UNITED
STATES


SECURITIES
AND EXCHANGE COMMISSION


Washington,
D.C. 20549





Form
10-KSB





[X]
ANNUAL REPORT UNDER SECTION 13 OR 15(D) OF THE


SECURITIES
EXCHANGE ACT OF 1934


For
Fiscal Year Ended


December
31, 2007





Commission
File # 033-31067





ECO2 PLASTICS,
INC.


(Exact
name of registrant as specified in its charter)





Delaware


(State or
other jurisdiction of incorporation or organization)





31-1705310


(IRS
Employer Identification Number)





680
Second Street, Suite 200


San Francisco, CA 94107


(Address
of principal executive offices)(Zip Code)





(415)
829-6000


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








Securities
registered pursuant to Section 12(b) of the Act: None


Securities
registered pursuant to Section 12(g) of the Act: Common Stock, $0.001 Par
Value




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




Check if
there is no disclosure of delinquent filers in response to Item 405 of
Regulation S-B not contained in this form, and no disclosure will be contained,
to the best of the registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-KSB or any
amendment to this Form 10-KSB. Yes x





Revenues
for year ended December 31, 2007 were $4,339,000.





Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, or a non-accelerated filer. See definition of “accelerated
filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check
one):  Non-accelerated filer  x





Indicate
by check mark whether the registrant is a shell company (as defined in Rule
12b-2 of the Exchange Act).  Yes oNo x





The
aggregate market value of the voting common stock held by non-affiliates of
the Company as of December 31, 2007 was approximately $9.1
millionbased upon 129,684,619shares held by such
persons and the closing price of $0.07 per share on that date.  Shares of
common stock held by each officer and director and by each person who owns 10%
or more of the outstanding common stock have been excluded because these people
may be deemed to be affiliates.  The determination of affiliate status is
not necessarily a conclusive determination for any other purpose.





The
registrant does not have any non-voting stock outstanding.





Number of
shares of the registrant's common stock outstanding as of December 31, 2007 was
195,847,863.













PART
I




ITEM
1. DESCRIPTION OF BUSINESS




Business
Description
 
 Founded
in 1999 and based in San Francisco, California, ECO2 Plastics,
Inc., a Delaware corporation (“ECO2” or the
“Company”), is a publicly-traded company (OTCBB:  ECOO), that has
developed a unique and revolutionary patent pending process and system, referred
to as the ECO2
Environmental System (the “ECO2
Environmental System”). The ECO2Environmental System cleans post-consumer plastics, without the use of
water, at a substantial cost savings versus traditional methods within a
proprietary, closed-loop system (the “Process”). This Process is licensed from
Honeywell FM&T (“Honeywell”) and the Department of Energy (“DOE”) on an
exclusive basis for the life of the patent. Since inception, ECO2 has
invested in the development of the technology and equipment comprising the Eco
2
Environmental System, which includes the filing of a new “Process Patent” with
Honeywell in May 2005 with the patent being granted in 2007. This also included
building several scaled up versions of the Prototype ECO2
Environmental System (the “Prototype”), testing of the Prototypes, building a
pilot plant, evaluating the product produced by the Prototype and real-time
testing. The Company’s first full scale production facility was constructed in
Riverbank, California and is now mechanically complete, producing saleable
product and ramping up to full scale operations.  ECO2’s goal is
to build and operate plastic recycling plants (the “ECO2Plants”)
in the USA that utilize the ECO2
Environmental System and to expand the ECO2
Environmental System worldwide. ECO2’s growth
strategy includes organic growth, strategic acquisitions and licensing or
partnership agreements, where appropriate.
 
 In 2004,
the State of California Integrated Waste Management Board (“CIWMB”), through the
Recycle Market Development Zone Loan (“RMDZ”) Program, approved a $2 million
“matching funds loan” to assist ECO2in
building a plant in California. In order to qualify for the loan the Company
leased an 80,000 square foot building in Riverbank, California. The matching
funds loan was released from an escrow account in draws based on certain
criteria including the presentation of invoices for equipment and when ECO2deposited
$600,000 into the escrow account. The matching funds loan was used to complete
Stage 1 and Stage 2 of the plant in Riverbank, California (the “Riverbank” or
“Plant”).
 
 The Plant
is strategically located between the San Francisco bay area and the greater
Sacramento metropolitan area. The Company believes that this location will allow
ECO2to provide convenient access for the generators of the feedstock (bales
of plastic bottles) from approximately 10 million residential
customers.
 
 ECO2intends to
locate its second plant in California to capture additional volumes generated in
the largest recycling market in the United States.   The Company has
engaged a team of engineers to conduct the preliminary design efforts and has
engaged a team of location and logistics specialists to support the Company in
the site selection process currently underway. In addition, a strong case can be
made for a third ECO2facility
in San Diego County, which has both a significant population, strong continued
growth and an ample supply of feedstock from Mexico. In 2007 the Company
purchased its feedstock for an average of $0.23 per pound and sells the finished
clean flake for an average of $0.50 per pound. Each plant the Company builds has
a potential revenue stream in excess of $30 million per year.
 
 Construction
of Riverbank is mechanically complete and the Plant has begun ramping up to
full-scale operations. Based on the current production runs, the company
believes that the Plant will produce approximately 50 million pounds of clean,
clear flake at optimal throughput.
  ECO2has access to a supply of raw material from the major collectors of
the post consumer used beverage containers in California, as well as from
several independent sources. Primary suppliers of material include buyback
operations, curbside collection programs, materials reclamation facilities,
waste haulers and a network of plastic brokers. With the cost advantages
afforded the company through its proprietary process, ECO2can
compete aggressively for the available supply of plastic. Approximately 700
million pounds annually of material is shipped from the western United States
through ports in California to Asian buyers each year.
 
 ECO2believes
it can utilize extensive contacts within the USA plastic container collection
and processing industries to its benefit. Through these contacts, ECO2and its
strategic alliance partners  conservatively have access to over 60% of
the domestically available Polyethylene Terephthalate (“PET”) and High Density
Polyethylene (“HDPE”) from post-consumer container streams. On a regional basis,
ECO2believes it can secure feedstock agreements with its extensive industry
contacts to meet the growth needs of each newly developed plant.
 
 In 2007,
a representative approached ECO2 from the
Vehicle Recycling Program of USCAR, a research consortium formed by General
Motors, Ford and Chrysler. ECO2 was asked
to develop a solution for the removal of PCB residue on plastic generated as a
by-product of auto shredder operations (“Auto Shredder Fluff”). Approximately
2.5% of a car’s weight is comprised of various forms of plastic. This plastic
ends up in the Auto Shredder Fluff with the resultant plastic often contaminated
with harmful PCB’s. Obviously this is a significant problem for auto
manufacturers, both economically and from a public relations and liability
standpoint.  ECO2has tested
contaminated samples submitted by the representative and has successfully
cleaned the plastic to acceptable environmentally safe
levels.  ECO2is
confident that these additional tests will result in further proof that its
technology for the removal of PCB residue is state of the art. In April 2007 VRP
granted the Company approximately $84,000 to further study the possibility of
using the ECO2
Environmental System to mitigate PCB contamination in Auto Shredder
Fluff.  Should the results of the study prove to be positive, the VRP
would then engage the Company to build a plant in Detroit to produce 4,000
pounds of flake per hour. The first payment of $20,000 was received in January
2008.  Once successful, the VRP has suggested the possibility to build
additional ECO2plants to
clean and consume the plastic domestically.
  Further,
ECO2believes that the international market for ECO2’s products
and services is substantial and has received multiple inquiries regarding the
potential for construction of ECO2plants
around the world. In most cases internationally, ECO2will be
able to secure the plant feedstock for lower cost (versus $0.23 per pound in the
USA), which should increase ECO2’s
operating profit margins.
 
 In 2006,
the Company was developing its recycling processes and plant operations and
technology development which approximated $2.0 million, which was considered
research and development expense as the Company had not commenced operations
other than at a testing level.  In 2007, the Company spent
approximately $326,000 on research and development.
 
 As of
March 25, 2008, ECO2 had
approximately 101 full time employees and 1 part-time employee.
 
 Competition
 
 Currently,
70% of the materials collected west of the Mississippi are exported to China in
the form of bales of crushed plastic bottles and containers. Despite growing
demand in California for ECO2type of
services, there is currently no significant competition in the PET or HDPE
segments of the market west of the Mississippi. Nearly all of the competitive
processing capacity exists east of the Mississipi and each facility deploys
higher cost, less effective water-wash recycling systems,.   ECO2is the
only company that washes PET without water using the ECO2
Environmental System, and as an end result, offers substantial operating
efficiency advantages, and significant positive environmental
benefits.


ITEM
2. DESCRIPTION OF PROPERTY





The
Company does not own any real property.  ECO2has
entered into a 5 year lease agreement expiring in March 2009 with a 5 year
option on a 58,000 sq. ft. steel frame building in the heavy industrial complex
building in Riverbank, California. The agreement includes 3,500 sq. ft. of
office space.  In addition, the Company leases approximately 2,300 square
feet of office space in San Francisco, California at 680 Second Street, Suite
200, pursuant to the terms of a 2 year lease.




ITEM
3. LEGAL PROCEEDINGS





On
October 16, 2007, Robert Trotter, dba Bob Trotter’s Welding (“Trotter”) filed a
claim against ECO2and its
Director and CTO, Gary De Laurentiis in Tuolumne County Superior
Court.  Trotter is alleging breach of contract and that he is due fees
for services provided in excess of $68,000, of which $7,500 is alleged to be due
from the Company.





The
Company is unaware of any other threatened or pending litigation against it not
in the ordinary course of business and that has not previously been
disclosed.





ITEM
4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS





Not
applicable.








PART
II




ITEM 5. MARKET FOR COMMON EQUITY AND
RELATED STOCKHOLDER MATTERS





As of
February 28, 2008, ECO2Plastics,
Inc. had 207,247,863 shares of common stock issued and outstanding and had
approximately 914 stockholders of record.  There are 0 shares of
preferred stock issued and outstanding.





ECO2’s common
stock is not traded on a registered securities exchange, or the
NASDAQ.  ECO2’s common
stock is quoted on the National Association of Securities Dealers OTC Bulletin
Board. The following table sets forth the range of high and low bid quotations
for each fiscal quarter for the past two (2) years. These quotations reflect
inter-dealer prices without retail mark-up, mark-down, or commissions, and may
not necessarily represent actual transactions.




FISCAL
      QUARTER
              ENDING
            
            HIGH
      BID
            
            LOW
      BIDDecember
      31, 2007
            
            $
            .08
            
            $
            .07September
      30, 2007
            
            $
            .15
            
            $
            .13June
      30, 2007
            
            $
            .21
            
            $
            .19March
      31, 2007 (1)
            
            $
            
            
            $December
      31, 2006
            
            $
            .16
            
            $
            .11September
      30, 2006
            
            $
            .15
            
            $
            .10June
      30, 2006
            
            $
            .16
            
            $
            .11March
      31, 2006
            
            $
            .14
            
            $
            .10





(1)
            Due
      to the Company’s name and symbol change in the first quarter of 2007, we
      are unable to obtain the high and low bid prices for that
      quarter.





On March
25, 2008, the closing price was $0.05 per share.


We have
never declared or paid cash dividends to our stockholders. We currently intend
to retain all available funds and any future earnings for use in the operation
of our business and we do not anticipate declaring or paying cash dividends for
the foreseeable future.





Securities
authorized for issuance under equity compensation plans as of December 31,
2007:





Equity
      Compensation Plan InformationPlan
      Category
            Number
      of securities to
            
            Weighted-average
            Number
      of securitiesbe
      issued upon exercise
            
            exercise
      price of
            remaining
      available forof
      outstanding options,
            
            outstanding
      options,
            future
      issuance underwarrants
      and rights (a)
            
            warrants
      and rights (b)
            equity
      compensationplans
      (excludingsecurities
      reflected incolumn
      (a))Equity
      compensation
            N/A
            
            N/A
            N/Aplans
      approved bysecurity
      holdersEquity
      compensation
            4,457,370(1)
            
            $.06
            N/Aplans
      not approved bysecurity
      holders
            15,000,000(2)
            
            Price
      as listed on the
            5,150,000OTCBB
      at the time ofissuance.19,500,000(3)
            
            $.06
            N/A1,500,000(4)
            
            $.06
            N/A750,000(5)
            
            $.06
            N/A500,000(6)
            
            $.06
            N/A1,000,000(7)
            
            $.06
            N/A12,000,000(8)
            
            $0.0975
            12,000,0005,000,000
      (9)
            
            $0.108
            N/A








(1)
            Consists
      of a warrant issued by the Company to Gary De Laurentiis, its Director and
      CTO, pursuant to which Mr. De Laurentiis may purchase up to 2,457,370
      shares of common stock of the Company, exercise price of $.06 per share
      and a Warrant issued by the Company pursuant to which Mr. De Laurentiis
      may purchase up to 2,000,000 shares of common stock of the Company at a
      price of $.06 per share.  These warrants were fully assigned and
      cancelled on August 11, 2005.





(2)
            2005
      Stock Plan of the Company adopted by the Board of Directors on January 28,
      2005. The 2005 Stock Plan (the “Plan”) was adopted by the Board of
      Directors as a method to compensate company employees, directors and
      non-employee independent contractors that provide services to the Company.
      The Plan is administered by two non-employee directors of the Company
      based upon recommendations for issuances by the Company’s
    CTO.





(3)
            Consists
      of a warrant issued by the Company to Gary De Laurentiis, its Director and
      CTO, pursuant to which Mr. De Laurentiis may purchase up to 20,000,000
      shares of common stock of the Company, exercise price of $.06 per share.
      While the Company authorized the warrant in the amount of 20,000,000
      shares, simultaneous with the issuance of the warrant, Mr. De Laurentiis
      transferred the rights represented by the warrant in the right to buy
      500,000 shares of common stock of the company to another. Accordingly, the
      presentation of the warrant in this report has been limited to the
      19,500,000 shares the right to purchase Mr. De Laurentiis actually
      received.  In connection with various assignments made from this
      warrant to other related and unrelated parties, Mr. De Laurentiis can
      purchase up to 7,384,682 shares of common stock of the Company in
      accordance with this warrant.





(4)
            Consists
      of a warrant issued by the Company to David M. Otto, corporate counsel to
      the Company, pursuant to which Mr. Otto may purchase up to 1,000,000
      shares of common stock of the Company, exercise price of $.06 per share
      and a warrant issued by the Company to Mr. Otto pursuant to which he may
      purchase up to 500,000 shares of common stock of the Company, exercise
      price of $.06 per share.




(5)
            Consists
      of a warrant issued by the Company to Frederick W. Smith, Jr., its former
      Chief Financial Officer, pursuant to which Mr. Smith may purchase up to
      500,000 shares of common stock of the Company, exercise price of $.06 per
      share and a warrant issued by the Company pursuant to which Mr. Smith may
      purchase up to 250,000 shares of common stock of the Company at an
      exercise price of $.06 per share.




(6)
            Consists
      of a warrant issued by the Company to George Kanakis, a former Director,
      pursuant to which Mr. Kanakis may purchase up to 500,000 shares of common
      stock of the Company, exercise price of $.06 per
  share.




(7)
            Consists
      of a warrant issued by the Company to Jeffrey Chartier, a former Director,
      pursuant to which Mr. Chartier may purchase up to 1,000,000 shares of
      common stock of the Company, exercise price of $.06 per
    share.





(8)
            Consists
      of a warrant issued by the Company to Mario Sandoval, its former Chief
      Operating Officer, pursuant to which Mr. Sandoval may purchase up to
      12,000,000 shares of common stock of the Company at an exercise price of
      $0.0975 per share.  This warrant was issued in accordance with
      Mr. Sandoval’s employment agreement, dated October 20,
      2006.  Under this agreement, Mr. Sandoval received a total of
      24,000,000 warrant shares, of which 17,000,000 had vested.  In
      connection with Mr. Sandoval’s departure, he agreed to return his
      previously issued common stock purchase warrant in exchange for 5,000,000
      shares of common stock, par value $0.001 per share, with a per share price
      at $0.07 per share which were filed on Form S-8 under the Securities Act
      of 1933 with the SEC.





(9)
            Consists
      of a warrant issued by the Company to Craig Hardy, its former Chief
      Financial Officer, who resigned in March 2008, pursuant to which Mr. Hardy
      may purchase up to 5,000,000 shares of common stock of the Company at an
      exercise price of $0.108 per share/cashless.  This warrant was
      issued in accordance with Mr. Hardy’s employment agreement, dated August
      10, 2007.  Under this agreement, Mr. Hardy is to receive a total
      of 5,000,000 warrant shares, of which 1,250,000 have
    vested.








Recent
Sales of Unregistered Securities





During
the period covered by this 10-KSB, the Company sold the following securities
which were not registered under the Securities Act of 1933 (the “Act”) and not
reported on any other form:





Director Notes –
During July through October 2007, the Company received cash proceeds of
approximately $2.5 million from various members of the Company’s Board of
Directors (the “Director Notes”).  In accordance with the Director
Notes, each lender received a promissory note with an interest rate of 15% per
annum (the “Note”).  All or any portion of the Note, any accrued
interest thereon and all other sums due under the Note, is due and payable on
demand within 90 days of the Note.  In connection with these notes,
lenders received common stock purchase warrants to purchase 22,657,000 shares of
Company common stock with an exercise price of $0.06 per share that expire in
April 2015.  The shares underlying the warrants are subject to piggy
back registration rights.  The exercise price of the warrants is
subject to anti-dilution downward adjustments in the event the Company sells
common stock at a price below the exercise price.  During 2007, two of
the Company’s Directors made loans due on demand with interest at 10% to the
Company in the aggregate total of $577,000.  The loan from one
Director in the amount of $300,000 was repaid, and the other $277,000 was
cancelled and replaced with Director Notes.




Short-term Notes-
During October through December 2007, the Company received cash proceeds of
approximately $ 2.0 million from new and existing investors and issued
to each lender a promissory note with an interest rate of 15% per annum, due and
payable on demand within 180 days (the “Short-Term Note”), and warrants to
purchase approximately 18.1 million shares of Company common stock with an
exercise price of $0.06 per share that expire in April 2015.  The
shares underlying the warrants are subject to piggy back registration
rights.  The exercise price of the warrants is subject to
anti-dilution downward adjustments in the event the Company sells common stock
at a price below the exercise price.





Private PlacementNotes -
During 2007, the Company received $5 million pursuant to investment terms
substantially similar to the PPM (defined below) (the “Additional Investment”)
and issued $5 million Private Placement Notes and Private
Placement Warrants to purchase 15,000,000 shares of common
stock.  In connection with the Additional Investment, the placement
agent received cash fees of approximately $100,000 and received warrants, with a
cashless exercise provision, to purchase 382,429 shares of restricted common
stock of the Company at a per share price of $0.06 exercisable for 10
years.  Pursuant to rights and terms of the Additional Investment
purchase agreement, the holder of $2 million of notes designated one person to
become a member of the Company’s Board of Directors, which such person was
appointed in 2007.  Additionally, in 2007, the Company issued three
PPM Units, comprised of $75,000 of Private Placement Notes and 225,000 Private
Placement Warrants in exchange for accrued liabilities, which such notes were
immediately converted into 769,231 shares of Company common stock in accordance
with terms of the notes.





During
2006, proceeds for approximately $7.9 million were received into escrow pursuant
to a private placement memorandum (the “PPM”) through the offering of Units for
$25,000 per unit, each Unit consisting of a $25,000 junior secured subordinated
convertible debenture (the “Private Placement Notes”), bearing interest at 10%
with principal and accrued interest due 18 months from issuance (“maturity
date”), convertible into shares of the Company’s common stock at a price of
$0.0975 per share, and a warrant, with a cashless exercise provision, to
purchase 75,000 shares of restricted common stock of the Company, exercisable
until April 15, 2015 at an exercise price of $0.06 per share (the “Private
Placement Warrants”).  The PPM closed in January 2007.











ITEM 6. MANAGEMENT'S DISCUSSION
AND ANALYSIS OR PLAN OF OPERATIONS





FORWARD
LOOKING STATEMENTS CAUTIONARY





This
Item 6 and the December 31, 2007 Annual Report on Form 10-KSB may contain
"forward-looking statements." In some cases, you can identify forward-looking
statements by terminology such as "may," "will," "should," "could," "expects,"
"plans," "intends," "anticipates," "believes," "estimates," "predicts,"
"potential" or "continue" or the negative of such terms and other comparable
terminology. These forward-looking statements include, without limitation,
statements about our market opportunity, our strategies, competition, expected
activities and expenditures as we pursue our business plan, and the adequacy of
our available cash resources. Although we believe that the expectations
reflected in any forward-looking statements are reasonable, we cannot guarantee
future results, levels of activity, performance or achievements. Actual results
may differ materially from the predictions discussed in these forward-looking
statements. Changes in the circumstances upon which we base our predictions
and/or forward-looking statements could materially affect our actual results.
Additional factors that could materially affect these forward-looking statements
and/or predictions include, among other things: (1) our limited operating
history; (2) our ability to pay down existing debt; (3) our ability to retain
the professional advisors necessary to guide us through our corporate
restructuring; (4) the risks inherent in the investigation, involvement and
acquisition of a new business opportunity; (5) unforeseen costs and expenses;
(6) potential litigation with our shareholders, creditors and/or former or
current investors; (7) the Company's ability to comply with federal, state and
local government regulations; and (8) other factors over which we have little or
no control.





The
following should be read in conjunction with the Company’s financial statements
included in this December 31, 2007 Annual Report on Form 10-KSB (the “Annual
Report”).





Business– 
ECO2Plastics, Inc., “ECO2” or the
“Company”, was incorporated under the laws of the State of Delaware in 2000, and
formed for the purpose of acquiring certain patented technology and the
development of a worldwide market for its usage.  ECO2has
developed a unique and revolutionary patent pending process and system, referred
to as the ECO2Environmental System (the “ECO2Environmental System”). The ECO2Environmental System cleans post-consumer plastics, without the use of
water, at a substantial cost savings versus traditional methods (the “Process”).
This Process is licensed from Honeywell and the Department of Energy on an
exclusive basis for the life of the patent. Since its inception, ECO2has
invested in the development of the technology and equipment comprising the
ECO2Environmental System, which includes a “Process Patent” granted in 2007.
This included building several scaled up versions of the Prototype ECO2Environmental System (the “Prototype”), testing of the Prototypes,
building a pilot plant, evaluating the product produced by the Prototype and
real-time testing. The Company’s first full scale production facility was
constructed in Riverbank, California and is now producing saleable product and
ramping up to full scale operations as it further develops the process. ECO2’s goal is
to build and operate plastic recycling plants in the USA that utilize the
ECO2Environmental System and to expand the ECO2Environmental System worldwide. ECO2’s growth
strategy includes organic growth, strategic acquisitions and licensing or
partnership agreements, where appropriate.





The
Company operates in the evolving field of plastics materials recycling. New
developments could both significantly and adversely affect existing and emerging
technologies in the field. The Company's success in developing additional
marketable products and processes and achieving a competitive position will
depend on its ability to attract and retain qualified management personnel and
to raise sufficient capital to meet its operating and development
needs.





Liquidity
and Capital Resources- At December
31, 2007, we had a working capital deficit of approximately $18.6 million,
compared to a working capital deficit of $3.2 million at December 31, 2006.
 At December 31, 2007, we had a total stockholders’ deficit of $11. 8
million compared with a total stockholder's equity of approximately $2.7 million
at December 31, 2006.  At December 31, 2007, the Company does not have
sufficient cash to meet its needs for the next twelve months.





The
Company has incurred recurring losses from operations and has a net working
capital deficiency and net capital deficiency that raises substantial doubt
about its ability to continue as a going concern. The Report of Independent
Registered Public Accounting Firm included in this Annual Report stated that
these conditions, among others, raise substantial doubt about the Company’s
ability to continue as a going concern. Historically, our cash needs have
been met primarily through proceeds from private placements of our equity
securities and debt instruments including debt instruments convertible into our
equity securities. Company management intends to raise additional cash to fund
future operations and to provide additional working capital. However, there is
no assurance that such financing will be obtained.  We expect to continue
to raise capital in the future, but cannot guarantee that such financing
activities will be sufficient to fund our current and future projects and our
ability to meet our cash and working capital needs.




The
Company’s Board of Directors and Chief Executive Officer continue to be actively
involved in discussions and negotiations with creditors and holders of Company
notes payable regarding conversion of amounts owed and warrants into shares of
Company common stock, and in continued fund-raising activities with new and
existing investors with respect to raising additional cash. Subsequent to
December 31, 2007:




·
              The
      Company received cash of approximately $1.9 million pursuant to issuance
      of short-term notes payable to new and existing
  investors;
  ·
              Holders
      of all convertible notes payable outstanding having a total principal
      amount outstanding of approximately $13.2 million (before debt discount of
      approximately $2.2 million), together with accrued interest of
      approximately $1.7 million, converted such notes and returned to the
      Company warrants to purchase approximately 39 million shares of
      common stock  at $0.06 per share and in exchange received
      approximately 243 million shares of the Company’s common
      stock;
  ·
              Pursuant
      to terms of a special offer made to all holders of warrants to purchase
      common stock, approximately 124 million warrants were exchanged  for
      approximately 82 million shares of Company common stock;
    and
  ·
              The
      Company entered into agreements with certain service providers pursuant to
      which the Company will issue approximately 16 million shares of its common
      stock as payment for amounts owed for services of approximately
      $754,000.







Following
is an unaudited pro forma illustration of the effects of this debt conversion,
warrants for shares exchange and issuance of shares for services as of
December 31, 2007, as if such conversions, warrants for share exchanges, and
shares for services had occurred as of that date (in
thousands):




Actual
              
              
              Note
      Conversions
              
              
              Shares
      for Warants
              
              
              Shares
      for Services
              
              
              Pro
      FormaTotal
      Liabilities
              
              $
              21,270
              
              
              $
              (12,700
              )
              
              $
              -
              
              
              $
              (754
              )
              
              $
              7,816Total
      stockholders’ equity (deficit)
              
              
              (11,755
              )
              
              
              12,700
              
              
              
              -
              
              
              
              754
              
              
              
              1,699Total
              
              $
              9,515
              
              
              $
              -
              
              
              $
              -
              
              
              $
              0
              
              
              $
              9,515Shares
      issued and issuable
              
              
              198,101
              
              
              
              243,000
              
              
              
              82,000
              
              
              
              19,000
              
              
              
              542,101Warrants
      issued and issuable
              
              
              182,697
              
              
              
              (39,000
              )
              
              
              (124,000
              )
              
              
              -
              
              
              
              19,697


Results
of Operations- Revenues were
$4.3 million during the year ended December 31, 2007 as compared to $61,000
during the prior year. Revenues increased quarter over quarter during 2007, with
quarterly revenues of approximately $99,000 during the first quarter, $418,000
during the second quarter and increasing to $1.4 million and $2.4 million during
the third and fourth quarters, respectively.  Revenues are expected to
continue to increase in future periods. Cost of goods sold consists of the cost
of raw materials processed and was approximately $4.2 million during the year
ended December 31, 2007 as compared to $50,000 in 2006. Gross profit was
$119,000 for the year ended December 31, 2007 as compared to $11,000 in
2006.  The plant has begun ramping towards full-scale operation and as
a result, significant volumes of inventory are consumed for quality testing
during these periods. Most of the tested material is shipped out of the plant at
prices significantly lower than market standard, which has resulted in a
relatively low gross profit in 2007. Additionally, during 2007, costs of goods
sold include write-downs for scrap and waste product of approximately
$204,000.  Gross profit is expected to increase in future
periods.





Plant
operations and technology development expenses increased to $6.9 million for the
year ended December 31, 2007 as compared to $2.0 million for 2006.  As
the Company ramps up the Riverbank Plant, operating expenses are increasing
commensurate with the increase in operating activity, comprised primarily of
payroll and related, utilities, occupancy, supplies, and repairs and maintenance
expenses.  Payroll and related costs approximated $2.4 million in 2007
as compared to $724,000 in 2006, and depreciation expense approximated $1.0
million in 2007 as compared to $495,000 in 2006.  Other plant
operating expenses approximated $3.5 million in 2007 as compared to $789,000 in
2006.  These expenses are expected to continue to increase in future
periods.  As production increases to closer to capacity volumes,
certain plant operations expenses will be included in cost of goods
sold.





General
and administrative expenses decreased to $9.3 million for the year ended
December 31, 2007 as compared to $12.9 million for 2006.  Payroll and
related costs approximated $6.4 million in 2007 as compared to $8.6 million in
2006.  The decrease in 2007 payroll and related was primarily due to
higher non-cash stock-based compensation relating to employment agreements
equity awards entered into in 2006 with certain executive officers and related
recruiter fees payable in equity securities.  Consulting and legal
fees expenses approximated $759,000 in 2007 as compared to $3.6 million in
2006.   The decrease in consulting and legal fees was primarily
due to higher non-cash stock-based compensation expense in 2006 of $2.4 million
as compared to $91,000 in 2007.  Also included in general and
administrative expenses are settlement provisions of approximately $680,000 in
2007 and $402,000 in 2006, which for the most part were the result of issuances
of equity securities.





The
Company recorded interest expense of approximately $16.6 million for the year
ended December 31, 2007 as compared to $4.8 million in 2006.  Interest
expense includes amortization of debt issue costs and debt discount of
approximately $14.8 million for 2007 and $4.1 million for 2006, which represents
most of the increase year over year. The increase in interest expense for 2007
as compared to the prior year was also, to a lesser extent, due to increased
average borrowings during 2007.




The
Company’s net loss increased approximately $11.9 million to $32.6 million for
the year ended December 31, 2007 from $20.8 million for 2006, due primarily to
the increase in interest expense, and to a lesser extent, increase in loss from
operations resulting from increases in plant operations and technology
development.





The
Company has approximately $34 million of net operating loss carry-forwards at
December 31, 2007 potentially available to offset future income taxes which
expire through 2027.  Realization is dependent on generating sufficient
taxable income prior to expiration of the loss carry-forwards.  A change of
greater than 50% of the Company ownership could significantly limit the
utilization of these loss carryforwards.  The Company continues to provide
a full valuation allowance to reduce its net deferred tax asset to zero,
inasmuch as Company management has not determined that realization of deferred
tax assets is more likely than not.





Cash
Provided (Used) by Operating, Investing and Financing Activities -During the year
ended December 31, 2007 cash used by operating activities increased to
approximately $7.2 million from $4.1 million during the prior year, due
primarily to an increase in loss from operations.





During
the year ended December 31, 2007, cash used by investing activities decreased to
approximately $3.1 million relating to capital expenditures on the recycling
plant as compared to $3.7 million during the prior year, since the plant was
substantially completed in 2006.  Expenditures during 2007 have
primarily related to additional capacity and process improvements.





During
the year ended December 31, 2007, cash provided by financing activities
increased to approximately $10.4 million from $7.8 million during the prior
year. During 2007, the Company received proceeds of approximately $7.9 million
(including approximately $1.2 million receivable for cash in escrow for
securities sold in 2006) from sales of private placement units comprised of
convertible promissory notes and warrants and subordinated notes and warrants,
and approximately $2.9 million from loans from Company Directors.














Critical
Accounting Policies and Estimates – The preparation of
financial statements included in this Annual Report requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities at the date of the financial statements and the reported amounts of
revenues and expenses during the reporting period.  On an on-going basis,
management evaluates its estimates and judgments. Management bases its estimates
and judgments on historical experiences and on various other factors that are
believed to be reasonable under the circumstances, the results of which form the
basis for making judgments about the carrying value of assets and liabilities
that are not readily apparent from other sources.  Actual results may
differ from these estimates under different assumptions or conditions.  The
more significant accounting estimates inherent in the preparation of the
Company's financial statements include estimates as to the depreciable lives of
property and equipment, valuation of equity related instruments issued, and the
valuation allowance for deferred income tax assets. Our accounting policies
are described in the notes to financial statements included in this Annual
Report. The more critical accounting policies are as described
below.




Going
concern presentation - The accompanying financial statements have
been prepared in conformity with accounting principles generally accepted in the
United States, which contemplate continuation of the Company as a going concern.
The Company has incurred recurring losses from operations and has a net working
capital deficiency and net capital deficiency that raises substantial doubt
about its ability to continue as a going concern. The Report of Independent
Registered Public Accounting Firm included in this Annual Report stated that
these conditions, among others, raise substantial doubt about the Company’s
ability to continue as a going concern. Company management intends to raise
additional financing to fund future operations and to provide additional working
capital. However, there is no assurance that such financing will be obtained in
sufficient amounts necessary to meet the Company’s needs. The accompanying
financial statements do not include any adjustments to reflect the possible
future effects on the recoverability and classification of assets or the amounts
and classifications of liabilities that may result from the outcome of this
uncertainty.





Revenue
recognition - The Company recognizes revenue when there is
persuasive evidence of an arrangement, the product has been delivered to the
customer, the sales price is fixed or determinable, and collectability is
reasonably assured. The Company recognizes revenues from sales of recycled
products upon shipment to customers. Amounts received in advance of when
products are delivered are recorded as liabilities until earned. Research or
other types of grants from governmental agencies or private organizations are
recognized as revenues if evidence of an arrangement exists, the amounts are
determinable and collectibility is reasonably assured with no further
obligations or contingencies remaining.  Incentive grants from the
California Department of Conservation recognized as revenues during 2007 were
approximately $117,000.








Income
taxes - The Company utilizes SFAS No. 109, “Accounting for Income
Taxes,” which requires recognition of deferred tax assets and liabilities for
the expected future tax consequences of events that have been included in the
financial statements or tax returns. Under this method, deferred income taxes
are recognized for the tax consequences in future years of differences between
the tax bases of assets and liabilities and their financial reporting amounts at
each period end based on enacted tax laws and statutory tax rates applicable to
the periods in which the differences are expected to affect taxable income.
Valuation allowances are established, when necessary, to reduce deferred tax
assets to amounts expected to be realized. The Company continues to provide a
full valuation allowance to reduce its net deferred tax asset to zero, inasmuch
as Company management has not determined that realization of deferred tax assets
is more likely than not. The provision for income taxes represents the tax
payable for the period and change during the period in net deferred tax assets
and liabilities.




Stock-based
compensation– The Company accounts for all options and warrant grants to
employees and consultants in accordance with SFAS 123R, which requires recording
an expense over the requisite service period for the fair value of all options
or warrants granted employees and consultants.




Recent
accounting pronouncements - In December 2006, the FASB issued FASB Staff
Position No. EITF 00-19-2 “Accounting for Registration Payment Arrangements”
(“FSP EITF 00-19-2”), which addresses an issuer’s accounting and disclosures
relating to registration payment arrangements. In accordance with FSP EITF
00-19-2, registration payment arrangements are accounted for as an instrument
separate and apart from the related securities and will be accounted for in
accordance with Statement of Financial Accounting Standards No. 5 “Accounting
for Contingencies,” accruing a liability if payment is probable and the amount
can be reasonably estimated. Unless the Company enters into agreements providing
for payments relating to registration arrangements, this pronouncement will have
no effect on the Company’s results of operation, financial position or
liquidity.
  In
September 2006, the FASB issued Statement of Financial Accounting Standards No.
157, Fair Value Measurements(“SFAS 157”). SFAS 157 defines fair value, establishes a framework for
measuring fair value and expands disclosures about fair value measurements but
does not require any new fair value measurements. SFAS 157 is effective for
financial statements issued for fiscal years beginning after November 15, 2007,
and interim periods within those fiscal years. It is expected that adoption of
SFAS 157 will not have a material impact on the Company’s results of operations,
financial position or liquidity.
 
 In
February 2007, the FASB issued Statement of Financial Accounting Standards No.
159, The Fair Value Option for
Financial Assets and Financial Liabilities (“SFAS 159”).  SFAS
159 is effective for fiscal years beginning after November 15,
2007.  It is expected that adoption of SFAS 159 will not have a
material impact on the Company’s results of operations, financial position or
liquidity.
 
 In June
2007, the Emerging Issues Task Force of the FASB issued EITF Issue No. 07-3,
Accounting for Nonrefundable
Advance Payments for Goods or Services to be Used in Future Research and
Development Activities, (“EITF 07-3”) which is effective for fiscal years
beginning after December 15, 2007. EITF 07-3 requires that nonrefundable advance
payments for future research and development activities be deferred and
capitalized. Such amounts will be recognized as an expense as the goods are
delivered or the related services are performed. It is expected that adoption of
EITF 07-3 will not have a material impact on the Company’s results of
operations, financial position or liquidity.
  In
December 2007, the FASB issued SFAS No. 141(R), “Business Combinations”(“SFAS 141(R)”), which replaces SFAS No. 141. SFAS No. 141(R) establishes
principles and requirements for how an acquirer recognizes and measures in its
financial statements the identifiable assets acquired, the liabilities assumed,
any non-controlling interest in the acquiree and the goodwill acquired. The
Statement also establishes disclosure requirements which will enable users to
evaluate the nature and financial effects of the business combination. SFAS
141(R) is effective for fiscal years beginning after December 15, 2008. The
adoption of SFAS 141(R) will have an impact on accounting for future business
combinations once adopted.
  In
December 2007, the FASB issued SFAS No. 160, “Noncontrolling Interests in
Consolidated Financial Statements – an amendment of Accounting Research Bulletin
No. 51”(“SFAS 160”), which establishes accounting and reporting
standards for ownership interests in subsidiaries held by parties other than the
parent, the amount of consolidated net income attributable to the parent and to
the noncontrolling interest, changes in a parent’s ownership interest and the
valuation of retained non-controlling equity investments when a subsidiary is
deconsolidated. The Statement also establishes reporting requirements that
provide sufficient disclosures that clearly identify and distinguish between the
interests of the parent and the interests of the non-controlling owners. SFAS
160 is effective for fiscal years beginning after December 15, 2008. The Company
has not determined the effect that the application of SFAS 160 will have on its
financial statements.


Off-Balance
Sheet Arrangements-
We do not have any off balance sheet arrangements that have or are likely to
have a material current or future effect on the Company's financial condition,
or changes in financial condition, liquidity or capital resources or
expenditures.





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





Our
exposure to market risk for changes in interest rates relates primarily to our
short-term investments and short and long-term obligations, all of which have
fixed interest rates. Thus, fluctuations in interest rates would not have a
material impact on the fair value of these securities.





ITEM
8.CHANGES
IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
DISCLOSURE.









ITEM
8A. CONTROLS AND PROCEDURES.









ITEM 8A(T). CONTROLS AND PROCEDURES.




(a)
Management’s Annual Report on Internal Control Over Financial
Reporting
  Our
management is responsible for establishing and maintaining adequate internal
control over financial reporting. Internal control over financial reporting is
defined in Rules 13a-15(f) and 15d-15(f) under the Securities Exchange Act, as
amended, as a process designed by, or under the supervision of, a company’s
principal executive and principal financial officers and effected by a company’s
board of directors, management and other personnel to provide reasonable
assurance regarding the reliability of financial reporting and the preparation
of financial statements for external purposes in accordance with generally
accepted accounting principles. Our internal control over financial reporting
includes those policies and procedures that:
  ·
              pertain
      to the maintenance of records that, in reasonable detail, accurately and
      fairly reflect the transactions and dispositions of our
      assets;
  ·
              provide
      reasonable assurance that transactions are recorded as necessary to permit
      preparation of financial statements in accordance with generally accepted
      accounting principles, and that our receipts and expenditures are being
      made only in accordance with authorizations of our management and
      directors;
  ·
              and
      provide reasonable assurance regarding prevention or timely detection of
      unauthorized acquisition, use or disposition of our assets that could have
      a material effect on the financial
  statements.
  Internal
control over financial reporting cannot provide absolute assurance of achieving
financial reporting objectives because of its inherent limitations. 
Internal control over financial reporting is a process that involves human
diligence and compliance and is subject to lapses in judgment and breakdowns
resulting from human failures. Internal control over financial reporting also
can be circumvented by collusion or improper management override.  Because
of such limitations, there is a risk that material misstatements may not be
prevented or detected on a timely basis by internal control over financial
reporting. However, these inherent limitations are known features of the
financial reporting process.  Therefore, it is possible to design into the
process safeguards to reduce, though not eliminate, this risk.  In
addition, projections of any evaluation of effectiveness to future periods are
subject to the risk that controls may become inadequate because of changes in
conditions or that the degree of compliance with the policies or procedures may
deteriorate.
  COSO Framework ur
management, including the chief executive officer and principal financial
officer, could not conclude that our internal controls and procedures were
sufficient to ensure that we maintained appropriate internal control over
financial reporting at December 31, 2007, as while we considered the criteria
established in the COSO Framework, we did not perform a complete assessment as
outlined in Commission Guidance Regarding Management’s Report on Internal
Control Over Financial Reporting Under Section 13(a) or 15(d) of the Exchange
Act. In
summary, the Company did not conduct sufficient testing of internal controls in
2007 to satisfy COSO requirements. As a result, we have put an implementation
plan in place whereby in 2008 sufficient testing to satisfy COSO requirements
will be performed. The absense of the ability to conclude as to the sufficiency
of internal controls, is a material weakness.
 
 Despite
the insufficient testing, we believe that our financial statements contained in
this Form 10-KSB filed with the SEC fairly present our financial position,
results of operations and cash flows for the fiscal year ending December 31,
2007 in all material respects. This annual report does not include an
attestation report of our independent registered public accounting firm
regarding internal control over financial reporting. Our internal controls were
not subject to attestation by our independent registered public accounting firm
pursuant to temporary rules of the Securities and Exchange Commission that
permit us to provide only management’s report in this annual
report.
  (b) Changes in Internal Control Over Financial
Reporting


ITEM
8B. OTHER INFORMATION.













ITEM
9.  DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.





Executive
Officers and Directors





NAME
            AGE
            POSITIONRodney
      S. Rougelot
            44
            Director
      and Chief Executive Officer and Interim Chief Financial
      OfficerGary
      M. De Laurentiis
            62
            Director
      and Chief Technology OfficerDavid
      M. Otto
            49
            DirectorLawrence
      A. Krause
            67
            DirectorRonald
      M. Domingue
            45
            DirectorRoy
      A. Herberger
            64
            DirectorWilliam
      Whittaker
            58
            ChairmanCraig
      Hardy
            39
            Former
      Chief Financial OfficerMario
      Sandoval
            44
            Former
      Chief Operating Officer





Rodney S.
Rougelot


Director
and Chief Executive Officer





Mr.
Rougelot brings to ECO2over 20
years of extensive experience in recycling, operations, finance, and mergers and
acquisitions.  Upon graduating from Harvard Business School, Mr.
Rougelot founded Recycling Resource, LLC (“Recycling Resource”) in 1991, which
rapidly became one of the leading recycling companies in
California.  After Recycling Resource was acquired by Tomra Pacific,
Inc. (“Tomra Pacific”) in 1998, Mr. Rougelot served as President of the
commercial division, building Tomra Pacific into one of the largest beverage
container recyclers in the United States.  Most recently in 2006, Mr.
Rougelot was engaged through Stone Yamashita Partners as a strategic consultant
with The Coca Cola Company.  Mr. Rougelot has served as Director and
Chief Executive Officer since July 2006 and was appointed interim Chief
Financial Officer in March 2008.





Mr.
Rougelot is not a director of any other public company, nor is he related to any
officer, director or affiliate of the Company.  Mr. Rougelot is not a
party to any pending legal proceeding, nor has he been subject to a bankruptcy
petition filed against him, nor been convicted in, or subject to, any criminal
proceeding.





Gary M.
De Laurentiis


Director
and Chief Technology Officer





Mr. De
Laurentiis has previously served as the Chairman, President and CEO since
founding the Company in 1999.  Mr. De Laurentiis was appointed Chief
Technology Officer in July 2006.  Mr. De Laurentiis has been active in
the plastics recycling business for nearly twenty (20) years.  In
partnership with the Chinese Government, he designed and built his first
plastics recycling plant in 1987.  In the years since, he has
designed, remodeled, built and operated plants in Mexico, North Carolina, Ohio,
Florida, California and Canada for both local governments and private
industries. From 1992 to 1995, Mr. De Laurentiis worked directly with the State
Government in Campeche Mexico, living on-site for eighteen (18) months while
directing the entire project. In 1996, an Ohio based group recruited Mr. De
Laurentiis to open a shuttered recycling plant. Mr. De Laurentiis left the
company in 1999 to start ECO2. From
collecting, brokering, recycling and remanufacturing, to lobbying on behalf of
the industry, Mr. De Laurentiis is intimately familiar with all levels of
plastics recycling.  The depth of Mr. De Laurentiis’ knowledge and his
continuing search for newer, safer and more efficient ways to recycle waste has
earned him the respect of his peers and the many regulatory agencies charged
with protecting the environment that regularly call upon him for
advice.





Mr. De
Laurentiis is not a director of any other public company, nor is he related to
any officer, director or affiliate of the Company.  Mr. De Laurentiis
is not a party to any pending legal proceeding, nor has he been subject to a
bankruptcy petition filed against him, nor been convicted in, or subject to, any
criminal proceeding.





David M.
Otto


Director





Mr. Otto
is a Seattle-based attorney and the President of The Otto Law Group, PLLC. Mr.
Otto’s practice is focused on corporate finance, securities, mergers &
acquisitions, corporate law and governance. Mr. Otto began his practice on Wall
Street in New York City in 1987 with the Hughes, Hubbard and Reed law firm,
where he concentrated on significant corporate leveraged buyout and takeover
transactions and equity and debt offerings for investment banks, venture capital
firms and Fortune 1000 companies. In 1991, Mr. Otto moved to Seattle in order to
dedicate his extensive experience to entrepreneurs, technology innovators,
start-up and emerging growth businesses. In July 1999, Mr. Otto founded the Otto
Law Group, PLLC in Seattle. Mr. Otto is a Director of Vocalscape Networks, Inc.,
SinoFresh Healthcare, Inc., TechAlt, Inc., SARS Corporation and Avisere, Inc. He
is a member of the American Bar Association Committee on the Federal Regulation
of Securities, Subcommittee on the 1933 Act and Chairman of the Legislation
Subcommittee of the ABA’s Venture Capital and Private Equity Committee. Mr. Otto
is admitted to practice law in New York and Washington. Mr. Otto earned an AB
from Harvard University and a JD from Fordham University School of
Law.  Mr. Otto has served as a Director since February
2006.





Mr. Otto
is not related to any officer, director or affiliate of the
Company.  Mr. Otto is not a party to any pending legal proceeding, nor
has he been subject to a bankruptcy petition filed against him, nor been
convicted in, or subject to, any criminal proceeding.











Lawrence
A. Krause


Director





Mr.
Krause has over 30 years experience in the financial industry and is president
of Lawrence A. Krause & Associates, Inc. Lawrence A. Krause &
Associates, Inc. is a registered investment firm and is composed of certified
financial planners. Their and his experiences encompass securities, investment
banking, real estate, business consulting, estate planning, education planning,
retirement planning and tax planning. Mr. Krause is recognized as a leader in
the field of financial and investment planning and has been named “Financial
Planner of the Year” by his peers in San Francisco and on several occasions has
been called “one of the nation’s leading financial planners” by the New York Times. Mr.
Krause founded one of the first comprehensive financial planning departments in
the United States for a major brokerage firm. Mr. Krause has extensive
experience as a partner of limited partnership and managing member of limited
liability corporate investment funds. Mr. Krause has been and currently remains
as a general partner in limited partnerships and a managing member in limited
liability companies which have invested in opportunities such as oil and gas,
venture capital, equipment leasing, real estate and proprietary manufacturing.
Mr. Krause received his B.A. from State University of Iowa, and has also
received a CFP (Certified Financial Planner) and CSA (Certified Senior
Advisor).  Mr. Krause has served as a Director since February
2006.





Mr.
Krause is not a director of any other public company, nor is he related to any
officer, director or affiliate of the Company.  Mr. Krause is not a
party to any pending legal proceeding, nor has he been subject to a bankruptcy
petition filed against him, nor been convicted in, or subject to, any criminal
proceeding.





Ronald M.
Domingue


Director





Mr.
Domingue brings extensive financial, logistics and engineering experience to
ECO2.  He
is a managing partner at Arbor Malone, LLC and was a co-founder of SupplyBase,
Inc. (“SupplyBase”), a supply-chain software company that was acquired by i2
Technologies, Inc.  Prior to SupplyBase, Mr. Domingue held positions in
product management, engineering and field marketing at GE Plastics, a subsidiary
of General Electric Company (“General Electric”), over a 13 year
career.  Mr. Domingue holds a Bachelor of Science in Mechanical
Engineering, Cum Laude, from the University of Vermont, a Masters of Science in
Mechanical Engineering from Rensselaer Polytechnic Institute, and he is a
graduate of General Electric’s Edison Engineering Program.  Mr.
Domingue has served as a Director since December 2006.





Mr.
Domingue is not a director of any other public company, nor is he related to any
officer, director or affiliate of the Company.  Mr. Domingue is not a
party to any pending legal proceeding, nor has he been subject to a bankruptcy
petition filed against him, nor been convicted in, or subject to, any criminal
proceeding.





William
Whittaker


Chairman





Mr.
Whittaker brings extensive asset management experience, both in real estate and
investment management, to ECO2.  Mr.
Whittaker currently manages assets worth approximately $125 million through
Whittaker Asset Management, Inc., a company of which he has been the Chairman
and CEO of since 1987.  Mr. Whittaker is also the controlling
principal of more than 40 privately held companies and/or partnerships that
either own commercial income properties or invest in operating
businesses.  Mr. Whittaker graduated from Stanford University in 1971
with an Economics degree and from the University of Santa Clara School of Law,
cum laude, in
1976.  He was admitted to the California State Bar in 1976 (inactive
1996) and the United States Tax Court in 1979.  Mr. Whittaker was appointed
as a Director in February 2007.





Mr.
Whittaker is not a director of any other public company, nor is he related to
any officer, director or affiliate of the Company.  Mr. Whittaker is
not a party to any pending legal proceeding, nor has he been subject to a
bankruptcy petition filed against him, nor been convicted in, or subject to, any
criminal proceeding.





Roy A.
Herberger


Director





Mr.
Herberger brings extensive marketing, management and corporate strategy
experience to the Company.  Mr. Herberger is currently President
Emeritus of the Thunderbird School of Global Management.  From 1989
until August 2004, Mr. Herberger served as President of Thunderbird, the Gavin
Graduate School of International Management in Glendale, Arizona.  His
experience includes research and consultancies with several major Asian
corporations.  Mr. Herberger has also published numerous articles on
international business negotiations in United States and international academic
and business periodicals.  He currently is a director of the Mayo
Clinic, Rochester; Pinnacle West Capital Corporation and MedAire,
Inc.  Mr. Herberger graduated from the University of Colorado in 1971
with a PhD in business and from the University of Texas, Austin with a M.A. in
1968 and B.A. in 1966.  Mr. Herberger was appointed as Director in May
2007.





Mr.
Herberger is not related to any officer, director or affiliate of the
Company.  Mr. Herberger is not a party to any pending legal
proceeding, nor has he been subject to a bankruptcy petition filed against him,
nor been convicted in, or subject to, any criminal proceeding.











Craig
Hardy


Former
Chief Financial Officer





Mr. Hardy
resigned from the Chief Financial Officer position in March 2008.  In
August 2007, Mr. Hardy was appointed Chief Financial Officer of ECO2.  Most
recently, Mr. Hardy was the Senior Finance Director atE&J Gallo Winery in
Modesto, California (“E&J Gallo”).  Mr. Hardy served as the
Finance Director of Operations and served as the Finance Director of Corporate
Planning and Analysis at E&J Gallo.  Prior to joining E&J
Gallo, Mr. Hardy served as the Finance Manager of GE Specialty Chemicals at
General Electric Company (“GE”) from 2001 to 2003.  Previous positions
Mr. Hardy has held with GE include Commercial Finance Manager of GE Silicones,
Six Sigma Master Black Belt of GE Industrial Systems and Senior Financial
Analyst of GE Industrial Systems.  Mr. Hardy earned a Bachelor of
Science in Business Administration in 1990 from State University of New York at
Buffalo and a Masters of Business Administration in 1995 from Union
College.





Mr. Hardy
is not a director of any other public company, nor is he related to any officer,
director or affiliate of the Company.  Mr. Hardy is not a party to any
pending legal proceeding, nor has he been subject to a bankruptcy petition filed
against him, nor been convicted in, or subject to, any criminal
proceeding.





Mario
Sandoval


Former
Chief Operating Officer





Mr.
Sandoval resigned from the Chief Operating Officer position effective March 1,
2008.  Mr. Sandoval was previously the Senior Process Leader with
Johns Manville in the BPS initiative, headquartered in Denver,
Colorado.  He was responsible for all aspects of the Plan to Make
implementation.  Prior to joining BPS, Mr. Sandoval was the Director
of Strategic Engineering Programs and the Director of Operations for performance
materials.  Prior to joining Johns Manville in July of 2004, Mr.
Sandoval was the Vice President and Supply Chain Leader for General Electric
Polymershapes (“GE”).  Previous positions Mr. Sandoval has held with
GE include Global Manufacturing Leader for Crystalline Plastics, Master Black
Belt and various operational leadership, quality and automation engineering
roles. He started his career with GE on the Chemical/Metallurgical Management
Training program.  Mr. Sandoval has a Bachelor of Science degree in
chemical engineering and computer science from New Mexico State
University.  Mr. Sandoval had served as Chief Operating Officer since
October 2006.





Mr.
Sandoval is not a director of any other public company, nor is he related to any
officer, director or affiliate of the Company.  Mr. Sandoval is not a
party to any pending legal proceeding, nor has he been subject to a bankruptcy
petition filed against him, nor been convicted in, or subject to, any criminal
proceeding.





Audit
Committee Financial Expert





The
Company does not have an audit committee financial expert.





Compliance
with Section 16(a) of the Exchange Act





Section
16(a) of the Exchange Act requires the Company’s officers, directors and persons
who beneficially own more than 10% of the Company’s common stock to file reports
of ownership and changes in ownership with the SEC. These reporting persons also
are required to furnish the Company with copies of all Section 16(a) forms they
file. None of the officers or directors of the Company have provided to the
Company any filed reports upon their acquisition or disposition of securities of
the Company. With the exception of the aforementioned, to the Company’s
knowledge, no officers, directors and persons who beneficially own more than 10%
of the Company’s common stock have failed to file the reports required pursuant
to Section 16(a).





Code
of Ethics





The
Company has adopted a Revised Code of Ethics. The Revised Code of Ethics is
attached as Exhibit 14.1. The Company hereby undertakes to provide any person
without charge, upon request, a copy of the Company’s Code of Ethics. Requests
for copies of the Company’s Code of Ethics should be sent to:





ECO2 Plastics,
Inc.


680
Second Street, Suite 200


San
Francisco, CA 94107


Attn:
Rodney S. Rougelot










ITEM 10.  EXECUTIVE
COMPENSATION.





SUMMARY
COMPENSATION TABLE





Name
      and Principal Position
            Year
            Salary
            Bonus
            Stock
      Awards
            Option
      Awards
            Non-Equity
      Incentive Plan Compensation
            Change
      in Pension Value and Nonqualified Deferred Compensation
      Earnings
            All
      Other Compensation
            TotalCEO
              Rodney
      S. Rougelot
              Appointed
      July 2006 (1)
            2007
            $330,000
            $0
            $1,382,000
            $0
            $0
            $0
            $0
            $1,712,0002006
            $129,198
            $0
            $4,600,000
            $0
            $0
            $0
            $8,700
            $4,737,8982005
            N/A
            N/A
            N/A
            N/A
            N/A
            N/A
            N/A
            N/ACTO
              Gary
      De Laurentiis
              (2)
            2007
            $290,000
            $0
            $160,000
            $0
            $0
            $0
            $0
            $450,0002006
            $291,628
            $0
            $847,000
            $0
            $0
            $0
            $7,500
            $1,146,1282005
            $84,000
            $0
            $0
            $0
            $0
            $0
            $168,000
            $252,000Former
      COO
              Mario
      Sandoval (3)
            2007
            $290,769
            $0
            $0
            $0
            $0
            $0
            $0
            $290,7692006
            $45,833
            $0
            $0
            $1,600,000
            $0
            $0
            $5,800
            $1,651,6332005
            N/A
            N/A
            N/A
            N/A
            N/A
            N/A
            N/A
            N/AFormer
      CFO
              Craig
      Hardy
              Appointed
      Aug. 2007
              (4)
            2007
            $78,846
            $0
            $0
            $198,000
            $0
            $0
            $0
            $78,8462006
            N/A
            N/A
            N/A
            N/A
            N/A
            N/A
            N/A
            N/A2005
            N/A
            N/A
            N/A
            N/A
            N/A
            N/A
            N/A
            N/A





(1)
            Under
      the terms of Mr. Rougelot’s employment agreement, he received 35,200,000
      shares of Company common stock, of which 17,600,000 (50%) shares are
      fully-vested, and of which 8,800,000 shares vested in September 2007 and
      the remaining 8,800,000 vest pro-rata from October 2007 to September
      2008.  The total value of the shares based on the $0.13 per
      share grant date quoted trading price of the Company’s common stock was
      approximately $4.6 million.  In connection with this agreement,
      the Company recorded compensation expense in 2007 of approximately $1.4
      million for fully-vested shares and for a portion of the unvested shares
      amortized on a straight-line basis over the vesting periods.  In
      addition, pursuant to terms of the executive’s employment agreement, the
      executive received an additional 8,800,000 fully-vested shares in
      connection with the certain agreement specified capital raising events,
      and as a result of the occurrence of such event, the Company recorded
      additional compensation expense of approximately $1.1 million based on the
      $0.125 per share closing quoted trading price on the date of the
      event.  A total of 44,000,000 million shares of Company common
      stock were issued to the executive in 2006, a portion of which is subject
      to return in accordance with vesting provisions.This information is
      also found in the Outstanding Equity Awards at Fiscal Year-End table and
      the Option Exercises and Stock Vested table below.





(2)
            Under
      the terms of Mr. De Laurentiis’ employment agreement, he will receive
      24,000,000 fully-vested shares or share equivalents (warrants), of which
      he had previously received 17,953,208 of such shares and share
      equivalents, or an additional 6,046,792 shares.  In connection
      with this agreement, inasmuch as the shares were fully vested in 2006, the
      Company recorded compensation expense and an increase in additional
      paid-in capital of $847,000, which was determined on the $0.14 per share
      quoted trading price on the date of the employment agreement.This information is
      also found in the Outstanding Equity Awards at Fiscal Year-End table and
      the Option Exercises and Stock Vested table below. In 2007, in connection
      with this agreement, Mr. DeLaurentiis received an additional 2,000,000
      fully-vested shares of Company common stock, which the Company recorded as
      compensation expense of $160,000, which was, determined on the $0.08 per
      share quoted trading price on the date of the
  award.




(3)
            Mario
      Sandoval served as the COO from October 2006 until his resignation
      effective March 1, 2008.  Under the terms of Mr. Sandoval’s
      employment agreement, he was to receive shares of Company common stock (or
      stock options, at the executive’s election) covering 5% of Common Stock
      Equivalents, as defined in the agreement.  The Effective Date of
      the employment agreement was October 19, 2006, at which date the executive
      received options to purchase 24,000,000 common shares (shares were not
      elected) of Company common stock, of which 12,000,000 (50%) warrant were
      fully-vested, and of which 6,000,000 warrants vest in October 2007 and the
      remaining 6,000,000 were to vest pro-rata from November 2007 to October
      2008. The warrants were exercisable at $0.0975 per share for ten years. In
      connection with this agreement, the Company recorded compensation expense
      of approximately $1.6 million based on the fair value as determined
      utilizing the Black-Scholes valuation model as of the Effective Date for
      fully-vested shares, and $155,000 for a portion of the unvested shares
      amortized on a straight-line basis over the vesting
      periods.  This information is also found in the Outstanding
      Equity Awards at Fiscal Year-End table and the Option Exercises and Stock
      Vested table below.  In connection with Mr. Sandoval’s
      departure, he agreed to return his previously issued common stock purchase
      warrant in exchange for 5,000,000 shares of common stock, par value $0.001
      per share, with a per share price at $0.07 per share which were filed on
      Form S-8 under the Securities Act of 1933 with the
  SEC.





(4)
            Craig
      Hardy served as the CFO from August 2007 until his resignation in March
      2008. Pursuant to the terms of Mr. Hardy’s employment agreement,
      he was to receive an annual salary of $250,000 and he was
      to receive equity in the Company of up to 5,000,000 shares of the
      Company’s issued and outstanding stock based on his length of service to
      the Company.  In connection with the employment agreement’s
      equity awards, Mr. Hardy was issued a common stock purchase warrant to
      acquire up to 5,000,000 shares of common stock at $0.108 per
      share/cashless.  This information is also found in the
      Outstanding Equity Awards at Fiscal Year-End table and the Option
      Exercises and Stock Vested table
  below.




GRANTS OF
PLAN BASED AWARDS.





No grants
of plan based awards were granted during the 2007 fiscal year.




DESCRIPTION
OF ADDITIONAL MATERIAL FACTORS





On August
10, 2007, Craig D. Hardy’s employment agreement was deemed effective by the
Board of Directors of the Company, making him the new Chief Financial
Officer.  Pursuant to the terms of the employment agreement, Mr. Hardy
shall receive an annual salary of $250,000 and he shall receive equity in the
Company of up to 5,000,000 shares of the Company’s issued and outstanding stock
based on his length of service to the Company.  Mr. Hardy elected to
receive the equity in the form of a common stock purchase warrant.  In
March 2008 Mr. Hardy resigned.





OUTSTANDING
EQUITY AWARDS AT FISCAL YEAR-END





Name
            Option
      Awards
            Stock
      AwardsNumber
      of Securities Underlying Unexercised Options
            Number
      of Securities Underlying Unexercised Options
            Equity
      Incentive Plan Awards: Number of Securities Underlying Unearned
      Options
            Option
      Exercise Price
            Option
      Expiration Date
            Number
      of Shares or Units of Stock That Have Not Vested
            Market
      Value of Shares or Units of Stock That Have Not
    Vested
            Equity
      Incentive Plan Awards: Number of Unearned Shares, Units or Other Rights
      That Have Not Vested
            Equity
      Incentive Plan Awards: Market or Payout Value of Unearned Shares, Units or
      Other Rights That Have Not VestedExercisable
            UnexercisableCEO
              Rodney
      S. Rougelot (1)
            0
            0
            0
            $0
            N/A
            6,600,000
            $462,000
            0
            $0CTO
              Gary
      De Laurentiis (2)
            0
            0
            0
            $0
            N/A
            0
            $0
            0
            $0Former
      COO
              Mario
      Sandoval (3)
            0
            0
            0
            $0
            N/A
            12,000,000
            $0
            0
            $0Former
      CFO
              Craig
      Hardy (4)
            0
            0
            0
            $0
            N/A
            3,750,000
            $0
            0
            $0





(1)
            Under
      the terms of Mr. Rougelot’s employment agreement, he received 35,200,000
      shares of Company common stock, of which 17,600,000 (50%) shares are
      fully-vested, and of which 8,800,000 shares vested in September 2007 and
      the remaining 8,800,000 vest pro-rata from October 2007 to September
      2008.  The total value of the shares based on the $0.13 per
      share grant date quoted trading price of the Company’s common stock was
      approximately $4.6 million.  In connection with this agreement,
      the Company recorded compensation expense in 2007 of approximately
      $1.4million for fully-vested shares and for a portion of the unvested
      shares amortized on a straight-line basis over the vesting
      periods.  In addition, pursuant to terms of the executive’s
      employment agreement, the executive received an additional 8,800,000
      fully-vested shares in connection with the certain agreement specified
      capital raising events, and as a result of the occurrence of such event,
      the Company recorded additional compensation expense of approximately $1.1
      million based on the $0.125 per share closing quoted trading price on the
      date of the event.  A total of 44,000,000 million shares of
      Company common stock were issued to the executive in 2006, a portion of
      which is subject to return in accordance with vesting provisions.This information is
      also found in the Summary Compensation table above and the Option
      Exercises and Stock Vested table
below.





(2)
            Under
      the terms of Mr. De Laurentiis’ employment agreement, he will receive
      24,000,000 fully-vested shares or share equivalents (warrants), of which
      he had previously received 17,953,208 of such shares and share
      equivalents, or an additional 6,046,792 shares.  In connection
      with this agreement, inasmuch as the shares were fully vested, the Company
      recorded compensation expense and an increase in additional paid-in
      capital of $847,000, which was determined on the $0.14 per share quoted
      trading price on the date of the employment agreement.Mr. De Laurentiis
      has not yet been issued these shares.  This information is also
      found in the Summary Compensation table above and the Option Exercises and
      Stock Vested table below.




(3)
            Mario
      Sandoval served as the COO from October 2006 until his resignation
      effective March 1, 2008.  Under the terms of Mr. Sandoval’s
      employment agreement, he is to receive shares of Company common stock (or
      stock options, at the executive’s election) covering 5% of Common Stock
      Equivalents, as defined in the agreement.  The Effective Date of
      the employment agreement is October 19, 2006, at which date the executive
      is to receive options to purchase 24,000,000 common shares (shares were
      not elected) of Company common stock, of which 12,000,000 (50%) warrant
      are fully-vested, and of which 6,000,000 warrants vest in October 2007 and
      the remaining 6,000,000 vest pro-rata from November 2007 to October 2008.
      The warrants are exercisable at $0.0975 per share for ten years. In
      connection with this agreement, the Company recorded compensation expense
      of approximately $1.6 million based on the fair value as determined
      utilizing the Black-Scholes valuation model as of the Effective Date for
      fully-vested shares, and $155,000 for a portion of the unvested shares
      amortized on a straight-line basis over the vesting periods.  In
      connection with Mr. Sandoval’s departure, he agreed to return his
      previously issued common stock purchase warrant in exchange for 5,000,000
      shares of common stock, par value $0.001 per share, with a per share price
      at $0.07 per share which were filed on Form S-8 under the Securities Act
      of 1933 with the SEC.  This information is also found in the
      Summary Compensation table aboveand the Option Exercises and Stock Vested
      table below.  Effective March 1, 2008 Mr. Sandoval
      resigned.





(4)
            Craig
      Hardy served as the CFO from August 2007 until his resignation in March
      2008. Pursuant to the terms of Mr. Hardy’s employment agreement,
      he was to receive an annual salary of $250,000 and he was
      to receive equity in the Company of up to 5,000,000 shares of the
      Company’s issued and outstanding stock based on his length of service to
      the Company.  In connection with the employment agreement’s
      equity awards, Mr. Hardy was issued a common stock purchase warrant to
      acquire up to 5,000,000 shares of common stock at $0.108 per
      share/cashless.This information is
      also found in the Summary Compensation table above and the Option
      Exercises and Stock Vested table below.










OPTION
EXERCISES AND STOCK VESTED TABLE FOR 2007





Name
            Option
      Awards
            Stock
      AwardsNumber
      of Shares Acquired on Exercise
            Value
      Realized on Exercise
            Number
      of Shares Acquired on Vesting
            Value
      Realized on VestingCEO
              Rodney
      S. Rougelot (1)
            0
            $0
            11,000,000
            $1,382,000CTO
              Gary
      De Laurentiis (2)
            0
            $0
            2,000,000
            $160,000Former
      COO
              Mario
      Sandoval (3)
            0
            $0
            0
            $0Former
      CFO
              Craig
      Hardy (4)
            0
            $0
            0
            $0





(1)
            Under
      the terms of Mr. Rougelot’s employment agreement, he received 35,200,000
      shares of Company common stock, of which 17,600,000 (50%) shares are
      fully-vested, and of which 8,800,000 shares vested in September 2007 and
      the remaining 8,800,000 vest pro-rata from October 2007 to September
      2008.  The total value of the shares based on the $0.13 per
      share grant date quoted trading price of the Company’s common stock was
      approximately $4.6 million.  In connection with this agreement,
      the Company recorded compensation expense in 2007 of approximately $1.4
      million for fully-vested shares and for a portion of the unvested shares
      amortized on a straight-line basis over the vesting periods.  In
      addition, pursuant to terms of the executive’s employment agreement, the
      executive received an additional 8,800,000 fully-vested shares in
      connection with the certain agreement specified capital raising events,
      and as a result of the occurrence of such event, the Company recorded
      additional compensation expense of approximately $1.1 million based on the
      $0.125 per share closing quoted trading price on the date of the
      event.  A total of 44,000,000 million shares of Company common
      stock were issued to the executive in 2006, a portion of which is subject
      to return in accordance with vesting provisions.In 2007, 11,000,000 of
      these shares vested.This information is also found in the Summary
      Compensation table and Outstanding Equity Awards at Fiscal Year-End table
      above.





(2)
            Under
      the terms of Mr. De Laurentiis’ employment agreement, he will receive
      24,000,000 fully-vested shares or share equivalents (warrants), of which
      he had previously received 17,953,208 of such shares and share
      equivalents, or an additional 6,046,792 shares.  In 2006, in
      connection with this agreement, inasmuch as the shares were fully vested,
      the Company recorded compensation expense and an increase in additional
      paid-in capital of $847,000, which was determined on the $0.14 per share
      quoted trading price on the date of the employment agreement.Mr. De Laurentiis
      has not yet been issued these shares.  In 2007, in connection
      with this agreement, Mr. DeLaurentiis received an additional 2,000,000
      fully-vested shares of Company common stock, which the Company recorded as
      compensation expense of $160,000, which was, determined on the $0.08 per
      share quoted trading price on the date of the award. This information is
      also found in the Summary Compensation table and the Outstanding Equity
      Awards at Fiscal Year-End table
above.





(3)
            Mario
      Sandoval served as the COO from October 2006 until his resignation
      effective March 1, 2008. Under the terms of Mr. Sandoval’s employment
      agreement, he is to receive shares of Company common stock (or stock
      options, at the executive’s election) covering 5% of Common Stock
      Equivalents, as defined in the agreement.  The Effective Date of
      the employment agreement is October 19, 2006, at which date the executive
      is to receive options to purchase 24,000,000 common shares (shares were
      not elected) of Company common stock, of which 12,000,000 (50%) warrant
      are fully-vested, and of which 6,000,000 warrants vest in October 2007 and
      the remaining 6,000,000 vest pro-rata from November 2007 to October 2008.
      The warrants are exercisable at $0.0975 per share for ten years. In
      connection with this agreement, the Company recorded compensation expense
      of approximately $1.6 million based on the fair value as determined
      utilizing the Black-Scholes valuation model as of the Effective Date for
      fully-vested shares, and $155,000 for a portion of the unvested shares
      amortized on a straight-line basis over the vesting periods.  In
      connection with Mr. Sandoval’s departure, he agreed to return his
      previously issued common stock purchase warrant in exchange for 5,000,000
      shares of common stock, par value $0.001 per share, with a per share price
      at $0.07 per share which were filed on Form S-8 under the Securities Act
      of 1933 with the SEC.  This information is also found in the
      Summary Compensation table and the Outstanding Equity Awards at Fiscal
      Year-End table above.





(4)
            Craig
      Hardy served as the CFO from August 2007 until his resignation in March
      2008. Pursuant to the terms of Mr. Hardy’s employment agreement,
      he was to receive an annual salary of $250,000 and he was
      to receive equity in the Company of up to 5,000,000 shares of the
      Company’s issued and outstanding stock based on his length of service to
      the Company.  In connection with the employment agreement’s
      equity awards, Mr. Hardy was issued a common stock purchase warrant to
      acquire up to 5,000,000 shares of common stock at $0.108 per
      share/cashless.This information is
      also found in the Summary Compensation table and the Outstanding Equity
      Awards at Fiscal Year-End table
  above.




PENSION
BENEFITS TABLE





The
Company did not offer a pension plan during fiscal year 2007.




NONQUALIFIED
DEFERRED COMPENSATION TABLE





The
Company did not offer any non-qualified deferred compensation plans during
fiscal year 2007.




DIRECTOR
COMPENSATION DISCLOSURE





On May
17, 2007, the Company issued Roy Herberger, a Director, a common stock purchase
warrant to acquire up to 500,000 shares of common stock at an exercise price of
$0.19 per share/cashless.







ITEM
11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED
STOCHOLDER MATTERS.





The
following table sets forth certain information regarding the beneficial
ownership of our common stock as of March 1, 2008:





Title
      of Class:
            Name
      and Address of Beneficial Holder:
            Amount
      and Nature of Beneficial Ownership:
            Percent
      of Class (9):Common,
      $.001 par value
            Gary
      De Laurentiis
              P.O.
      Box 760, 5300 Claus Rd.,
              Riverbank,
      CA  95367
            14,791,201
      (1)
            6%Common,
      $.001 par value
            Lawrence
      A. Krause
              1001
      Bayhill Drive, Suite 170
              San
      Bruno, CA 94066
            15,325,000
      (2)
            5%Common,
      $.001 par value
            David
      M. Otto
              601
      Union Street, Suite 4500
              Seattle,
      WA 98164
            17,032,514
      (3)
            6%Common,
      $.001 par value
            Rodney
      S. Rougelot
              P.O.
      Box 760, 5300 Claus Rd.
              Riverbank,
      CA  95367
            43,919,000
      (4)
            15%Common,
      $.001 par value
            Ronald
      M. Domingue
              5300
      Claus Road, Box 760
              Riverbank,
      CA 95367
            16,711,307
      (5)
            6%Common,
      $.001 par value
            William
      Whittaker
              8070
      La Jolla Shores Drive, #508
              La
      Jolla, CA 92037
            29,822,970
      (6)
            10%Common,
      $.001 par value
            Mario
      Sandoval
              5300
      Claus Road, Box 760
              Riverbank,
      CA 95367
            5,000,000
            2%Common,
      $.001 par value
            Voting
      Trustee
              5300
      Claus Road, Box 760
              Riverbank,
      CA 95367
            6,600,000
      (7)
            2%Common
      stock purchase warrant
            Roy
      A. Herberger
              5834 N22nd Place
              Phoenix, AZ 85016
            500,000
      (8)
            <1%Total
      Held by Officers and Directors:
            
            149,701,992 (9)Total
      Held by Officers, Directors and Certain Beneficial Owners:
            
            149,701,992(9)





(1)
            Of
      this amount, Mr. De Laurentiis owns 7,406,519 shares of common
      stock.  He has a common stock purchase warrant to acquire up to
      7,384,682 shares at $0.06 per share/cashless.  This warrant
      expires on April 15, 2015.





(2)
            As
      the principal of KW Securities Corporation, Mr. Krause has a common stock
      purchase warrant to acquire up to 14,625,000 shares at $0.06 per
      share/cashless.  This warrant expires on April 15,
      2015.  Mr. Krause also owns common stock purchase warrants to
      acquire up to a total of 700,000 shares at $0.06 per
      share/cashless.  These warrants expire on April 15,
      2015.





(3)
            Mr.
      Otto individually owns 2,500,000 shares of common stock.  An
      additional 3,231,085 shares of common stock are held The Otto Law Group,
      PLLC, of which Mr. Otto is the principal.  Mr. Otto also has
      common stock purchase warrants to purchase a total of 1,500,000 shares of
      common stock with a strike price of $0.06 per
      share/cashless.  These warrants expire on April 15,
      2010.    Cambridge Partners, LLC, of which Mr. Otto is
      one of two members, has common stock purchase warrants to acquire up to a
      total of 2,000,000 shares of common stock with a strike price of $0.06 per
      share/cashless.  These warrants expire on April 15,
      2015.  Finally, Saratoga Capital Partners, LLC (“Saratoga”), an
      entity Mr. Otto is also a member of, has a common stock purchase warrants
      to acquire up to a total of 7,801,429 shares of common stock with a strike
      price of $0.06 per share/cashless.  These warrants expire on
      April 15, 2015.  Saratoga also has 10% convertible notes
      totaling $350,000 which can convert at $0.0975 per
  share.





(4)
            Mr.
      Rougelot has common stock purchase warrant to acquire up to a total of
      6,519,000 shares at $0.06 per share/cashless.  These warrant
      expires on April 15, 2015.  Mr. Rougelot also has 10%
      convertible debentures totaling $30,769 with a $0.0975 conversion
      rate.  Under the terms of Mr. Rougelot’s employment agreement,
      he is eligible to receive an aggregate amount of restricted common stock
      equal 44,000,000 shares, of which 39,600,000 have fully
      vested.




(5)
            Of
      this amount, Mr. Domingue owns 9,025,640 shares of common
      stock.  Mr. Domingue owns common stock purchase warrants to
      acquire up to a total of 4,766,667 shares at $0.12 per
      share/cashless.  Mr. Domingue owns common stock purchase
      warrants to acquire up to a total of 2,919,000 shares at $0.06 per
      share/cashless.  These warrant expires on April 15,
      2015.  He also has 10% convertible notes totaling $117,716 which
      can convert at $0.0975 per share.





(6)
            Mr.
      Whittaker is the general partner of Whittaker Capital Partners I, LP
      (“WCP”).  WCP has (i) warrants to purchase a total of 29,234,202
      shares of common stock, each with a strike price of $0.06 per share; (ii)
      a warrant to purchase 588,768 shares of common stock at $0.12 per
      share/cashless; and (ii) 10% convertible notes totaling $5,921,734 which
      can convert at $0.0975 per share.  These warrants expires on
      April 15, 2015.




(7)
            Under
      the terms of Mr. Rougelot’s employment agreement, he is eligible to
      receive an aggregate amount of restricted common stock equal to a total of
      44,000,000 shares.  Of this amount, 6,600,000 shares have not
      vested.  In connection with an irrevocable proxy, David M. Otto
      has been appointed attorney-in-fact to vote the shares in connection with
      any shareholder meeting of ECO2 in
      accordance with, and under the direction of, the Company’s Board of
      Directors.  The amount of shares the Voting Trustee may vote
      will adjust in accordance with the vesting schedule in Mr. Rougelot’s
      employment agreement.




(8)
            Of
      this amount, Mr. Herberger has a common stock purchase warrant to acquire
      up to 500,000 shares of common stock with an excerise price of $0.19 per
      share cashless.  This warrant expires May 17,
  2011.




(9)
            As
      of February 28, 2008, ECO2Plastics, Inc. had 207,247,863 shares of common stock issued and
      outstanding.  The total amount of shares that could be issued to
      certain beneficial owners and management within the next 60 days is
      78,538,748shares.  Based on these amounts, the percentage
      ownership is based on a fully diluted amount of
      285,786,611shares.










ITEM
12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS





During
July through October 2007, the Company received cash proceeds of approximately
$2.5 million from various members of the Company’s Board of Directors (the
“Director Notes”).  In accordance with the Director Notes, each lender
received a promissory note with an interest rate of 15% per annum (the
“Note”).  All or any portion of the Note, any accrued interest thereon
and all other sums due under the Note, is due and payable on demand within 90
days of the Note.  In connection with these notes, lenders received
common stock purchase warrants to purchase 22,657,000 shares of Company common
stock with an exercise price of $0.06 per share that expire in April
2015.  The shares underlying the warrants are subject to piggy back
registration rights.  The exercise price of the warrants is subject to
anti-dilution downward adjustments in the event the Company sells common stock
at a price below the exercise price.  During 2007, two of the
Company’s Directors made loans due on demand with interest at 10% to the Company
in the aggregate total of $577,000.  The loan from one Director in the
amount of $300,000 was repaid, and the other $277,000 was cancelled and replaced
with Director Notes.





Pursuant
to an agreement for legal services with The Otto Law Group, PLLC (“OLG”), a law
firm, the managing partner of which is one of the Company’s Directors, the
Company periodically issued to the law firm vested non-forfeitable common
shares, and proceeds from the sale of such shares by the firm and reported to
the Company were credited against invoice amounts due for legal services. There
were no reported stock sale proceeds during 2006.  The agreement had
no stated term. During 2006, the Company issued the firm 2,802,925 shares of its
common stock and recorded legal expense of approximately $336,000, which was
determined based on the $0.12 per share quoted trading price on date of
issuance.  In 2006, the Company entered into an engagement agreement
with OLG, whereby the prior agreement was superseded and replaced, and among
other things, the Company issued the firm 2,500,000 shares of its common
stock.  The shares were valued at the quoted trading prices of $0.11
on the grant date, resulting in an expense of $275,000.  During 2007
and 2006, the Company incurred legal fee services from the firm of approximately
$293,000 and $967,000, respectively.   Accounts payable to OLG
for legal services are included in accounts payable to related parties in the
accompanying balance sheet.





During
2006, the Company issued 2,802,925 shares of its common stock to Cambridge
Partners, LLC (“Cambridge”) for investor advisory services provided to the
Company and recorded consulting expense of approximately $336,000, which was
determined based on the $0.12 per share quoted trading price on the issuance
date.  The managing partner of OLG, one of the Company’s Directors, is
one of the two members of Cambridge.





In 2006,
the Company entered into an agreement with KW Securities, Inc. (“KW”), a
registered broker dealer and a company owned by one of the Company’s Directors,
for KW to serve as placement agent for the Private Placement Offering. Pursuant
to terms of the agreement, as amended, among other things, the Company shall pay
compensation of warrants to purchase Company common stock at a per share price
of $0.06 at varying rates of warrants for funds raised based on securities
sold.  In connection with sales of Private Placement units and
Subordinated Notes and warrants in 2006, the Company has recorded debt issue
costs of approximately $2.1 million based on the fair value of 14,625,000
warrants exercisable at $0.06 per share for approximately eight and one-half
years, determined utilizing the Black-Scholes valuation model, which such
warrants were issued to KW in 2007.  Upon the closing of the PPM in
2007, the agreement with KW terminated.




In 2006,
the Company entered into a Funding Agreement with Itec Capital Group, LLC
(“ICG”), a Washington limited liability company owned by the managing partner of
OLG, who is one of the Company’s Directors, and another one of the Company’s
Directors, and KW, a company owned by that Director.  Pursuant to
terms of the Funding Agreement, the Company agreed to pay fees of 8% of Notes
payable issued pursuant to certain financings and issue warrants based on
securities sold and common shares convertible or exercisable
into.  Pursuant to a consulting agreement between ICG and Excipio
Group, S.A. (“Excipio”), an entity, ICG agreed to pay Excipio a dollar amount
and securities to be agreed upon from time to time upon completion of certain
defined objectives and projects, and in this regard, ICG has agreed to pay
Excipio fees and warrants in the amounts ICG receives from the
Company.  In November 2006, Excipio, ICG and the Company entered into
a mutual settlement and release agreement, pursuant to which, among other
things, in full satisfaction of amounts owed under all prior agreements or
arrangements, the Company agreed to pay approximately $429,000 (in addition to
$296,000 previously paid) and issue a warrant to purchase 1,440,000 shares of
Company common stock with an exercise price of $0.06 per share for approximately
eight and one-half years and a warrant to purchase 3,748,000 shares of Company
common stock with an exercise price of $0.12 per share for approximately three
and one-half years.  The $429,000 was payable $200,000 upon execution
of the settlement agreement and in varying amounts based on certain conditions,
and was paid in full in 2007.  In connection with the settlement
agreement, the consulting agreement between ICG and Excipio was cancelled and
any further obligation under the consulting agreement has been waived and
dismissed, and the Funding Agreement between the Company and ICG was amended to
reflect the settlement of fees and expenses owed and paid under the Funding
Agreement and that no additional fees or expenses shall accrue or become due in
accordance with the Funding Agreement.








ITEM
13. EXHIBITS





See
Exhibit Index immediately following the signature page below.





ITEM
14. PRINCIPAL ACCOUNTANT FEES AND SERVICES





Salberg
& Company, P.A. served as our independent registered public accounting
firm for the fiscal year 2007 and 2006.




During
the fiscal years ended December 31, 2007 and 2006, fees in connection with
services provided by Salberg & Company, P.A. are as set forth
below:





Fee
      Category
            
            
            2007
            
            
            2006Audit
      Fees
            
            $
            125,000
            
            $
            112,000Audit-Related
      Fees
            
            
            4,800
            
            
            1,500Tax
      Fees
            
            
            -All
      Other Fees
            
            
            -Total
            
            $
            131,300
            
            $
            113,500





Audit
fees consisted of fees for the audit of the Company's annual financial
statements and review of quarterly financial statements. Audit related fees
consist of services normally provided in connection with statutory and
regulatory filings or engagements, consents and assistance with and review of
Company documents filed with the SEC.




Tax fees
consisted primarily of fees for tax compliance, tax advice and tax planning
services.




We made
no other payments to Salberg & Company, P.A. during 2007 which constituted
other fees.





Policy
for Pre-Approval of Audit and Non-Audit Services




The Audit
Committee's policy is to pre-approve all audit, audit-related and non-audit
services to be provided by the independent registered public accounting firm and
adopt and implement policies for such pre-approval. The independent registered
public accounting firm shall not be engaged to perform specific non-audit
services proscribed by law or regulation. The Committee may delegate
pre-approval authority to a member of the Committee. The decisions of any
Committee member to whom pre-approval authority is delegated must be presented
to the full Audit Committee at its next scheduled meeting.




All
engagements of the independent registered public accounting firm to perform any
audit services and non-audit services have been pre-approved by the Committee in
accordance with the pre-approval policy. The policy has not been waived in any
instance.

















PART
III





ITEM
1. INDEX TO EXHIBITS





Exhibit
      No.
            
            Description
            
            Location3.1(i)
            
            Amendment
      to Restated Certificate of Incorporation
            
            Incorporated
      by reference to Exhibit A to the DEFR14C filed by the Company on November
      30, 20053.2(i)
            
            Restated
      Certificate of Incorporation
            
            Incorporated
      by reference to Exhibit B to the DEF-14C filed by the Company on September
      9, 20023.3(i)
            
            Certificate
      of Incorporation
            
            Incorporated
      by reference to the Form S-18 Registration Statement filed by the Company,
      File No. 33-31-673.4(i)
            
            Amendment
      to Restated Certificate of Incorporation
            
            Incorporated
      by reference to the DEF-14C filed by the Company on February 22,
      2007.3.5(ii)
            
            Bylaws
            
            Incorporated
      by reference to Exhibit B to the DEF-14C filed by the Company on September
      9, 20024.1
            
            Form
      of Common Stock Warrant issued to Gary De Laurentiis (2,457,370), George
      Kanakis and George Gitschel
            
            Incorporated
      by reference to Exhibit 4.5 to the 10-KSB filed by the Company on April
      15, 20054.2
            
            Form
      of Common Stock Purchase Warrant issued to Jeffrey
Chartier
            
            Incorporated
      by reference to Exhibit 4.2 to the 10-KSB filed by the Company on May 17,
      20064.3
            
            Form
      of Common Stock Purchase Warrant issued to George Kanakis
            
            Incorporated
      by reference to Exhibit 4.2 to the 10-KSB filed by the Company on May 17,
      20064.4
            
            Form
      of Common Stock Warrant issued to David M. Otto
            
            Incorporated
      by reference to Exhibit 4.5 to the 8-K filed by the Company on November
      22, 20054.5
            
            Form
      of Common Stock Warrant issued to Frederick Smith, Jr.
            
            Incorporated
      by reference to Exhibit 4.6 to the 8-K filed by the Company on November
      22, 20054.6
            
            Form
      of Common Stock Warrant issued to Gary M. De Laurentiis
      (20,000,000)
            
            Incorporated
      by reference to Exhibit 4.7 to the 8-K filed by the Company on November
      22, 20054.7
            
            Conversion
      of Dormition Skete, Inc. Promissory Notes
            
            Incorporated
      by reference to Exhibit 4.1 to the 8-K filed by the Company on November
      22, 20054.8
            
            Conversion
      of Dormition Skete, Inc. Promissory Note
            
            Incorporated
      by reference to Exhibit 4.2 to the 8-K filed by the Company on November
      22, 200510.1
            
            Commitment
      Letter from the California Integrated Waste Management
    Board
            
            Incorporated
      by reference to Exhibit 10.1 to the 10-QSB filed by the Company on
      November 15, 200410.2
            
            Agreement
      with H. Muehlstein & Co., Inc.
            
            Incorporated
      by reference to Exhibit 10.2 to the 10-KSB filed by the Company on April
      15, 200510.3
            
            Business
      Loan Agreement with the California Integrated Waste Management
      Board
            
            Incorporated
      by reference to Exhibit 10.1 to the 10-QSB filed by the Company on August
      19, 200510.4
            
            Promissory
      Note with the California Integrated Waste Management Board
            
            Incorporated
      by reference to Exhibit 10.2 to the 10-QSB filed by the Company on August
      19, 200510.5
            
            Commercial
      Security Agreement with the California Integrated Waste Management
      Board
            
            Incorporated
      by reference to Exhibit 10.3 to the 10-QSB filed by the Company on August
      19, 200510.6
            
            Commercial
      Guarantee with the California Integrated Waste Management
      Board
            
            Incorporated
      by reference to Exhibit 10.4 to the 10-QSB filed by the Company on August
      19, 200510.7
            
            Amendment
      No. 3 to Patent License Agreement with Honeywell
            
            Incorporated
      by reference to Exhibit 10.5 to the 10-QSB filed by the Company on August
      19, 200510.8
            
            Form
      of Loan Agreement with Capital Growth Equity Fund I, LLC
            
            Incorporated
      by reference to Exhibit 10.1 to the 10-QSB filed by the Company on
      December 6, 200510.9
            
            Form
      of Promissory Note with Capital Growth Equity Fund I, LLC
            
            Incorporated
      by reference to Exhibit 10.2 to the 10-QSB filed by the Company on
      December 6, 200510.10
            
            Form
      of Common Stock Purchase Warrant with Capital Growth Equity Fund I,
      LLC
            
            Incorporated
      by reference to Exhibit 10.3 to the 10-QSB filed by the Company on
      December 6, 200510.11
            
            Form
      of Loan Agreement with Capital Growth Investors
            
            Incorporated
      by reference to Exhibit 10.4 to the 10-QSB filed by the Company on
      December 6, 200510.12
            
            Form
      of Promissory Note with Capital Growth Investors
            
            Incorporated
      by reference to Exhibit 10.5 to the 10-QSB filed by the Company on
      December 6, 200510.13
            
            Form
      of Common Stock Purchase Warrant with Capital Growth Equity Fund I,
      LLC
            
            Incorporated
      by reference to Exhibit 10.6 to the 10-QSB filed by the Company on
      December 6, 200510.14
            
            Form
      of Loan Agreement with KW Investors
            
            Incorporated
      by reference to Exhibit 10.7 to the 10-QSB filed by the Company on
      December 6, 200510.15
            
            Form
      of Promissory Note with KW Investors
            
            Incorporated
      by reference to Exhibit 10.8 to the 10-QSB filed by the Company on
      December 6, 200510.16
            
            Form
      of Common Stock Purchase Warrant with KW Investors
            
            Incorporated
      by reference to Exhibit 10.9 to the 10-QSB filed by the Company on
      December 6, 200510.17
            
            Form
      of Common Stock Purchase Agreement with Tiger Paw Capital
      Corp.
            
            Incorporated
      by reference to Exhibit 10.10 to the 10-QSB filed by the Company on
      December 6, 200510.18
            
            Form
      of Investors Rights Agreement with Tiger Paw Capital Corp.
            
            Incorporated
      by reference to Exhibit 10.11 to the 10-QSB filed by the Company on
      December 6, 200510.19
            
            Form
      of Right of First Refusal Agreement with Tiger Paw Capital
      Corp.
            
            Incorporated
      by reference to Exhibit 10.12 to the 10-QSB filed by the Company on
      December 6, 200510.20
            
            Form
      of Covenant to Adjust with Tiger Paw Capital Corp.
            
            Incorporated
      by reference to Exhibit 10.13 to the 10-QSB filed by the Company on
      December 6, 200510.21
            
            Form
      of Consulting Agreement with Tiger Paw Capital Corp.
            
            Incorporated
      by reference to Exhibit 10.14 to the 10-QSB filed by the Company on
      December 6, 200510.22
            
            Form
      of Conditional Approval Letter from California Department of Conservation,
      Division of Recycling
            
            Incorporated
      by reference to Exhibit 10.15 to the 10-QSB filed by the Company on
      December 6, 200510.23
            
            Form
      of Conditional Commitment for Guarantee from California Department of
      Conservation, Division of Recycling
            
            Incorporated
      by reference to Exhibit 10.16 to the 10-QSB filed by the Company on
      December 6, 200510.24
            
            Form
      of Loan Agreement with the Elevation Fund, LLC
            
            Incorporated
      by reference to Exhibit 10.1 to the 8-K filed by the Company on August 18,
      200510.25
            
            Form
      of Promissory Note with the Elevation Fund, LLC
            
            Incorporated
      by reference to Exhibit 10.2 to the 8-K filed by the Company on August 18,
      200510.26
            
            Form
      of Common Stock Purchase Warrant with the Elevation Fund,
    LLC
            
            Incorporated
      by reference to Exhibit 10.3 to the 8-K filed by the Company on August 18,
      200510.27
            
            Form
      of Security Agreement with the Elevation Fund, LLC
            
            Incorporated
      by reference to Exhibit 10.4 to the 8-K filed by the Company on August 18,
      200510.28
            
            Form
      of Common Stock Purchase Agreement with Doug Froese
            
            Incorporated
      by reference to Exhibit 10.5 to the 8-K filed by the Company on November
      29, 200510.29
            
            Form
      of Investors Rights Agreement with Doug Froese
            
            Incorporated
      by reference to Exhibit 10.6 to the 8-K filed by the Company on November
      29, 200510.30
            
            Form
      of Right of First Refusal Agreement with Doug Froese
            
            Incorporated
      by reference to Exhibit 10.8 to the 8-K filed by the Company on November
      29, 200510.31
            
            Form
      of Covenant to Adjust with Doug Froese
            
            Incorporated
      by reference to Exhibit 10.7 to the 8-K filed by the Company on November
      29, 200510.32
            
            Form
      of Loan Agreement with Ji Y. Baek
            
            Incorporated
      by reference to Exhibit 10.1 to the 10-QSB filed by the Company on August
      14, 200610.33
            
            Form
      of Loan Agreement with Leroy and Lois Goldman
            
            Incorporated
      by reference to Exhibit 10.1 to the 8-K filed by the Company on September
      20, 200610.34
            
            Form
      of Loan Agreement with Arbor Malone, LLC
            
            Incorporated
      by reference to Exhibit 10.2 and 10.4 to the 8-K filed by the Company on
      September 20, 2006 and Exhibit 10.1 to the 8-K/A filed by the Company on
      September 21, 200610.35
            
            Form
      of Loan Agreement with Ji Y. Baek
            
            Incorporated
      by reference to Exhibit 10.3 to the 8-K filed by the Company on September
      20, 200610.36
            
            Form
      of Employment Agreement with Gary De Laurentiis
            
            Incorporated
      by reference to Exhibit 10.5 to the 8-K filed by the Company on September
      20, 200610.37
            
            Form
      of Employment Agreement with Rodney S. Rougelot
            
            Incorporated
      by reference to Exhibit 10.6 to the 8-K filed by the Company on September
      20, 200610.38
            
            Form
      of Settlement and Release Agreement with Rose Waste Systems, Inc. and
      George Gitschel.
            
            Incorporated
      by reference to Exhibit 10.7 to the 8-K filed by the Company on September
      20, 200610.39
            
            Form
      of Employment Agreement with Mario Sandoval
            
            Incorporated
      by reference to Exhibit 10.1 to the 8-K filed by the Company on October
      23, 200610.40
            
            Form
      of Honeywell Patent License Agreement Amendment 4
            
            Incorporated
      by reference to Exhibit 10.1 to the 10-QSB filed by the Company on
      November 20, 200610.41
            
            Form
      of Funding Agreement with Itec Capital Group, LLC
            
            Incorporated
      by reference to Exhibit 10.2 to the 10-QSB filed by the Company on
      November 20, 200610.42
            
            Form
      of Mutual Settlement and Release Agreement with Excipio Group,
      S.A.
            
            Incorporated
      by reference to Exhibit 10.3 to the 10-QSB filed by the Company on
      November 20, 200610.43
            
            Form
      of Service Agreement with TSG, LLC
            
            Incorporated
      by reference to Exhibit 10.4 to the 10-QSB filed by the Company on
      November 20, 200610.44
            
            Form
      of Engagement Agreement with KW Securities Corp.
            
            Attached.
      Referenced to Exhibit 10.5 to the 10-QSB filed by the Company on November
      20, 2006.10.45
            
            Form
      of Restricted Stock Agreement with Rodney S. Rougelot
            
            Incorporated
      by reference to Exhibit 10.1 to the 8-K filed by the Company on January 5,
      2007.10.46
            
            Form
      of Consulting Services Agreement with The Otto Law Group,
    PLLC
            
            Incorporated
      by reference to Exhibit 10.1 to the S-8 filed by the Company on March 31,
      2008.10.47
            
            Form
      of Consulting Services Agreement with Gaspers Electric
            
            Incorporated
      by reference to Exhibit 10.1 to the S-8 filed by the Company on March 31,
      2008.10.48
            
            Form
      of Consulting Services Agreement with Ladco Electric
            
            Incorporated
      by reference to Exhibit 10.1 to the S-8 filed by the Company on March 31,
      2008.10.49
            
            Form
      of Consulting Services Agreement with Millerick Engineering
            
            Incorporated
      by reference to Exhibit 10.1 to the S-8 filed by the Company on March 31,
      2008.10.50
            
            Form
      of Consulting Services Agreement with Vertec Biosolvents
            
            Incorporated
      by reference to Exhibit 10.1 to the S-8 filed by the Company on March 31,
      2008.14
            
            Code
      of Ethics
            
            Incorporated
      by reference to Exhibit 14 to the 10-KSB filed by the Company on April 15,
      2005.14.1
            
            Revised
      Code of Ethics
            
            Attached23.1
            
            Consent
      of Salberg & Company, P.A.
            
            Attached31.1
            
            Certification
      pursuant to Section 302 of the Sarbanes-Oxley Act
            
            Attached32.1
            
            Certification  pursuant
      to Section 906 of the Sarbanes-Oxley Act
            
            Attached99.1
            
            Audit
      and Finance Committee Charter
            
            Incorporated
      by reference to Exhibit 99.1 to the 10-KSB filed by the Company on April
      15, 200599.2
            
            Compensation
      and Nominating Committee Charter
            
            Incorporated
      by reference to Exhibit 99.2 to the 10-KSB filed by the Company on April
      15, 200599.3
            
            Policy
      Governing Director Nominations and Security Holder-Board
      Communications
            
            Incorporated
      by reference to Exhibit 99.3 to the 10-KSB filed by the Company on April
      15, 2005





ECO2 Plastics,
Inc.
 December
31, 2007 and 2006 Financial Statements
 Index
   Report
      of Independent Registered Public Accounting Firm
                F-1Balance
      Sheet
                F-2Statements
      of Operations
                F-3Statement
      of Changes in Stockholders’ Equity (Deficit)
                F-4Statements
      of Cash Flows
                F-5Notes
      to Financial Statements
                F-6
  
 
 Report of
Independent Registered Public Accounting Firm
 
 
 To the
Board of Directors and Shareholders of:
 ECO2
Plastics, Inc.
 
 We have
audited the accompanying balance sheet of ECO2 Plastics, Inc. as of December 31,
2007 and the related statements of operations, changes in stockholders' equity
(deficit), and cash flows for the years ended December 31, 2007 and
2006.  These financial statements are the responsibility of the
Company's management.  Our responsibility is to express an opinion on
these financial statements based on our audits.
 
 We
conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States).  Those standards require
that we plan and perform the audits to obtain reasonable assurance about whether
the financial statements are free of material misstatement.  An audit
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements.  An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement
presentation.  We believe that our audits provide a reasonable basis
for our opinion.
 
 In our
opinion, the financial statements referred to above present fairly, in all
material respects, the financial position of ECO2 Plastics, Inc. as of December
31, 2007 and the results of its operations and its cash flows for the years
ended December 31, 2007 and 2006 in conformity with accounting principles
generally accepted in the United States of America.
 
 The
accompanying financial statements have been prepared assuming the Company will
continue as a going concern.  As discussed in Note 1 to the financial
statements the Company reported a net loss of approximately $32.6 million and
used cash for operating activities of approximately $7.2 million during the year
ended December 31, 2007, and, as of December 31, 2007, had a working capital
deficiency of approximately $18.6 million and a stockholders’ deficit and
accumulated deficit of approximately $11.8 million and $78.8 million,
respectively.  These matters raise substantial doubt about the
Company’s ability to continue as a going concern.  Management's plans
as to these matters are also described in Note 1.  The financial
statements do not include any adjustments that might result from the outcome of
this uncertainty.
 
 
 
 SALBERG
& COMPANY, P.A.
 Boca
Raton, Florida
 March 26,
2008
  F1
 ECO2
      Plastics, Inc.Balance
      SheetDecember
      31, 2007(in
      thousands, except share and per share data)Current
      assetsCash
      and cash equivalents
                
                $
                101Accounts
      receivable, net of allowance of $48
                
                
                581Inventory
                
                
                475Prepaid
      expenses and other current assets
                
                
                2Total
      current assets
                
                
                1,159Property
      and equipment, net
                
                
                7,864Deferred
      debt issue costs, net
                
                
                445Other
      assets
                
                
                47Total
      assets
                
                $
                9,515Current
      liabilitiesAccounts
      payable
                
                $
                2,900Accounts
      payable to related parties
                
                
                692Accrued
      liabilities
                
                
                645Accrued
      interest on notes payableDue
      to related parties
                
                
                846Due
      to others
                
                
                801Notes
      and convertible notes payable, net of debt discountDue
      to related parties, net of debt discount of $1,856
                
                
                7,415Due
      to others, net of debt discount of $2,558
                
                
                5,910Current
      portion of note payable to California Integrated Waste Management
      Board
                
                
                200Participation
      Certificates obligations issued prior to 2004
                
                
                354Total
      current liabilities
                
                
                19,763Note
      payable to California Integrated Waste Management Board, net of current
      portion
                
                
                1,507Total
      liabilities
                
                
                21,270Commitments
      and contingencies (Note 12)Stockholders'
      deficitPreferred
      stock, $0.001 par value, 10,000,000 shares authorized, none issued and
      outstanding
                
                
                -Common
      stock, $0.001 par value, 750,000,000 shares authorized,190,920,594
      shares issued and outstanding
                
                
                1917,180,000
      shares issuable
                
                
                7Additional
      paid-in capital
                
                
                66,843Deferred
      stock-based consulting
                
                
                (24)Accumulated
      deficit
                
                
                (78,772)Total
      stockholders' deficit
                
                
                (11,755)Total
      liabilities and stockholders' deficit
                
                $
                9,515
 See
accompanying notes to financial statements.
  F2
 ECO2
      Plastics, Inc.Statements
      of Operations(in
      thousands, except per share data)Year
      ended December 31,2007
                
                
                2006Revenue
                
                $
                4,339
                
                
                $
                61Cost
      of goods sold
                
                
                4,220
                
                
                
                50Gross
      profit
                
                
                119
                
                
                
                11Operating
      expensesPlant
      operations and technology development
                
                
                6,877
                
                
                
                2,008General
      and administrative, including share-basedpayments
      expense of $5,987 and $10,045
                
                
                9,273
                
                
                
                12,943Total
      operating expenses
                
                
                16,150
                
                
                
                14,951Loss  from
      operations
                
                
                (16,031
                )
                
                
                (14,940
                )Other
      income (expense)Interest
      expense, including amortization of debt discountand
      debt issue costs of $14,868 and $4,077
                
                
                (16,595
                )
                
                
                (4,740
                )Gain
      on extinguishment of debt
                
                
                -
                
                
                
                117Change
      in fair value liability of warrants and derivatives
                
                
                -
                
                
                
                (1,197
                )Total
      other income (expense)
                
                
                (16,595
                )
                
                
                (5,820
                )Loss
      before income taxes
                
                
                (32,626
                )
                
                
                (20,760
                )Income
      taxes
                
                
                -
                
                
                
                -Net
      loss
                
                $
                (32,626
                )
                
                $
                (20,760
                )Net
      loss per share, basic and diluted
                
                $
                (0.21
                )
                
                $
                (0.25
                )Weighted
      average shares used in computingnet
      loss per share, basic and diluted
                
                
                152,660
                
                
                
                84,387
  See
accompanying notes to financial statements.
 
 F3
 
 ECO2
      Plastics, Inc.Statement
      of Changes in Stockholders' Equity (Deficit)For
      the Years Ended December 31, 2007 and 2006(in
      thousands, except share data)Common
      Stock
              
              Additional
              
              DeferredCommon
      stock
              
              Issuable
              
              paid-in
              
              stock-based
              
              AccumulatedShares
              
              Amount
              
              Shares
              
              Amount
              
              capital
              
              consulting
              
              deficit
              
              TotalBalance
      at December 31, 2005
              
              
              62,325,024
              
              $
              63
              
              
              -
              
              $
              -
              
              $
              19,357
              
              $
              (508
              )
              $
              (25,386
              )
              $
              (6,474
              )Issuance
      of shares and reclassification from temporaryequity
      for common stock price reduction contingency
              752,731
              
              
              1
              
              
              
              
              
              
              
              
              164
              
              
              
              
              
              
              
              
              165Increase
      in additional paid-in capital upon repaymentof
      convertible debt with embedded derivative
              
              
              
              
              
              
              
              
              
              
              
              
              168
              
              
              
              
              
              
              
              
              168Increase
      in additional paid-in capital upon conversionof
      convertible debt with embedded derivative
              
              
              
              
              
              
              
              
              
              
              
              
              34
              
              
              
              
              
              
              
              
              34Reclassification
      of fair value liability for warrants andembedded
      options upon repayment of certain notes
              
              
              
              
              
              
              
              
              
              
              
              
              9,148
              
              
              
              
              
              
              
              
              9,148Issuance
      of shares on exercise of warrants
              
              
              8,757,142
              
              
              9
              
              
              
              
              
              
              
              
              -
              
              
              
              
              
              
              
              
              9Contribution
      of warrants for assignment
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              413
              
              
              
              
              
              
              
              
              413Reclassification
      of fair value liability for warrants assigned
              
              
              
              
              
              
              
              
              
              
              
              
              (413
              )
              
              
              
              
              
              
              
              (413
              )Stock
      issue costs
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              (82
              )
              
              
              
              
              
              
              
              (82
              )Value
      of beneficial conversion feature and warrantsissued
      with borrowings after August 18, 2006
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              7,405
              
              
              
              
              
              
              
              
              7,405Share-based
      payments -Shares
      issued and issuable for services
              
              
              13,464,824
              
              
              13
              
              
              9,036,923
              
              
              9
              
              
              2,774
              
              
              
              
              
              
              
              
              2,796Warrants
      issuable for services
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              2,902
              
              
              
              
              
              
              
              
              2,902Shares
      issued for executive compensation
              
              
              26,400,000
              
              
              26
              
              
              
              
              
              
              
              
              3,862
              
              
              
              
              
              
              
              
              3,888Shares
      issuable for executive compensation
              
              
              
              
              
              
              
              
              6,046,792
              
              
              6
              
              
              841
              
              
              
              
              
              
              
              
              847Warrants
      issuable for executive compensation
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              1,775
              
              
              
              
              
              
              
              
              1,775Amortization
      of deferred stock-based compensation
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              508
              
              
              
              
              
              508Issuances
      of shares and warrants for settlements
              
              
              2,564,103
              
              
              2
              
              
              
              
              
              
              
              
              399
              
              
              
              
              
              
              
              
              401Net
      loss
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              (20,760
              )
              
              (20,760
              )Balance
      at December 31, 2006
              
              
              114,263,824
              
              
              114
              
              
              15,083,715
              
              
              15
              
              
              48,747
              
              
              -
              
              
              (46,146
              )
              
              2,730Issuance
      of shares recorded as issuable in 2006
              
              
              15,083,715
              
              
              15
              
              
              (15,083,715
              )
              
              (15
              )
              
              
              
              
              
              
              
              
              
              
              -Value
      of warrants issued with notes payable
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              8,961
              
              
              
              
              
              
              
              
              8,961Shares
      issued for warrant exercises
              
              
              4,119,596
              
              
              4
              
              
              
              
              
              
              
              
              (2
              )
              
              
              
              
              
              
              
              2Shares
      issued upon conversion of notes payableand
      related accrued interest
              
              
              32,730,740
              
              
              33
              
              
              
              
              
              
              
              
              3,159
              
              
              
              
              
              
              
              
              3,192Share
      based payments -Shares
      issued and issuable for services
              
              
              4,890,411
              
              
              5
              
              
              180,000
              
              
              -
              
              
              900
              
              
              (24
              )
              
              
              
              
              881Warrants
      issued for services
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              279
              
              
              
              
              
              
              
              
              279Warrants
      issued for executive compensation
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              204
              
              
              
              
              
              
              
              
              204Shares
      vested for executive compensation
              
              
              13,240,000
              
              
              13
              
              
              
              
              
              
              
              
              (13
              )
              
              
              
              
              
              
              
              -Shares
      issued for executive compensation
              
              
              1,100,000
              
              
              1
              
              
              
              
              
              
              
              
              291
              
              
              
              
              
              
              
              
              292Shares
      issuable for executive compensation
              
              
              
              
              
              
              
              
              7,000,000
              
              
              7
              
              
              402
              
              
              
              
              
              
              
              
              409Shares
      issued for accrued compensation
              
              
              492,308
              
              
              1
              
              
              
              
              
              
              
              
              132
              
              
              
              
              
              
              
              
              133Shares
      issued for settlement
              
              
              5,000,000
              
              
              5
              
              
              
              
              
              
              
              
              670
              
              
              
              
              
              
              
              
              675Stock-based
      compensation expense
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              3,115
              
              
              
              
              
              
              
              
              3,115Net
      loss
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              (32,626
              )
              
              (32,626
              )Balance
      at December 31, 2007
              
              
              190,920,594
              
              $
              191
              
              
              7,180,000
              
              $
              7
              
              $
              66,843
              
              $
              (24
              )
              $
              (78,772
              )
              $
              (11,755
              )








F4




ECO2
      Plastics, Inc.Statements
      of Cash Flows(in
      thousands)Year
      ended December 31,2007
              
              
              2006Cash
      flows from operating activities:Net
      loss
              
              $
              (32,626
              )
              
              $
              (20,760
              )Adjustments
      to reconcile net loss to net cash used by operating
      activities:Depreciation
      and amortization
              
              
              1,135
              
              
              
              551Gain
      on extinguishment of debt
              
              
              -
              
              
              
              117Change
      in fair value of warrants and derivatives
              
              
              -
              
              
              
              1,197Share-based
      payments expense
              
              
              5,312
              
              
              
              10,045Amortization
      of debt issue costs  and discount
              
              
              14,868
              
              
              
              4,077Provision
      for settlement paid in common stock
              
              
              675
              
              
              
              401Provision
      for doubtful accounts
              
              
              48
              
              
              
              -Changes
      in operating assets and liabilities:Accounts
      receivable
              
              
              (628
              )
              
              
              -Inventory
              
              
              (262
              )
              
              
              (145
              )Prepaid
      expenses and deposits
              
              
              50
              
              
              
              (44
              )Accounts
      payable
              
              
              2,590
              
              
              
              228Accrued
      liabilities
              
              
              1,538
              
              
              
              307Other
              
              
              106
              
              
              
              (41
              )Net
      cash used by operating activities
              
              
              (7,194
              )
              
              
              (4,067
              )Cash
      flows from investing activities:Purchase
      of property, plant & equipment
              
              
              (3,201
              )
              
              
              (3,638
              )Net
      cash used by investing activities
              
              
              (3,201
              )
              
              
              (3,638
              )Cash
      flows from financing activities:Decrease
      in restricted cash in CIWMB escrow
              
              
              -
              
              
              
              58Payments
      on CIWMB note payable
              
              
              (191
              )
              
              
              (93
              )Proceeds
      from issuance of notes payable
              
              
              11,057
              
              
              
              9,755Principal
      payments on notes payable
              
              
              (300
              )
              
              
              (1,200
              )Proceeds
      from exercise of warrants
              
              
              2
              
              
              
              -Payments
      of debt issue costs
              
              
              (169
              )
              
              
              (750
              )Net
      cash provided  by financing activities
              
              
              10,399
              
              
              
              7,770Net
      increase  in cash and cash equivalents
              
              
              4
              
              
              
              65Cash
      and cash equivalents, beginning of period
              
              
              97
              
              
              
              32Cash
      and cash equivalents, end of period
              
              $
              101
              
              
              $
              97Supplemental
      disclosures of cash flow information:Cash
      paid for interest
              
              $
              78
              
              
              $
              281Cash
      paid for income taxes
              
              $
              -
              
              
              $
              -Supplemental
      disclosures of non-cash investing and financing
activities:Debt
      discounts
              
              $
              8,413
              
              
              $
              10,939Deferred
      Debt issue costs
              
              $
              82
              
              
              $
              2,962Reclassification
      of fair value of derivative liabilities to equity
              
              $
              -
              
              
              $
              6,918Common
      stock issued for debt conversion or settlement
              
              $
              3,116
              
              
              $
              279Net
      assets and liabilities settled with common stock
              
              $
              750
              
              
              $
              619Reclassification
      of fair value of warrrant to derivative liability
              
              $
              -
              
              
              $
              413


See
accompanying notes to financial statements.




F5




ECO2 Plastics,
Inc.


Notes
to Financial Statements


December
31, 2007 and 2006








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




Organization and
Business – ECO2 Plastics,
Inc., (“ECO2”) or the
(“Company”) was incorporated under the laws of the State of Delaware in 2000,
and formed for the purpose of acquiring certain patented technology and the
development of a worldwide market for its usage.  In March 2007, the
Company changed its name from Itec Environmental Group, Inc.




ECO2 has
developed a unique and revolutionary patented process and system, referred to as
the Eco2TM
Environmental System (the “Eco2
Environmental System”). The Eco2
Environmental System cleans post-consumer plastics, without the use of water, at
a substantial cost savings versus traditional methods (the “Process”). This
Process is licensed from Honeywell Federal Manufacturing & Technologies, LLC
(“Honeywell”) and the Department of Energy on an exclusive basis for the patent
life. Since its inception, ECO2has
invested in the development of the technology and equipment comprising the
Eco2
Environmental System, which includes a “Process Patent” granted in 2007. This
included building several scaled up versions of the Prototype Eco2
Environmental System (the “Prototype”), testing of the Prototypes, building a
pilot plant, evaluating the product produced by the Prototype and real-time
testing. The Company’s first full scale production facility was constructed in
Riverbank, California and is now producing saleable product and ramping up to
full scale operations as it further develops the process.  ECO2’s goal is
to build and operate plastic recycling plants in the USA that utilize the
Eco2
Environmental System and to expand the Eco2
Environmental System worldwide. ECO2’s growth
strategy includes organic growth, strategic acquisitions and licensing or
partnership agreements, where appropriate.





Business risks and
uncertainties - The Company operates in the evolving field of plastics
materials recycling and its business is reliant on its licensing of technology
from Honeywell. New developments could both significantly and adversely affect
existing and emerging technologies in the field. The Company's success in
developing additional marketable products and processes and achieving a
competitive position will depend on, among other things, its ability to attract
and retain qualified management personnel and to raise sufficient capital to
meet its operating and development needs. While the Company is seeking financing
through equity and loans, there can be no assurance that it will be successful
in accomplishing its objectives.





Basis of presentation and
Going Concern - The accompanying financial statements have been prepared
in conformity with accounting principles generally accepted in the United States
of America, which contemplate the Company’s continuation as a going concern.
Since inception, the Company has reported losses and operating activities have
used cash, and it has a net working capital deficiency that raises substantial
doubt about its ability to continue as a going concern. The Company reported a
net loss of approximately $32.6 million for the year ended December 31, 2007,
and operating activities used cash of approximately $7.2 million, and as of
December 31, 2007, had a working capital deficit of $18.6 million and a
stockholders’ deficit of $11.8 million, including accumulated losses from
inception of $78.8 million.




Company
management intends to raise additional debt and equity financing to fund future
capital expenditures, operations and to provide additional working capital, and
in this regard during 2007, the Company received cash of approximately $5.0
million pursuant to sales of securities in connection with private placement
debt offerings and $4.5 million pursuant to terms or short-term notes
payable.  Subsequent to December 31, 2007, the Company has (i)
received approximately $1.9 million of additional loans from new and existing
investors, (ii) issued approximately 243 million shares of Company common stock
in consideration for conversion of all convertible notes payable of
approximately $13.2 million together with related accrued interest of
approximately $1.7 million and the surrender of outstanding warrants to purchase
approximately 39 million shares of Company common stock, (iii) entered into
agreements with certain service providers providing for issuance of 16
million shares of Company common stock as payment for amounts owed of
approximately $754,000,
and entered into agreements with holders of warrants to purchase Company common
stock pursuant to which the Company will issue approximately
82 million shares of its common stock in exchange for the
cancellation of warrants to purchase approximately 124 million
shares.  The Company’s Board of Directors and Chief Executive Officer
continue to be actively involved in discussions and negotiations with creditors
and holders of Company notes payable regarding conversion of amounts owed and
warrants into shares of Company common stock, and in continued fund-raising
activities with new and existing investors.  There is no assurance
that continued financing proceeds will be obtained in sufficient amounts
necessary to meet the Company's needs. In view of these matters, continuation as
a going concern is dependent upon the Company's ability to meet its financing
requirements, raise additional capital, and the future success of its operations
or completion of a successful business combination.




The
accompanying financial statements do not include any adjustments to reflect the
possible future effects on the recoverability and classification of assets or
the amounts and classifications of liabilities that may result from the possible
inability of the Company to continue as a going concern.




F6


Use of estimates in the
preparation of financial statements - Preparation of financial statements
in conformity with generally accepted accounting principles requires management
to make estimates and assumptions that affect reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the financial statements and reported amounts of revenue and expenses during the
reporting period. Actual results could differ from those estimates. The more
significant accounting estimates inherent in the preparation of the Company's
financial statements include estimates as to the depreciable lives of property
and equipment, valuation of accounts receivable and inventories, valuation of
equity related instruments and derivatives issued and issuable, and valuation
allowance for deferred income tax assets.





Cash and cash
equivalents - The Company considers deposits that can be redeemed on
demand and investments that have original maturities of less than three months
when purchased to be cash equivalents.





Accounts Receivable and
allowance for doubtful accounts - The Company’s accounts receivable are
due from companies in the packaging, manufacturing and recycling
industries.  Payments from customers are due within 30 days after a
satisfactory credit check.  If not satisfactory, payment is required
in advance of shipment. Accounts receivable are stated at amounts due from
customers net of an allowance for doubtful accounts.  Accounts
outstanding beyond payment terms are considered past due.  The Company
determines its allowance by considering a number of factors, including the
length of time accounts receivable are past due, the Company’s previous loss
history, the customer’s current ability to pay its obligations, and the
condition of the general economy and industry as a whole.  The Company
writes off accounts receivable when they become uncollectible, and payments
subsequently collected on such accounts are debited to the allowance for
doubtful accounts.





Inventories–Inventories
are recorded at lower of cost, determined on a first-in-first out basis, or
market for below grade products.




Property and
equipment – Property and equipment are recorded at cost less accumulated
depreciation and amortization.  Expenditures for major additions and
improvements are capitalized, and minor maintenance, repairs and replacements
are charged to expense as incurred.  When property and equipment are
retired or otherwise disposed of, the cost and accumulated depreciation are
removed from the accounts and any resulting gain or loss is included in the
results of operations.  Depreciation and amortization are provided
using the straight-line method over the estimated useful lives of the respective
assets, which are three years for furniture and equipment, seven years for the
recycling plant, and the shorter of asset life or lease term for leasehold
improvements.




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




Deferred debt issue
costs – The Company capitalizes direct incremental costs paid to third
parties incurred in connection with borrowings.  These costs are
amortized as an adjustment to interest expense over the life of the
borrowing.





Debt discount – The
Company records, as applicable, fees paid to lenders, the fair value of warrants
issued with debt securities, value of beneficial conversion features of
convertible debt, or fair value of derivatives embedded in convertible debt
instruments relating to debt securities, as a debt discount, which is amortized
as an adjustment to interest expense over the borrowing term.




Contingencies -
Certain conditions may exist as of the date financial statements are issued,
which may result in a loss to the Company, but which will only be resolved when
one or more future events occur or fail to occur. Company management and its
legal counsel assess such contingent liabilities, and such assessment inherently
involves an exercise of judgment. In assessing loss contingencies related to
legal proceedings that are pending against the Company or unasserted claims that
may result in such proceedings, the Company's legal counsel evaluates the
perceived merits of any legal proceedings or unasserted claims as well as the
perceived merits of the amount of relief sought or expected to be sought
therein. If the assessment of a contingency indicates that it is probable that a
liability has been incurred and the amount of the liability can be reasonably
estimated, then the estimated liability would be accrued in the Company's
financial statements. If the assessment indicates that a potentially material
loss contingency is not probable but is reasonably possible, or is probable but
cannot be reasonably estimated, then the nature of the contingent liability,
together with an estimate of the range of possible loss if determinable would be
disclosed.




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





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





Revenue recognition -
The Company recognizes revenue when there is persuasive evidence of an
arrangement, the product has been delivered to the customer, the sales price is
fixed or determinable, and collectibility is reasonably assured. The Company
recognizes revenues from sales of recycled products upon shipment to
customers.  Amounts received in advance of when products are delivered
are recorded as liabilities in the accompanying balance sheet.













Cost of goods sold –
Cost of goods sold includes the cost of raw materials processed, and during 2007
includes write-downs for scrap and waste product of approximately
$204,000.





Income taxes - The
Company accounts for income taxes in accordance with SFAS No. 109, “Accounting for Income Taxes,”
which requires recognition of deferred tax assets and liabilities for expected
future tax consequences of events that have been included  in financial
statements or tax returns. Under this method, deferred income taxes are
recognized for tax consequences in future years of differences between the tax
bases of assets and liabilities and their financial reporting amounts at each
period end based on enacted tax laws and statutory tax rates applicable to the
periods in which the differences are expected to affect taxable income.
Valuation allowances are established, when necessary, to reduce deferred tax
assets to amounts expected to be realized.  The Company continues to
provide a full valuation allowance to reduce its net deferred tax asset to zero,
inasmuch as Company management has not determined that realization of deferred
tax assets is more likely than not. The provision for income taxes represents
taxes payable for the period and change during the period in net deferred tax
assets and liabilities.





The
Company adopted FASB Interpretation No. 48, “Accounting for Uncertainty in
Income Taxes-an interpretation of FASB Statement No. 109” (“FIN 48”) on January
1, 2007. The Company has identified its federal income tax return and state
income tax return in California as “major” tax jurisdictions, as defined. The
periods subject to examination for our federal and California state income tax
returns are the tax years ended in 2000 and thereafter, since the Company has
net operating loss carryforwards for tax years starting in 2000. The Company
believes its income tax filing positions and deductions will be sustained on
audit and does not anticipate any adjustments that would result in a material
change to its financial position. Therefore, no reserves for uncertain income
tax positions have been recorded pursuant to FIN 48, and no cumulative effect
adjustment was recorded related to the adoption of FIN 48. The Company’s policy
for recording interest and penalties associated with audits, if
any,  is to record such items as a component of income (loss) before
taxes. If applicable, penalties and interest paid are recorded in interest and
other expense and interest received is recorded in interest income in the
statement of operations.




Research and development
cost – Research and development represent costs incurred in connection
with the Company’s development of recycling processes, and such costs are
expensed as incurred and included in technology development expenses. In 2006,
the Company was developing its recycling processes and plant operations and
technology development which approximated $2.0 million, which was considered
research and development expense as the Company had not commenced operations
other than at a testing level.  In 2007, the Company spent approximately
$326,000on
reasearch and development.





Shipping costs –
Shipping cost related to purchased inventory is capitalized as part of inventory
and ultimately recognized as cost of goods sold upon sale.  Cost
incurred to ship products to customers is also recorded as cost of goods
sold.





Stock-based
compensation – The Company accounts for stock-based compensation in
accordance with Statement of
Financial Accounting Standard (“SFAS”) No. 123R, Accounting for Stock-Based
Compensation(“FAS 123R”). FAS 123R sets forth the accounting for
share-based payment transactions in which an enterprise receives employee
services in exchange for (a) equity instruments of the enterprise or (b)
liabilities that are based on the fair value of the enterprise's equity
instruments or that may be settled by the issuance of such equity instruments.
The statement requires that such transactions be accounted for using a
fair-value-based method, which requires recording expense over the requisite
service period for the fair value of options or warrants granted to employees
and consultants.





Basic and diluted net loss
per share - Basic net loss per common share is computed by dividing net
loss by the weighted-average number of common shares outstanding during the
period. Diluted net loss per common share is determined using the
weighted-average number of common shares outstanding during the periods,
adjusted for the dilutive effect of common stock equivalents, consisting of
shares that might be issued upon exercise of common stock options, warrants or
convertible promissory notes. In periods where losses are reported, the
weighted-average number of common shares outstanding excludes common stock
equivalents, because their inclusion would be
anti-dilutive.  Computations of net loss per share for year ended
December 31, 2007, exclude 135,651,501 shares relating to common stock issuable
upon conversion of convertible notes payable, and 182,697,176 shares issuable
upon exercise of outstanding and issuable warrants to purchase common stock.
Computations of net loss per share for the year ended December 31, 2006, exclude
113,442,359 shares relating to common stock issuable upon conversion of
convertible notes payable, and 123,903,310 shares issuable upon exercise of
outstanding and issuable warrants. These common stock equivalents could have the
effect of decreasing diluted net income per share in future
periods.




Reclassifications –
Certain amounts in 2006 financial statements have been reclassified to conform
to 2007 presentations.





Recent accounting
pronouncements - In December 2006, the FASB issued FASB Staff Position
No. EITF 00-19-2 “Accounting for Registration Payment Arrangements” (“FSP EITF
00-19-2”), which addresses an issuer’s accounting and disclosures relating to
registration payment arrangements. In accordance with FSP EITF 00-19-2,
registration payment arrangements are accounted for as an instrument separate
and apart from the related securities and will be accounted for in accordance
with Statement of Financial Accounting Standards No. 5 “Accounting for
Contingencies,” accruing a liability if payment is probable and the amount can
be reasonably estimated. Unless the Company enters into agreements providing for
payments relating to registration arrangements, this pronouncement will have no
effect on the Company’s results of operation, financial position or
liquidity.




In
September 2006, the FASB issued Statement of Financial Accounting Standards No.
157, Fair Value Measurements(“SFAS 157”). SFAS 157 defines fair value, establishes a framework for
measuring fair value and expands disclosures about fair value measurements but
does not require any new fair value measurements. SFAS 157 is effective for
financial statements issued for fiscal years beginning after November 15, 2007,
and interim periods within those fiscal years. It is expected that adoption of
SFAS 157 will not have a material impact on the Company’s results of operations,
financial position or liquidity.





In
February 2007, the FASB issued Statement of Financial Accounting Standards No.
159, The Fair Value Option for
Financial Assets and Financial Liabilities (“SFAS 159”).  SFAS
159 is effective for fiscal years beginning after November 15,
2007.  It is expected that adoption of SFAS 159 will not have a
material impact on the Company’s results of operations, financial position or
liquidity.





In June
2007, the Emerging Issues Task Force of the FASB issued EITF Issue No. 07-3,
Accounting for Nonrefundable
Advance Payments for Goods or Services to be Used in Future Research and
Development Activities, (“EITF 07-3”) which is effective for fiscal years
beginning after December 15, 2007. EITF 07-3 requires that nonrefundable advance
payments for future research and development activities be deferred and
capitalized. Such amounts will be recognized as an expense as the goods are
delivered or the related services are performed. It is expected that adoption of
EITF 07-3 will not have a material impact on the Company’s results of
operations, financial position or liquidity.




In
December 2007, the FASB issued SFAS No. 141(R), “Business Combinations”(“SFAS 141(R)”), which replaces SFAS No. 141. SFAS No. 141(R) establishes
principles and requirements for how an acquirer recognizes and measures in its
financial statements the identifiable assets acquired, the liabilities assumed,
any non-controlling interest in the acquiree and the goodwill acquired. The
Statement also establishes disclosure requirements which will enable users to
evaluate the nature and financial effects of the business combination. SFAS
141(R) is effective for fiscal years beginning after December 15, 2008. The
adoption of SFAS 141(R) will have an impact on accounting for future business
combinations once adopted.




In
December 2007, the FASB issued SFAS No. 160, “Noncontrolling Interests in
Consolidated Financial Statements – an amendment of Accounting Research Bulletin
No. 51”(“SFAS 160”), which establishes accounting and reporting
standards for ownership interests in subsidiaries held by parties other than the
parent, the amount of consolidated net income attributable to the parent and to
the noncontrolling interest, changes in a parent’s ownership interest and the
valuation of retained non-controlling equity investments when a subsidiary is
deconsolidated. The Statement also establishes reporting requirements that
provide sufficient disclosures that clearly identify and distinguish between the
interests of the parent and the interests of the non-controlling owners. SFAS
160 is effective for fiscal years beginning after December 15, 2008. The Company
has not determined the effect that the application of SFAS 160 will have on its
financial statements.





Note
2.   Inventories





Inventories
at December 31, 2007, consist of the following (in thousands):





Raw
      materials
              
              $
              263Work-in-process
              
              
              11Finished
      goods
              
              
              201Total
              
              $
              475


Note 3.  Property and
Equipment





Property
and equipment at December 31, 2007, consist of the following (in
thousands):


Furniture
      and equipment
              
              $
              265Recycling
      plant and construction in progress
              
              
              9,390Total
      property and equipment
              
              
              9,655Less
      accumulated depreciation and amortization
              
              
              (1,791
              )Property
      and equipment, net
              
              $
              7,864


During
2007, the Company sold certain excess equipment with a net book value of
approximately $170,000 and recognized a loss of approximately $96,000, which is
included in general and administrative expense.  During 2006, the
Company capitalized interest of approximately $43,000 into the recycling plant
during the construction period.





Note
4.  Technology License





Pursuant
to terms of a license agreement entered into by the Company and Honeywell, as
amended, the Company obtained an exclusive, nontransferable, worldwide license
rights for the life of the underlying patent to practice the methods and to
make, use, and sell the products and/or services and to certain sublicense
rights, which are covered by the proprietary rights, limited to the field of use
of separating and recovering motor oil from high density polyethylene plastic.
Under this agreement, the Company is required to pay royalties at a rate of
$0.005 per pound of recycled plastics sold, with minimum annual royalties of
$50,000 for 2006, $100,000 for 2007, $200,000 for 2008 and $300,000 for 2009 and
for years thereafter.  Honeywell may terminate this agreement in the
event of, among other things, the nationalization of the industry which
encompasses any products or services, any suspension of payments under the terms
of the agreement by government regulation, a substantial change in ownership of
the Company (whether resulting from merger, acquisition, consolidation or
otherwise), another company or person acquiring control of the Company, or the
existence of a state of war between the United States and any country where the
Company has a license to manufacture products or provide services.





Note
5.  Notes Payable to California Integrated Waste Management
Board





Notes
payable and related unamortized debt discount at December 31, 2007, consist of
the following (in thousands):




Note
      payable to CIWMB
              
              $
              1,715Debt
      discount, net of amortization
              
              
              (8
              )1,707Less
      current portion
              
              
              200Note
      payable to CIWMB, net of discount and net of current
    portion
              
              $
              1,507


In 2005,
pursuant to terms of a Business Loan Agreement, Security Agreements and $2
million Promissory Note with the California Integrated Waste Management Board
(“CIWMB”), the Company received cash into escrow after deduction of $10,000 loan
fees paid to CIWMB. The loan fee was recorded as a debt discount, which is
amortized over the loan term.  The promissory note bears interest at 4.25%
per annum, with interest only monthly payments during the first year, and then
principal and interest monthly payments of approximately $22,500 starting in
July 2006 until fully paid in May 2015. The promissory note is collateralized by
equipment purchased for the recycling plant, a secondary security interest in
all other machinery and equipment and other Company assets, and guaranteed by
the Company's Chief Technical Officer (former Chief Executive Officer). Minimum
annual principal payments approximate $200,000 in 2008, $209,000 in 2009,
$219,000 in 2010, $229,000 in 2011, $240,000 in 2012 and $618,000 thereafter
during 2013 through 2015.





Note
6.  Notes and Convertible Notes Payable





Notes and
convertible notes payable and related unamortized debt discount at December 31,
2007, all of which are classified as current liabilities, consist of the
following (in thousands):


Notes
              
              
              Unamortized
      debt discount
              
              
              Notes,
      net of debt discount
              
              
              Accrued
      interestSubordinated
      Convertible Notes
              
              $
              292
              
              
              $
              -
              
              
              $
              292
              
              
              $
              58Director
      Notes
              
              
              2,351
              
              
              
              -
              
              
              
              2,351
              
              
              
              127Short-term
      Notes
              
              
              2,162
              
              
              
              (1,100
              )
              
              
              1,062
              
              
              
              39Private
      Placement Convertible Notes
              
              
              12,934
              
              
              
              (3,314
              )
              
              
              9,620
              
              
              
              1,423Total
              
              $
              17,739
              
              
              $
              (4,414
              )
              
              $
              13,325
              
              
              $
              1,647


Amounts
due related parties and others are presented separately on the accompanying
balance sheet as follows (in thousands):




Due
      to related parties
              
              $
              9,271
              
              
              $
              (1,856
              )
              
              $
              7,415
              
              
              $
              846Due
      to others
              
              
              8,468
              
              
              
              ( 2,558
              )
              
              
              5,910
              
              
              
              801Total
              
              $
              17,739
              
              
              $
              ( 4,414
              )
              
              $
              13,325
              
              
              $
              1,647


As
discussed in Note 13 Subsequent Events, subsequent to December 31, 2007, the
Company issued approximately 241 million shares of its common stock in
consideration for conversion of all outstanding subordinated and private
placement convertible notes payable totaling approximately $13.2 million and
related accrued interest of approximately $2 million, and the surrender of
outstanding warrants to purchase approximately 38.7 million shares of Company
common stock.





Subordinated Notes -
During 2006, the Company received $2.8 million pursuant to a private placement
of subordinated convertible notes (the “Subordinated Notes”), bearing interest
at 10%, with principal and accrued interest due 12 months from issuance,
convertible into shares of the Company’s common stock at a price of $0.0975 per
share, and warrants, with cashless exercise provisions, to purchase 28,000,000
shares of restricted common stock, exercisable until April 2015 at an exercise
price of $0.12 per share (the “Subordinated Notes Warrants”).  The
conversion price of the debentures is subject to anti-dilution downward
adjustments in the event the Company sells common stock or securities
convertible into common stock at a price below the conversion price. The
Subordinated Notes rank pari passu with Private Placement Notes and are
subordinated only to the security interest granted to CIWMB.  The
shares underlying the notes and warrants are subject to piggy back registration
rights.  In 2006, the holder of a $200,000 short-term convertible note
payable converted the note, plus accrued interest into a Subordinated Note of
$202,000 and 2,020,000 warrants.  During 2006, debt discount relating
to these Subordinated Notes of approximately $3.2 million was recorded, of which
approximately $1.9 million and $1.3 million was amortized to interest expense
during 2007 and 2006, respectively.  The fair value of warrants was
computed using a Black-Scholes option pricing model with the following
assumptions: expected term of 9 years (based on the contractual term),
volatility of approximately 180% (based on historical volatility), zero
dividends and interest rate of approximately 4.6%.  The discount has
been fully amortized at December 31, 2007. In the event holders of
Subordinated Notes elect to convert such notes into shares of Company common
stock, the Company will issue Subordinated Notes Warrants exercisable into that
number of shares of the Company’s common stock equal to the quotient of (i) 65%
of the value of the converted notes divided by (ii) a per share price of $0.12,
a total of 16,260,833 warrants if all notes are converted. The Subordinated
Notes became due in 2007, and in 2007, Subordinated Notes in the amount of
approximately $2.7 million, together with accrued interest of approximately
$269,000, were converted into approximately 30.5 million shares of common
stock.  At December 31, 2007, there were Subordinated Notes
approximating $292,000, all of which were subsequently converted into common
stock in 2008.





Director Notes –
During 2007, two of the Company’s Directors made loans due on demand with
interest at 10% to the Company in the aggregate total of
$577,000.  The loan from one Director in the amount of $300,000 was
repaid, and the other $277,000 was cancelled and replaced with Director
Notes. During July through October 2007, the Company received cash proceeds
of approximately $2.4 million from various members of the Company’s Board of
Directors (the “Director Notes”).  In accordance with the Director
Notes, each lender received a promissory note with an interest rate of 15% per
annum (the “Note”).  All or any portion of the Note, any accrued
interest thereon and all other sums due under the Note, is due and payable on
demand within 90 days of the Note.  In connection with these notes,
lenders received common stock purchase warrants to purchase 22,657,000 shares of
Company common stock with an exercise price of $0.06 per share that expire in
April 2015.  The shares underlying the warrants are subject to piggy
back registration rights.  The exercise price of the warrants is
subject to anti-dilution downward adjustments in the event the Company sells
common stock at a price below the exercise price.  Debt discount
relating to the value of warrants issued of approximately $2.7 million was
recorded and which has been amortized to interest expense in
2007.   The fair value of warrants was computed using a
Black-Scholes option pricing model with the following assumptions: expected term
of 7.8 years (based on the contractual term), volatility of approximately 180%
(based on historical volatility), zero dividends and interest rate of
approximately 4.6%.





Short-term Notes-
During October through December 2007, the Company received cash proceeds of
approximately $ 2.2 million from new and existing investors and issued
to each lender a promissory note with an interest rate of 15% per annum, due and
payable on demand within 180 days (the “Short-Term Note”), and warrants to
purchase approximately 15 million shares of Company common stock with an
exercise price of $0.06 per share that expire in April 2015.  The
shares underlying the warrants are subject to piggy back registration
rights.  The exercise price of the warrants is subject to
anti-dilution downward adjustments in the event the Company sells common stock
at a price below the exercise price.  Debt discount relating to the
value of warrants issued of approximately $1.1 million was recorded, of which
has approximately $270,000 has been amortized to interest expense in 2007, the
remainder of which will be amortized to interest expense in
2008.   The fair value of warrants was computed using a
Black-Scholes option pricing model with the following assumptions: expected term
of 7.8 years (based on the contractual term), volatility of approximately 180%
(based on historical volatility), zero dividends and interest rate of
approximately 4.6%.





Private Placement Notes-  During 2006, proceeds were received into escrow pursuant to
a private placement memorandum (the “PPM”) through the offering of Units for
$25,000 per unit, each Unit consisting of a $25,000 junior secured subordinated
convertible debenture (the “Private Placement Notes”), bearing interest at 10%
with principal and accrued interest due 18 months from issuance (“maturity
date”), convertible into shares of the Company’s common stock at a price of
$0.0975 per share, and a warrant, with a cashless exercise provision, to
purchase 75,000 shares of restricted common stock of the Company, exercisable
until April 15, 2015 at an exercise price of $0.06 per share (the “Private
Placement Warrants”).  The conversion price of the debentures and
exercise price of the warrant are subject to anti-dilution downward adjustments
in the event the Company sells common stock or securities convertible into
common stock at a price below the conversion or exercise prices. The Private
Placement Notes are collateralized by a security interest in substantially all
of the Company’s assets, which such security interest is subordinated only to
the security interest granted to CIWMB, and rank pari passu with the
Subordinated Notes.  The shares underlying the debentures and warrants
are subject to piggy back registration rights.  In addition, a
registration statement must be filed within 30 days after an investor elects to
convert all or any portion of the debenture.  During 2006, proceeds
were received for approximately $7.9 million of Private Placement Notes and
approximately 23.7 million warrants.  At December 31, 2006,
approximately $1.2 million of escrowed funds had not been disbursed to the
Company, which was reported as a receivable for cash in escrow for securities
sold, and which was received by the Company in 2007. In 2007, the offering
closed and the debentures and warrants were issued. During 2006, holders of
$150,000 of other notes payable converted those notes, plus accrued interest
into subscription units comprised of approximately $159,000 of Private Placement
Notes and 450,000 warrants, and the Company also issued $60,000 of Private
Placement Notes and 180,000 Private Placement Warrants.  In 2006, debt
discount of approximately $7.7 million was recorded, of which approximately $5.2
million and $1.8 million was amortized to interest expense in 2007 and 2006,
respectively.  During 2007, Private Placement Notes in the amount of
approximately $125,000, together with accrued interest of approximately $13,000,
were converted into approximately 1.4 million shares of common
stock.  At December 31, 2007, there were Private Placement Notes of
$2.4 million that were due beyond their maturity date, all of which were
converted into shares of common stock in 2008.





Prior to
August 18, 2006, the Company had certain notes payable outstanding that included
a variable conversion price, which qualified the embedded conversion option as a
derivative pursuant to SFAS 133 and related interpretations, since the
conversion price was variable and the ability to have enough authorized common
shares to fulfill its potential obligations under convertible debt contracts was
not under Company control.  In such circumstances, the debenture
instrument is separated into a debt instrument and an embedded option instrument
for financial statement purposes and the embedded option instrument is recorded
as a liability at fair value and marked to fair value at each reporting date
through the statement of operations as other income or expense.  The
existence of the absence of the ability to have enough authorized common shares
to fulfill its potential obligations for the repaid notes, required that all
conversion features and all warrants outstanding also be accounted for at fair
value and marked to fair value through the statement of operations. At
Private Placement Note issuance dates through August 18, 2006, the total fair
value liability recorded for Private Placement Note embedded conversion options
and Private Placement Warrants was approximately $3.8 million and at August 18,
2006, the total fair value liability recorded was $2.4 million. The full fair
value of the warrants of approximately $1.1 million, and $1.5 million of the
$2.7 million fair value of the embedded conversion feature were allocated to
debt discount, the maximum to be recorded, and the remaining $1.2 million to
operations for the year ended December 31, 2006, respectively, as a change in
fair value of warrants and derivatives.  At August 18, 2006, when the
Company no longer had an inability to have enough authorized common shares to
fulfill its potential obligations, the fair value liability of approximately
$2.4 million recorded was reclassified to additional paid-in
capital.





During
2007, the Company received $5 million pursuant to investment terms substantially
similar to the PPM (the “Additional Investment”) and issued $5 million Private
Placement Notes and Private Placement Warrants to purchase 15,000,000
shares of common stock.  In connection with the Additional Investment,
the placement agent received cash fees of approximately $100,000 and received
warrants, with a cashless exercise provision, to purchase 382,429 shares of
restricted common stock of the Company at a per share price of $0.06 exercisable
for 10 years.  Pursuant to rights and terms of the Additional
Investment purchase agreement, the holder of $2 million of notes designated one
person to become a member of the Company’s Board of Directors, which such person
was appointed in 2007.  Additionally, in 2007, the Company issued
three PPM Units, comprised of $75,000 of Private Placement Notes and 225,000
Private Placement Warrants in exchange for accrued liabilities, which such notes
were immediately converted into 769,231 shares of Company common stock in
accordance with terms of the notes.  During 2007, debt discount,
comprised of warrant and beneficial conversion feature values, of approximately
$5 million was recorded.  The fair value of warrants was computed
using a Black-Scholes option pricing model with the following assumptions:
expected term of 8 years (based on the contractual term), volatility of 180%
(based on historical volatility), zero dividends and interest rate of
4.6%.  During 2007 approximately $2.4 million of the discount was
amortized to interest expense.








Note
7. Common Stock and Stock Warrants





Authorized Shares -
The Articles of Incorporation authorize a maximum of 750,000,000 shares of
$0.001 par value common stock and 10,000,000 shares of $0.001 par value
preferred stock. Each share of common stock is entitled to one voting right, the
right to share in earnings and the right to share in assets upon
liquidation.





Common Stock Issued for
Services - During July 2006, the Company entered into an employment
agreement with an individual to serve as its Chief Executive Officer and a
Director, pursuant to which, among other things, the executive received
44,000,000 shares of Company common stock, of which 26,400,000 were fully
vested, and of which 11,000,000 shares vested in 2007, and the remaining vest at
approximately 733,000 shares per month through September 2008.  The
total value of the shares based on the grant date quoted trading price of the
Company’s common stock was approximately $5.7 million.  The Company
recognized stock-based compensation expense of approximately $1.4 million and
$3.9 million in 2007 and 2006, respectively, and as of December 31, 2007, there
was approximately $405,000 of unrecognized compensation expense related to
unvested stock, which is expected to be recognized as expense in
2008





Pursuant
to an agreement with an executive recruiter and placements of the Company’s
Chief Executive and Operating Officers in 2006, the recruiter received
11,456,923 shares of Company common stock, of which 9,036,923 shares were
immediately fully-vested, and of which 2,420,000 shares vested in September
2007, and warrants to purchase 519,750 shares of Company common stock at a per
share price of $0.06 per share exercisable for 10 years, and warrants to
purchase 4,950,000 shares of Company common stock at a per share price of
$0.0975 exercisable for 10 years.  The shares are valued at
approximately $1.5 million based on the quoted trading prices of $0.13 and
$0.135 on the effective dates and the warrants are valued at approximately
$737,000 computed using a Black-Scholes option pricing model with the following
assumptions: contractual term of 10 years, volatility of 183% (based on
historical volatility over the term), zero dividends and interest rate of 4.8%.
The Company recognized stock-based compensation expense of approximately
$445,000 and $1.8 million during 2007 and 2006, respectively.  As of
December 31, 2007, there is no additional expense to be recognized with respect
to these issuances of equity securities.





In
February 2007, the Company entered into an employment agreement with an
individual to serve as its Vice President of Sales & Marketing, pursuant to
which, among other things, the executive received 4.4 million shares of Company
common stock, 1.1 million of which were fully-vested and the remainder vesting
evenly over the next three years, and is entitled to receive warrants to
purchase 1.1 million shares of Company common stock at $0.30 per share on the
one year anniversary of the employment agreement and warrants to purchase 1.1
million shares of Company common stock at $0.40 per share on the second year
anniversary.  The warrants have a four-year term and vest ratably over
3 years.  The shares are valued at approximately $1.1 million based on
the quoted trading price of $0.25 on the effective date and the warrants are
valued at approximately $511,000 computed using a Black-Scholes option pricing
model with the following assumptions: contractual terms of 4 and 10 years,
volatility of 184% (based on historical volatility over the term), zero
dividends and interest rate of 4.5%.  In connection with this
agreement, the Company recorded compensation expense for fully-vested shares and
for a portion of the unvested shares amortized on a straight-line basis over the
vesting periods.  The Company recorded compensation expense of
approximately $792,000 during 2007.  In addition, the executive
received three Private Placement Units, consisting of $75,000 of Private
Placement Notes and Private Placement Warrants to purchase 225,000 shares of
Company common stock, for which the Company recorded compensation expense of
$75,000.  As of December 31, 2007, there was approximately $820,000 of
unrecognized compensation expense related to unvested stock and warrants, which
is expected to be recognized as expense of approximately $620,000 in 2008 and
$185,000 in 2009, and $15,000 in 2010.





Pursuant
to an agreement for legal services with the Company’s outside law firm, the
Company periodically issued the firm vested non-forfeitable common shares, and
proceeds from the sale of such shares by the firm and reported to the Company
were credited against invoice amounts due for legal services. During 2006, the
Company issued the firm 2,802,925 shares of its common stock and recorded legal
expense of approximately $336,000, which was determined based on the $0.12 per
share quoted trading price on date of issuance.  In 2006, the Company
entered into an engagement agreement with the firm, whereby the prior agreement
was superseded and replaced, and among other things, the Company issued to the
firm 2,500,000 shares of its common stock and recorded legal expense of
$275,000, based on the quoted trading price of $0.11 on the grant
date





During
2006, the Company issued 8,161,899 shares of its common stock to
non-employee service providers for consulting and investor advisory services
provided to the Company and recorded consulting expense of approximately
$925,000 based on the $0.11 or $0.12 per share quoted trading price on the grant
dates.





During
July 2006, the Company entered into an employment agreement with its former
Chief Executive Officer to serve as Chief Technology Officer, pursuant to which,
among other things, the executive received 24,000,000 fully-vested shares or
share equivalents (warrants), of which he had previously received 17,953,208 of
such shares and share equivalents.  In connection with this agreement,
inasmuch as the shares were fully vested, the Company recorded compensation
expense and an increase in additional paid-in capital of $847,000, which was
determined on the $0.14 per share quoted trading price on the date of the
employment agreement.  Further, pursuant to this agreement the Company
agreed to issue 2,000,000 shares of its common stock to this executive upon
satisfying obligations, as defined, and in December 2007, the Company’s Board of
Directors resolved that such obligations had been satisfied and that the shares
shall be issued.  The Company recorded expense of $160,000, which was
determined based on the $0.08 per share quoted trading price on the date of the
board resolution.  As of December 31, 2007, the shares had not been
issued and are accordingly reported as common stock issuable.  In
2008, the shares were issued.





During
2007, the Company granted 5,070,411 shares of Company common stock, of
which 180,000 remain to be issued to various non-employee service providers and
has recorded the fair value of shares issued based on the closing market price
of stock on the respective measurement dates of approximately $899,000 as an
increase in additional paid-in capital.  Stock-based compensation
expense is recognized over the requisite service periods, all of which, except
one relating to rent, expired in 2007.  At December 31, 2007, the
approximately $24,000 of excess of the fair value of shares issued over expense
recognized is recorded as deferred stock-based consulting, a component of
stockholders’ deficit, which is expected to be recognized as expense in 2008 -
2010.





Stock Issued for Settlement
Agreement - During 2006, the Company entered into a settlement agreement
with a former vendor, pursuant to which, among other things, the Company
issued 2,564,103 shares of its common stock, and as a result recorded
settlement expense of $282,000, based on the quoted trading price of the
Company’s common stock of $0.11 per share on the settlement date.





During
2007, the Company entered into a settlement agreement with a former consultant,
pursuant to which, among other things, the Company issued 5 million shares of
its common stock, and as a result recorded settlement expense of $680,000, based
on the quoted trading price of the Company’s common stock of $0.135 per share on
the settlement date, which included $5,000 of related legal
expenses.





Stock Issued for Conversion
of Notes Payable – During 2007, Subordinated Notes in the amount of
approximately $2.7 million, together with accrued interest of approximately
$269,000, were converted into 30,545,769 shares of common stock, and Private
Placement Notes in the amount of approximately $125,000, together with accrued
interest of approximately $13,000, were converted into approximately 1,415,740
shares of common stock.





Stock Issued for Consulting
Agreement - In February 2007, the Company entered into a consulting
services agreement, which terminated December 31, 2007, with the Company’s
former Chief Financial Officer, pursuant to which, among other things, the
Company issued to the former officer 492,308 fully-vested shares of its common
stock, and agreed to pay annual compensation of $120,000 in consideration for
services during the term and in exchange for release of any claim to accrued
compensation while previously employed by the Company, which such amount was
$168,000.  In connection with this agreement, the Company recorded the
shares issued as an increase in common stock and additional paid-in capital of
approximately $133,000 based on the $0.27 quoted trading price on the agreement
date and compensation expense of approximately $85,000.





Stock Issued Upon Exercise
of Warrants - During 2007, pursuant to receipt of notices of cash and
cashless exercises of 6,048,439 warrants, the Company issued 4,119,596 shares of
its common stock and received proceeds of approximately $2,000.  In
2006, the Company issued 8,757,142 shares of its common stock in connection with
the exercise of warrants to purchase common stock in exchange for the purchase
price of approximately $9,000.





Common Stock
Issuablefor
Services - Pursuant to terms of a mutual settlement and release
agreement, in early 2008, among other things, the Company issued 5,000,000
shares of its common stock to a former executive, and the former executive
returned to the Company for cancellation all previously issued warrants, which
include vested warrants to purchase approximately 17 million shares and
forfeited all rights to acquire additional shares under the employment
agreement.  The Company recorded the 5,000,000 shares issuable, net of
the approximately $101,000 fair value of warrants surrendered, as compensation
expense of approximately $249,000 during 2007, based on the $0.07 quoted trading
price of the Company’s common stock and black-scholes fair value computations at
year-end, when it was determined that it was more likely than not that such an
arrangement would be agreed to.





Covenant to Adjust Common
Stock Shares – In January 2006, terms of Common Stock Purchase and
Covenant to Adjust Agreements entered into in 2005, were amended to eliminate
any further adjustments to the original purchase price, and the Company recorded
the issuance of 752,731 shares and the previously recorded temporary equity
redemption value of approximately $165,000 was reclassified to permanent
stockholders’ equity. These shares have not been issued by the transfer
agent.





Stock
Warrants – In connection with borrowings and other
transactions, the Company issues warrants to purchase its common
stock.  The fair value of warrants issued during 2007 and 2006 was
estimated using the Black-Scholes option-pricing model with the following
assumptions: dividend yield of 0%; expected volatility of approximately 160% to
183% (based on historical volatility over the terms); risk-free interest rates
of approximately 5%; and terms of 3.5 to 10 years.  The
weighted-average fair value of warrants granted during 2007 and 2006
approximated $0.19 and $0.13, respectively.





Prior to
August 18, 2006, due to outstanding convertible debt with variable conversion
terms, the Company determined that pursuant to EITF 00-19, all of the Company’s
warrants and investment rights granted to non-employees were to be classified as
liabilities.  During 2006, the Company recognized approximately $1.2
million of other income relating to the change in fair value of warrants during
the period which is included in the accompanying statement of operations as the
change in fair value liability of warrants and derivatives. Upon repayment of
the notes August 18, 2006, the Company no longer had the inability to have
enough authorized common shares to fulfill its potential obligations, and the
fair value liability of all outstanding warrants and investment rights recorded
at that date was reclassified to additional paid-in capital.





In
October 2006, the Company entered into an employment agreement with an
individual to serve as its Chief Operating Officer, pursuant to which, among
other things, the executive will receive shares of Company common stock (or
stock options, at the executive’s election) covering 5% of Common Stock
Equivalents, as defined in the agreement.  The executive received
options to purchase 24,000,000 shares (shares were not elected) of Company
common stock, of which 12,000,000 were fully-vested, and of which 6,000,000
warrants vest in October 2007 and the remaining 6,000,000 vest pro-rata from
November 2007 to October 2008. The warrants are exercisable at $0.0975 per share
for ten years, and have an estimated fair value of approximately $3.2 million as
determined utilizing the Black-Scholes valuation model as of the Effective Date
with the following assumptions: contractual term of 10 years, volatility of 174%
(based on historical volatility over the term), zero dividends and interest rate
of 4.8%.  During 2007 and 2006, the Company recognized stock-based
compensation expense of approximately $810,000 and $1.8 million, respectively,
and as of December 31, 2007, there was approximately $655,000 of unrecognized
compensation expense related to unvested stock warrants.  Pursuant to
terms of a mutual settlement and release agreement, in early 2008, among other
things, the former executive returned to the Company for cancellation all
previously issued warrants and forfeited all rights to acquire additional shares
under the employment agreement, and the Company issued to the former executive
5,000,000 shares of restricted common stock.  Warrants cancelled and
forfeited are reflected as cancelled in 2007 in the following table of warrant
activity, and there will be no further recognition of compensation
expense.





During
2007, the Company issued warrants to a new Director to purchase 500,000 shares
of its common stock at an exercise price of $0.19 per share with a 4-year term
and recorded compensation expense of approximately $89,000 based on the fair
value as determined utilizing the Black-Scholes valuation
model. Additionally, the Company issued warrants to a new employee to
purchase 2,000,000 shares of its common stock at an exercise price of $0.0975
with a ten year term and recorded compensation expense of approximately $204,000
based on the fair value as determined utilizing the Black-Scholes valuation
model. The closing stock price at the issuance date was $0.19 per
share.  The warrants issued to the new employee were assigned to the
Company by one of its other executive officers, which was recorded as a
contribution of capital in accordance with the provisions of SFAS
123R.  As of December 31, 2007, there was approximately $176,000 of
unrecognized compensation expense related to unvested warrants, which is
expected to be recognized as expense of approximately $115,000 in 2008, $49,000
in 2009 and $12,000 in 2010.





In August
2007, the Company entered into an employment agreement with an individual to
serve as its Chief Financial Officer, pursuant to which, among other things, the
executive received warrants to purchase 5,000,000 shares of Company common
stock, 25% of which are fully-vested and the remainder vesting 1,250,000 per
year over the next three years.  The warrants have a four-year term
and an exercise price of $0.12 per share, and are valued at approximately
$540,000 based on a Black-Scholes option pricing model valuation with the
following assumptions: expected term of 4 years, volatility of 160% (based on
historical volatility over the term), zero dividends and interest rate of
4.6%.  In connection with this agreement, the Company will record
compensation expense for fully-vested shares and for a portion of the unvested
shares amortized on a straight-line basis over the vesting
periods.  The Company recorded compensation expense of approximately
$231,000 during 2007.  As of December 30, 2007, there was
approximately $309,000 of unrecognized compensation expense related to unvested
stock and warrants, which is expected to be recognized as expense of
approximately $195,000 in 2008, $86,000 in 2009 and $28,000 in
2010.  In March 2008, the executive resigned.





The
intrinsic value of stock warrants is calculated by aggregating the difference
between the closing market price of the Company’s common stock at the reporting
period end and the exercise price of stock warrants which have an exercise price
less than that market price.





The
following summarizes activity for stock warrants issued to lenders for
borrowings, all of which are exercisable:




Outstanding
              
              
              Weighted
      average exercise price
              
              
              Weighted
      average remaining contractual life in years
              
              
              Aggregate
      intrinsic value (in thousands)Balance
      at December 31, 2005
              
              
              13,478,439
              
              
              $
              0.02
              
              
              
              8.6
              
              
              $
              1,350Granted
              
              
              55,180,000
              
              
              
              0.09Exercised
              
              
              (8,800,000
              )
              
              
              0.002Balance
      at December 31, 2006
              
              
              59,858,439
              
              
              
              0.09
              
              
              
              5.8
              
              
              $
              3,518Granted
              
              
              68,746,817
              
              
              
              0.08Exercised
              
              
              (5,198,439
              )
              
              
              0.06Balance
      at December 31, 2007
              
              
              123,406,817
              
              
              $
              0.09
              
              
              
              6.2
              
              
              $
              962


The
following summarizes activity for stock warrants issued to consultants for
services, all of which are exercisable:




Outstanding
              
              
              Weighted
      average exercise price
              
              
              Weighted
      average remaining contractual life in years
              
              
              Aggregate
      intrinsic value (in thousands)Balance
      at December 31, 2005
              
              
              5,782,121
              
              
              $
              0.05
              
              
              
              5.3
              
              
              $
              410Granted
              
              
              26,412,750
              
              
              
              0.09Balance
      at December 31, 2006
              
              
              32,194,871
              
              
              
              0.08
              
              
              
              7.4
              
              
              $
              2,491Granted
              
              
              382,429
              
              
              
              0.08Exercised
              
              
              (850,000
              )
              
              
              0.001Exercised/
      Cancelled
              
              
              (12,121
              )
              
              
              29.70Balance
      at December 31, 2007
              
              
              31,715,179
              
              
              $
              0.08
              
              
              
              5.9
              
              
              $
              220


The
following summarizes activity for stock warrants issued to employees,
substantially all or which are exercisable:


Outstanding
              
              
              Weighted
      average exercise price
              
              
              Weighted
      average remaining contractual life in years
              
              
              Aggregate
      intrinsic value (in thousands)Balance
      at December 31, 2005
              
              
              19,850,000
              
              
              $
              0.06
              
              
              
              9.7
              
              
              $
              1,191Granted
              
              
              12,000,000
              
              
              
              0.10Balance
      at December 31, 2006
              
              
              31,850,000
              
              
              
              0.07
              
              
              
              9.2
              
              
              $
              2,416Granted
              
              
              5,725,000
              
              
              
              0.13Exercised/
      Cancelled
              
              
              (10,000,000
              )
              
              
              0.10Balance
      at December 31, 2007
              
              
              31,715,179
              
              
              $
              0.09
              
              
              
              5.6
              
              
              $
              151


The
following summarizes activity for all stock warrants:


Outstanding
              
              
              Weighted
      average exercise price
              
              
              Weighted
      average remaining contractual life in years
              
              
              Aggregate
      intrinsic value (in thousands)Balance
      at December 31, 2005
              
              
              39,110,560
              
              
              $
              0.05
              
              
              
              8.3
              
              
              $
              2,951Granted
              
              
              93,592,750
              
              
              
              0.08Exercised
              
              
              (8,800,000
              )
              
              
              0.002Balance
      at December 31, 2006
              
              
              123,903,310
              
              
              
              0.08
              
              
              
              6.9
              
              
              $
              8,425Granted
              
              
              74,854,246
              
              
              
              0.08Exercised
              
              
              (6,048,439
              )
              
              
              0.06Exercised/
      Cancelled
              
              
              (10,012,121
              )
              
              
              0.14Balance
      at December 31, 2007
              
              
              182,696,996
              
              
              $
              0.09
              
              
              
              6.1
              
              
              $
              1,333


Additional
information regarding all warrants outstanding as of December 31, 2007, is as
follows:




Range
      of exercise prices
              
              
              Shares
              
              Weighted
      average remaining life
              
              Weighted
      average exercise price$0.001
              
              
              
              60,000
              
              3.7
      years
              
              $0.001$0.05
              
              
              
              1,100,000
              
              2.5
      years
              
              0.05$0.06
              
              
              
              130,700,972
              
              7.8
      years
              
              0.06$0.09
      - $ 0.11
              
              
              
              16,451,249
              
              6.3
      years
              
              0.10$0.12
      - $0.13
              
              
              
              33,584,775
              
              2.8
      years
              
              0.12$0.19
      - $0.25
              
              
              
              800,000
              
              3.0
      years
              
              0.21182,696,996
              
              6.1
      years
              
              $0.09




Note
8.   Related Party Transactions




As
summarized in Note 6 Notes Payable, certain of the Company’s Directors are
holders of the Company’s notes payable in the aggregate amount of approximately
$9.3 million and $7.0 million at December 31, 2007 and 2006,
respectively.  Accrued interest payable on the notes approximated
$846,000 and $245,000 at December 31, 2007 and 2006, respectively.





Pursuant
to an agreement for legal services with The Otto Law Group, PLLC (“OLG”), a law
firm, the managing partner of which is one of the Company’s Directors, the
Company periodically issued to the law firm vested non-forfeitable common
shares, and proceeds from the sale of such shares by the firm and reported to
the Company were credited against invoice amounts due for legal services. There
were no reported stock sale proceeds during 2006.  The agreement had
no stated term. During 2006, the Company issued the firm 2,802,925 shares of its
common stock and recorded legal expense of approximately $336,000, which was
determined based on the $0.12 per share quoted trading price on date of
issuance.  In 2006, the Company entered into an engagement agreement
with OLG, whereby the prior agreement was superseded and replaced, and among
other things, the Company issued the firm 2,500,000 shares of its common
stock.  The shares were valued at the quoted trading prices of $0.11
on the grant date, resulting in an expense of $275,000.  During 2007
and 2006, the Company incurred legal fee services from the firm of approximately
$293,000 and $967,000, respectively.   Accounts payable to OLG
for legal services are included in accounts payable to related parties in the
accompanying balance sheet.





During
2006, the Company issued 2,802,925 shares of its common stock to Cambridge
Partners, LLC (“Cambridge”) for investor advisory services provided to the
Company and recorded consulting expense of approximately $336,000, which was
determined based on the $0.12 per share quoted trading price on the issuance
date.  The managing partner of OLG, one of the Company’s Directors, is
one of the two members of Cambridge.





In 2006,
the Company entered into an agreement with KW Securities, Inc. (“KW”), a
registered broker dealer and a company owned by one of the Company’s Directors,
for KW to serve as placement agent for the Private Placement Offering. Pursuant
to terms of the agreement, as amended, among other things, the Company shall pay
compensation of warrants to purchase Company common stock at a per share price
of $0.06 at varying rates of warrants for funds raised based on securities
sold.  In connection with sales of Private Placement units and
Subordinated Notes and warrants in 2006, the Company has recorded debt issue
costs of approximately $2.1 million based on the fair value of 14,625,000
warrants exercisable at $0.06 per share for approximately eight and one-half
years, determined utilizing the Black-Scholes valuation model, which such
warrants were issued to KW in 2007.  Upon the closing of the PPM in
2007, the agreement with KW terminated.





In 2006,
the Company entered into a Funding Agreement with Itec Capital Group, LLC
(“ICG”), a Washington limited liability company owned by the managing partner of
OLG, who is one of the Company’s Directors, and another one of the Company’s
Directors, and KW, a company owned by that Director.  Pursuant to
terms of the Funding Agreement, the Company agreed to pay fees of 8% of Notes
payable issued pursuant to certain financings and issue warrants based on
securities sold and common shares convertible or exercisable
into.  Pursuant to a consulting agreement between ICG and Excipio
Group, S.A. (“Excipio”), an entity, ICG agreed to pay Excipio a dollar amount
and securities to be agreed upon from time to time upon completion of certain
defined objectives and projects, and in this regard, ICG has agreed to pay
Excipio fees and warrants in the amounts ICG receives from the
Company.  In November 2006, Excipio, ICG and the Company entered into
a mutual settlement and release agreement, pursuant to which, among other
things, in full satisfaction of amounts owed under all prior agreements or
arrangements, the Company agreed to pay approximately $429,000 (in addition to
$296,000 previously paid) and issue a warrant to purchase 1,440,000 shares of
Company common stock with an exercise price of $0.06 per share for approximately
eight and one-half years and a warrant to purchase 3,748,000 shares of Company
common stock with an exercise price of $0.12 per share for approximately three
and one-half years.  The $429,000 was payable $200,000 upon execution
of the settlement agreement and in varying amounts based on certain conditions,
and was paid in full in 2007.  In connection with the settlement
agreement, the consulting agreement between ICG and Excipio was cancelled and
any further obligation under the consulting agreement has been waived and
dismissed, and the Funding Agreement between the Company and ICG was amended to
reflect the settlement of fees and expenses owed and paid under the Funding
Agreement and that no additional fees or expenses shall accrue or become due in
accordance with the Funding Agreement.





Included
in accounts payable to related parties at December 31, 2007 is approximately
$55,000 due to certain of the Company’s officers, primarily relating to expense
reimbursements owed.





Note
9.  Income Taxes





At
December 31, 2007, the Company has available approximately $34 million of net
operating loss carryforwards available to offset future federal and state income
taxes, respectively, which expire through 2027. Realization is dependent on
generating sufficient taxable income prior to expiration of the loss
carryforwards. A change of greater than 50% of the Company ownership could
significantly limit utilization.  At December 31, 2007 and 2006, the
Company has provided a valuation allowance to reduce its net deferred tax asset
to zero. The valuation allowance increased by approximately $4.5 million and
$3.2 million during 2007 and 2006, respectively.





Deferred
income taxes represent the net tax effects of temporary differences between the
carrying amounts of assets and liabilities for financial reporting purposes
and  income tax purposes.  Significant components of
deferred tax assets and liabilities consist of the following at December 31,
2007 and 2006:


2007
              
              
              2006Deferred
      tax assetsNet
      operating loss carryforward
              
              $
              12,788
              
              
              $
              8,174Accrued
      liabilities due to related parties
              
              
              235
              
              
              
              216Total
      deferred tax assets
              
              
              13,023
              
              
              
              8,390Deferred
      tax liabilities - property and equipment
              
              
              (228
              )
              
              
              (10
              )Net
      deferred tax assets before valuation allowance
              
              
              12,795
              
              
              
              8,380Valuation
      allowance
              
              
              (12,795
              )
              
              
              (8,380
              )Net
      deferred tax assets
              
              $
              -
              
              
              $
              -


A
reconciliation of the provision for income tax with income tax computed by
applying the federal statutory income tax rate to loss before provision for
income taxes for years ended December 31 is as follows:


2007
              
              
              2006Income
      tax benefit computed at statutory rate
              
              
              (34
              %)
              
              
              (34
              %)State
      income tax benefit, net of federal benefit
              
              
              (3
              %)
              
              
              (2
              %)Nondeductible
      stock-based compensation and other
              
              
              21
              %
              
              
              21
              %Valuation
      allowance
              
              
              16
              %
              
              
              15
              %Effective
      tax rate
              
              
              0
              %
              
              
              0
              %




Note
10. Participation Certificates Obligations Issued Prior to
2004





In 2000,
the Company’s Board of Directors authorized the issuance of common stock to
various investors.  An agreement between the Company’s then President
and investors allowed participants in the Italian General Plastics Development
Program to make advances based on Company common stock. Funds thus generated
(approximately $815,000) were to be repaid when the Company became a public
company. Upon repayment of funds advanced, investors would retain their stock
ownership. To comply with Italian regulations, the Company’s then President
personally issued shares of Company common stock to the investors. Funds
advanced by investors were made to and deposited in accounts in the former
President's name.  The Company’s former President has represented that
funds received were assets of Company and that the Company has assumed the
related obligations, and accordingly, based on the substance of the
transactions, the transactions have been presented as Company borrowings in the
accompanying balance sheet.  Prior to December 31, 2004, the Company
entered into various agreements, including a settlement and release agreement,
with certain investors pursuant to which the investors received shares of
Company common stock in exchange for their prior participation
certificates.  The balance outstanding approximates $354,000, which
has not changed since 2004.








Note 11.Concentrations and Major
Customers





As
described in Note 4, the Company’s business is reliant on its licensing of
technology from Honeywell.







During
2007, the Company had revenues of over 10% of total revenue from individual
customers and related accounts receivable over 10% of total accounts receivable
at December 31, 2007 as follows (“*” means < 10%):




Per
      cent of total revenues
              
              
              Per
      cent of total accounts receivableCustomer
      1
              
              
              40
              %
              
              
              *Customer
      2
              
              
              24
              %
              
              
              40
              %Customer
      3
              
              
              15
              %
              
              
              *Customer
      4
              
              
              10
              %
              
              
              20
              %


Note
12.  Commitments and Contingencies




Leases




Agency Agreement - In
2005, the Companyentered
into a three year Agency Agreement with H. Muehlstein & Co., Inc.
(“Muehlstein”), pursuant to which Muehlstein will act as the Company’s exclusive
agent for the annual purchase and sale of up to sixty million pounds, subject to
increase under certain circumstances, of ECO2’s PET
flake and post-consumer HDPE natural flake and pellets in the USA and
Canada.  This agreement prohibits the Company from engaging additional
sales agents, but does not limit the Company’s direct sales to
customers.





Legal proceeding –
The Company is subject to various lawsuits and other claims in the normal course
of business.  The Company establishes accruals for specific
liabilities in connection with legal actions deemed to be probable and
reasonably estimable.  No material amounts have been accrued as of
December 31, 2007 in these accompanying financial statements with respect to any
legal matters. Company management does not expect that the ultimate resolution
of pending legal matters in future periods, including the matter described below
will have a material effect on the Company’s financial condition or results of
operations.





In
October 2007, a former vendor filed a claim against the Company and its former
Chief Executive Officer, now Chief Technology Officer, who is also one of the
Company’s directors, in Tuolumne County Superior Court in the state of
California.  The claim alleges breach of contract and that the
plaintiff is due fees for services provided in excess of $68,000, of which
$7,500 is alleged to be due from the Company.





Note
13.  Subsequent Events





In
January 2008, the Company received $300,000 cash from a new investor and issued
a $300,000 promissory note bearing interest at 15% and due in sixty
days.  The Company and note holder are in discussions regarding, among
other things, extensions of the due date, which has passed.





Subsequent
to December 31, 2007, the Company received cash of approximately $1.9
million from new and existing investors and issued $1.9 million of
Short-Term Notes and warrants to purchase approximately 18.9 million shares of
Company common stock with an exercise price of $0.06 per share that expire in
2015.





Subsequent
to December 31, 2007, the Company issued approximately 243 million shares of its
common stock in consideration for conversion of all outstanding convertible
notes payable totaling approximately $13.2 million (before debt discount of
approximately $2.2 million) and related accrued interest of approximately $1.7
million, and the surrender of outstanding warrants to purchase
approximately 39 million shares of Company common stock having an exercise
price of $0.06 per share and expiring in April 2015.  To the extent that
the number of shares issued exceed the number that would otherwise have been
convertible into pursuant to original conversion terms, the fair value of such
excess will be recorded as a conversion premium expense based on the quoted
trading price on the conversion dates.





In
February 2008, the Company made a special offer to holders of warrants to
purchase Company common stock to exchange all outstanding warrants into shares
of Company common stock in a number of shares equal to 60% to 75% (depending on
the warrant) of the number of warrant shares exchanged for no cash
consideration.  Holders of approximately 124 million warrants accepted
the offer and the Company will issue approximately 82 million shares of its
common stock.





Additionally,
subsequent to December 31, 2007, the Company entered into agreements with
certain service providers that have provided services to the Company
to issue shares of its common stock in satisfaction of amounts owed, and in
connection with these agreements agreed to issue approximately 16 million
shares of its common stock in satisfaction of approximately $754,000
owed.  Amounts owed of approximately $187,000 and $567,000 were
included in accounts payable and accounts payable – related party, respectively,
at December 31, 2007. The shares will be valued at approximately
$829,000, based on the quoted trading price on the agreement dates, and the
Company will record a a conversion premium expense of approximately
$75,000.





Following
is an unaudited summary pro forma illustration of the effects of the above
described debt conversions, warrants for shares exchange and issuance of
shares for services as of December 31, 2007 as if such conversions,
warrants for shares exchange and shares for services had occurred as of that
date (in thousands):




Actual
            
            
            Note
      Conversions
            
            
            Shares
      for Warants
            
            
            Shares
      for Services
            
            
            Pro
      FormaTotal
      Liabilities
            
            $
            21,270
            
            
            $
            (12,700
            )
            
            $
            -
            
            
            $
            (754
            )
            
            $
            7,816Total
      stockholders’ equity (deficit)
            
            
            (11,755
            )
            
            
            12,700
            
            
            
            -
            
            
            
            754
            
            
            
            1,699Total
            
            $
            9,515
            
            
            $
            -
            
            
            $
            -
            
            
            $
            0
            
            
            $
            9,515Shares
      issued and issuable
            
            
            198,101
            
            
            
            243,000
            
            
            
            82,000
            
            
            
            19,000
            
            
            
            542,101Warrants issued
      and issuable
            
            
            182,697
            
            
            
            (39,000
            )
            
            
            (124,000
            )
            
            
            -
            
            
            
            19,697








SIGNATURES
  Pursuant
to the requirements of Section 13 or 15(d) of the Securities Exchange Act of
1934, the Registrant has duly caused this report to be signed on its behalf by
the undersigned; thereunto duly authorized, in the City of San Francisco, State
of California, on April 14, 2008.
   Registrant
  ECO2
PLASTICS, INC.
   /s/
Rodney S. Rougelot
 By:
Rodney S. Rougelot
 Director, Chief Executive Officer
and
 Interim Chief Financial Officer
   Pursuant
to the requirements of the Securities Exchange Act of 1934, this report has been
signed below by the following persons on behalf of Registrant and in the
capacities indicated on April 14, 2008
   /s/
William
Whittaker
 William Whittaker
 Chairman
   /s/
Gary M.
DeLaurentiis
 Gary
M. De Laurentiis
 Director and Chief Technology
Officer
   /s/
David M.
Otto
 David
M. Otto
 Director
   /s/
Lawrence A.
Krause
 Lawrence A. Krause
 Director
   /s/
Ronald
Domingue
 Ronald Domingue
 Director
   /s/ Roy A. Herberger