 30, 2006 and 2005 respectively. Royalties and spare parts sales are a result of orders placed by our customer (primarily Shaw) and the Company has no influence over the timing of the revenues.

Cost of Revenues

Cost of revenues was $1,408,834 for the nine months ended September 30, 2006, as compared to $68,270 for the nine months ended September 30, 2005. Gross profits increased during the nine months of 2006 compared to 2005 due to the higher sales volume.

Operating Expenses

Operating expenses for the nine months ended September 30, 2006 were $3,785,691 compared to $3,987,498 for the nine months ended September 30, 2005. This decrease results from a non-cash 2005 charge resulting from an option award to a former chairman. No comparable charge occurred in 2006.

Loss From Operations

Loss from operations for the nine months ended September 30, 2006 was $3,119,201 compared to $3,845,661 loss for the nine months ended September 30, 2005.  The decrease in loss from operations in 2006 versus 2005 is due to the Companys higher sale volume and related gross profit and a reduction in non-cash compensation expense associated with a 2005 option grant to a former chairman.

Interest Expense

Interest expense was $1,673,142 and $1,051,946 for the nine months ended September 30, 2006 and 2005, respectively. This increase was attributable to the valuation of warrants issued in connection with 2006 convertible debt associated with the Companys private placement offering as compared to the valuation of similarly issued warrants in 2005. The accounting treatment of the warrants, when combined with the convertibility feature of the debt, effectively reduces the cost to acquire a share of stock. This reduction, when compared to the conversion price (market value as prescribed by the Companys Board) results in a beneficial conversion feature, which means that a purchaser of the convertible debt could convert immediately and effectively make a profit. Accounting guidelines dictate that the beneficial conversion feature be appropriately accounted for and that has resulted in an interest expense charge of $351,000. Additionally, the establishment of new payment terms of loans to two former officers and stockholders required a loan forbearance cost of $371,000 plus the issuance of additional warrants to purchase common stock at $1.00. These warrants have a value for accounting purposes of $390,000 which will be expensed as interest ratably over the remaining period of the loans. The expense in the nine months ended September 30, 2006 of the warrants related to the establishment of the new payment terms was $254,000.



21



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Preferred Stock Dividends

Preferred stock dividends were $159,390 for the nine months ended September 30, 2006 and $276,375 for the nine months ended September 30, 2005. These dividends reflect Company obligations to preferred stockholders that have not been paid and decreased from 2005 because a significant number of holders chose to convert their preferred stock into common stock

Net Loss Applicable to Common Stock

Net loss applicable to common stock was $4,902,496 for the nine months ended September 30, 2006, compared to a net loss of $5,162,066 for the nine months ended September 30, 2005.  Net loss per common share was $0.09 for the nine months ended September 30, 2006 and $0.11 for the nine months ended September 30, 2005.  The primary cause of the decrease in net loss applicable to common stock is the increased revenues and gross profits discussed above.

Liquidity and Capital Resources

Net cash used in operating activities was $1,343,470 for the nine months ended September 30, 2006, compared to $4,686,676 for the nine months ended September 30, 2005. This decrease relates to a reduction in inventories due to the sale of robotic systems, and an increase in accounts payable and accrued expenses during 2006 compared to 2005.

The Companys net cash used in investing activities was $1,085,933 for the nine months ended September 30, 2006 compared to net cash used by investing activities of $61,641 for the nine months ended September 30, 2005. The change in cash is due to a building of two robotic systems for the Companys use in coating removal services. Additionally, in 2006 the Company constructed a tactical water filtration system which will be used for demonstration purposes.

The Companys net cash provided by financing activities was $2,263,317 for the nine months ended September 30, 2006 compared to $5,084,000 for the nine months ended September 30, 2005. The decrease is a result of the Companys reduction and ultimate termination of its convertible note program initiated in November 2004 and limited additional borrowings.

The Company has been seeking to finalize a financing with a limited number of institutional investors which, if closed, will provide $5 million in net proceeds from debt financing which will alleviate our liquidity pressure. Three investors have agreed to lend us $3.75 million. They have further agreed that as they seek additional institutional investors, the Company may also seek accredited investors to provide the balance of $1.25 million either through subscriptions for the same debt financing or an equity financing at a discount to fair market value. To date, two investors identified by the Company have subscribed to this offering for a total of $300,000 additional capital towards the $5.0 million. The commitment of the three institutional investors extends to December 29, 2006 to allow all parties the opportunity to raise the additional money. While we are hopeful we can close this transaction in the next week, we can not assure you we will be successful.

As of December 7, 2006, the Company had $95,016 and lacks financial resources to meet its September 30, 2006 working capital deficit of $6,041,997 and future operating costs. This lack of necessary working capital is adversely impacting the Companys ability to do business, particularly in terms of timely payment of vendors, 16 weeks of accrued management salaries and expenses. Dennis McGuire, President & CEO has provided a short-term loan and expects to continue to do so as needed to help maintain the Companys operations.

Our continued operations depend on Oshkosh/Pierce ability to make sales of its TWFT, BAE Systems continuing to provide ships at its shipyards for the company to perform its services, as well as our Singapore customer to execute on its agreement to purchase our robotic systems. Additionally, we have engaged marketing and investment consultants to find a strategic investor or buyer for one or more of our technologies, and/or other outside sources of funding. Although our Oshkosh/Pierce TWFT product has a longer sales cycle than the Companys other products, the eventual payoff is expected to benefit the Company by the TWFT joining many other proven products now being marketed and distributed by Oshkosh/Pierce and provide a reliable stream of growing revenues to the Company. We expect this to begin in the last half of 2007. We expect to increase revenue from BAE Systems once we obtain the necessary capital to produce additional robots.



22



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The Companys short-term and long-term liquidity requirements are expected to result from working capital needs to purchase inventory, retire existing trade liabilities and to pay other operating expenses. The private placement of $5.0 million is expected to allow the Company to bring working capital including vendors and payrolls to a current position and produce at least an additional $1.8 million of income producing assets as well as fund operations for six months and bring the Company to a positive cash flow position.

Related Party Transactions

The Company received a short term loan from officers during the quarter for $134,000.  Also during the quarter, the Company repaid $278,500 of short term loans from various officers, which included prior loans made to meet our working capital needs.  As of the date of this Report, all of these loans have been repaid.

Subsequent to the end of the quarter, one officer advanced the Company $5,000 and the Company repaid a total of $60,500 of short term loans to various officers.

Additionally, as of September 30, 2006, management participating in the Management Compensation Adjustment Plan have accrued $308,000 of salaries and commissions pending an improved working capital situation.

Forward-Looking Statements

This Report contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 relating to our liquidity, our ability to complete the proposed financing and our ability to sell or license our technology(ies).Additionally, words such as seek, intend, believe, plan, estimate, expect, anticipate and other similar expressions identify forward-looking statements within the meaning of the Act. Some or all of the results anticipated by these forward-looking statements may not occur. Forward-looking statements involve known and unknown risks and uncertainties, both general and specific to the matters discussed in this Report. Factors that could cause or contribute to such differences include, but are not limited to, our ability to generate revenues from the sale of our products, our ability to negotiate a fair price for one or more of our technologies, our ability to resolve contractual issues and the condition of the public equity markets including our common stock price. See also the risk factors contained in our Form 10-KSB for the year ended December 31, 2005. We do not intend to update the results of these forward-looking statements.

Item 3.

Controls and Procedures.

We have established disclosure controls and procedures to ensure that material information relating to the Company and its consolidated subsidiaries is made known to the officers who certify the Companys financial reports, as well as other members of senior management and the Board of Directors, to allow timely decisions regarding required disclosures. As of the end of the period covered by this report, the Company carried out an evaluation, under the supervision and with the participation of the Companys management, including the Companys Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of the Companys disclosure controls and procedures pursuant to Rule 13a-15 of the Securities and Exchange Act of 1934. Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that the Companys disclosure controls and procedures are effective in timely alerting them to material information related to the Company that is required to be included in the Companys annual and periodic SEC filings.

Our management, including our Chief Executive Officer and Chief Financial Officer, does not expect that our disclosure controls and procedures or our internal controls will prevent all error and all fraud. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the Company have been detected.



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PART II  OTHER INFORMATION

Item 1.

Legal Proceedings.

None.

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds.

During the period from August 24, 2006 until September 28, 2006, the Company sold $500,000 of units consisting of 8% unsecured promissory notes and shares of the Companys common stock. For each dollar invested, the investors received one share of common stock.

On August 10 and 11, 2006, the Company issued, under its 2006 Equity Compensation Plan, 230,958 shares of restricted stock to its non-employee directors upon election to the Companys board of directors and appointment to various board committees. The shares vest and become in equal increments on the first, second and third anniversary of the issuance of the shares.

On August 8, 2006, the Company sold $25,000 of its one year 12% convertible promissory notes. The notes may be converted into shares of the Companys common stock at $0.56 per share. On July 28, 2006, the Company issued, under its 2003 Stock Option Plan for Outside Directors and Advisory Board Members, options to purchase 100,000 shares of the Companys stock exercisable at $0.53 per share to a director upon his initial appointment to the Companys board of directors.  The options vest and become exercisable in equal increments on July 7, 2006, 2007 and 2008. The options expire on July 28, 2016.

The Company issued the securities described above pursuant to Sections 4(2) and 4(6) and Rule 506 under the Securities Act of 1933 and in reliance on similar exemptions under applicable state securities laws.

Item 3.

Defaults Upon Senior Securities.

There were no defaults upon senior securities during the three months ended September 30, 2006.

Item 4.

Submission of Matters to a Vote of Security Holders.

(a)

Our annual meeting of stockholders was initially held on August 10, 2006. The meeting was adjourned and reconvened on September 8, 2006 for the purpose of considering the proposal to reincorporate in Delaware.

(b)

The following is a list of all nominees for director of the Company who were elected at the annual meeting and whose term of office continued after the annual meeting:

|                    
|--------------------
|George R. Sterner   
|Joe M. Allbaugh     
|Michael R. Donn, Sr.
|Barry I. Hechtman   
|Stephen R. Johnson  
|J. Francis Lavelle  
|James C. Rushing III
|Charles Vinick      

(c)

The results of the vote of the stockholders taken at the annual meeting by ballot and proxy as solicited by us on behalf of the board of directors were as follows:



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(i)

The results of the vote taken at the annual meeting for the election of the nominees for our board of directors were as follows:

|                     |  |  |            |  |  |          
|-------------------- |  |  | ---------- |  |  | ---------
|Nominee              |  |  | For        |  |  | Withheld 
|George R. Sterner    |  |  | 38,378,285 |  |  | 1,114,425
|Joe M. Allbaugh      |  |  | 38,396,785 |  |  | 1,095,925
|Michael R. Donn, Sr. |  |  | 38,463,656 |  |  | 1,029,054
|Barry I. Hechtman    |  |  | 37,178,134 |  |  | 2,314,576
|Stephen R. Johnson   |  |  | 38,489,806 |  |  | 1,002,904
|J. Francis Lavelle   |  |  |            |  |  |          
|James C. Rushing III |  |  | 38,833,425 |  |  | 659,285  
|Charles Vinick       |  |  |            |  |  |          



Messrs. Lavelle and Vinick were not on the ballot and were elected under Other Business.

(ii)

Votes were taken on the following additional proposals, the results of which are tabulated in the table below:

|                                                                                                                                                                                                                                                                       |  |  |            |  |  |           |  |  |           |  |  |                  | 
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  |  | ---------- |  |  | --------- |  |  | --------- |  |  | ---------------- | 
|Proposal                                                                                                                                                                                                                                                               |  |  | For        |  |  | Against   |  |  | Abstain   |  |  | Broker Non-Votes | 
|To amend the Companys articles of incorporation to increase the authorized common stock from 100,000,000 to 150,000,000                                                                                                                                               |  |  | 34,391,308 |  |  | 3,152,683 |  |  | 1,948,719 |  |  | 0                | 
|To amend the Companys articles of incorporation to create a class of 5,000,000 shares of preferred stock, $0.01 par value containing such rights, preferences and limitations as may be determined from time to time by further resolution of the board of directors. |  |  | 25,690,704 |  |  | 1,937,327 |  |  | 2,876,569 |  |  | 8,988,110        | 
|To approve an amendment of the Companys articles of incorporation changing the name to Ecosphere Technologies, Inc.                                                                                                                                                   |  |  | 38,287,647 |  |  | 920,162   |  |  | 284,901   |  |  | 0                | 
|To approve the merger of the Company with and into its wholly-owned Delaware subsidiary, for the sole purpose of changing the Companys state of incorporation.                                                                                                        |  |  | 28,125,964 |  |  | 2,206,362 |  |  | 172,274   |  |  | 8,988,110        | 
|To approve the 2006 Equity Incentive Plan.                                                                                                                                                                                                                             |  |  | 26,092,553 |  |  | 3,236,812 |  |  | 1,175,235 |  |  | 8,988,110        | 
|To approve and ratify the appointment of Tedder, James, Worden & Associates, P.A. as the Companys independent registered public accounting firm for 2006.                                                                                                             |  |  | 38,940,887 |  |  | 214,650   |  |  | 337,173   |  |  | 0                | 





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Item 5.

Other Information.

None.

Item 6.

Exhibits.

Exhibits.

|               |  |                                                       
|-------------- |  | ------------------------------------------------------
|Exhibit
Number |  | Description                                           
|               |  |                                                       
|3.1            |  | Certificate of Incorporation                          
|3.2            |  | Bylaws                                                
|10.1           |  | Management Compensation Adjustment Plan(1)            
|10.2           |  | CMU License Agreement(1)                              
|10.3           |  | 2006 Equity Incentive Plan                            
|10.4           |  | Summary of Employment Agreement for Joe M. Allbaugh   
|10.5           |  | Restricted Stock Agreement                            
|31.1           |  | Certification of Chief Executive Officer (Section 302)
|31.2           |  | Certification of Chief Financial Officer (Section 302)
|32.1           |  | Certification of Chief Executive Officer (Section 906)
|32.2           |  | Certification of Chief Executive Officer (Section 906)



(1)

Contained in the Quarterly Report on Form 10-QSB filed on August 10, 2006.



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SIGNATURES

In accordance with the requirements of the Securities and Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

|                 |  |                                                   
|---------------- |  | --------------------------------------------------
|                 |  | ECOSPHERE TECHNOLOGIES, INC.                      
|December 8, 2006 |  | /s/ DENNISMCGUIRE                                 
|                 |  | Dennis McGuire                                    
|                 |  | President and Chief Executive Officer             
|December 8, 2006 |  | /s/ JAMESC. RUSHINGIII                            
|                 |  | James C. Rushing III                              
|                 |  | Chief Financial Officer / Chief Accounting Officer





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