- Quarterly Report (10-Q)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

(Mark One)

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

For the quarterly period ended March 31, 2009

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

For the transition period from to

Commission file number: 000-51991

Basin Water, Inc.

(Exact name of registrant as specified in its charter)


Delaware		20-4736881
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)

9302 Pittsburgh Avenue, Suite 210 Rancho Cucamonga, California		91730
(Address of principal executive offices)		(Zip Code)

(909) 481-6800

(Registrant’s telephone number, including area code)

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

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

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

Large accelerated filer ¨ Accelerated filer x Non-accelerated filer ¨ Smaller reporting company ¨

(Do not check if a smaller reporting company)

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

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date: On May 18, 2009 there were 22,223,364 shares of common stock, par value $0.001, outstanding.

BASIN WATER, INC.

INDEX


			Page No.
Part I.	Financial Information:

	Item 1.	Financial Statements:

		Condensed Consolidated Balance Sheets – March 31, 2009 (unaudited) and December 31, 2008 (audited)	1

		Condensed Consolidated Statements of Operations (unaudited) – Three months ended March 31, 2009 and 2008	2

		Condensed Consolidated Statement of Changes in Equity (unaudited) – Three months ended March 31, 2009	3

		Condensed Consolidated Statements of Cash Flows (unaudited) – Three months ended March 31, 2009 and 2008	4

		Notes to Condensed Consolidated Financial Statements (unaudited)	5

	Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	16

	Item 3.	Quantitative and Qualitative Disclosures About Market Risk	22

	Item 4.	Controls and Procedures	22

Part II.	Other Information:

	Item 1.	Legal Proceedings	25

	Item 1A.	Risk Factors	25

	Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	26

	Item 3.	Defaults Upon Senior Securities	26

	Item 4.	Submission of Matters to a Vote of Security Holders	26

	Item 5.	Other Information	26

	Item 6.	Exhibits	26

Signatures			27

PART I – FINANCIAL INFORMATION

Item 1.

Financial Statements

BASIN WATER, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

(In thousands, except share and per share data)


	March 31, 2009			December 31, 2008
	(Unaudited)
ASSETS
Current assets
Cash and cash equivalents	$	8,832		$	11,954
Accounts receivable, net of $278 and $190 allowance for doubtful accounts		1,922			1,464
Accounts receivable under long-term contracts		1,242			3,776
Unbilled receivables, net of $544 and $544 allowance for doubtful accounts		2,404			2,234
Inventory, net of $297 and $246 reserves		1,535			1,387
Prepaid expenses and other		917			1,030

Total current assets		16,852			21,845

Property and equipment
Property and equipment		31,900			31,894
Less: accumulated depreciation		3,938			3,640

Property and equipment, net		27,962			28,254

Other assets
Goodwill		2,490			2,490
Intangible assets, net		2,242			2,382
Patent costs, net		3,206			3,233
Investment in affiliate		150			1,857
Other assets		1,160			1,115

Total other assets		9,248			11,077

Total assets	$	54,062		$	61,176

LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities
Accounts payable	$	2,320		$	2,485
Current portion of notes payable		202			408
Current portion of capital lease obligations		13			10
Current portion of deferred revenue and advances		1,545			1,280
Current portion of contract loss reserve		1,640			1,542
Accrued expenses and other		3,116			3,289

Total current liabilities		8,836			9,014

Notes payable, net of current portion		108			109
Capital lease obligations, net of current portion		—			5
Deferred revenue, net of current portion		354			257
Deferred revenue - affiliate		—			797
Contract loss reserve, net of current portion		5,688			6,428
Other long-term liabilities		271			337

Total liabilities		15,257			16,947

Commitments and contingencies
Equity
Basin Water, Inc. stockholders’ equity
Common stock, $0.001 par value -100,000,000 shares authorized, 22,223,364 and 22,205,923 shares issued and outstanding		22			22
Additional paid-in capital		113,250			112,698
Treasury stock		(552	)		(552	)
Accumulated deficiency		(74,393	)		(68,371	)

Total Basin Water, Inc. stockholders’ equity		38,327			43,797

Noncontrolling interest		478			432

Total equity		38,805			44,229

Total liabilities and equity	$	54,062		$	61,176

See accompanying notes to unaudited condensed consolidated financial statements.

BASIN WATER, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(In thousands, except per share data)


	Three Months Ended March 31,
	2009			2008
	(Unaudited)
Revenues
System sales	$	1,422		$	1,064
Contract revenues		2,130			1,785

Total revenues		3,552			2,849

Cost of revenues
Cost of system sales		1,072			833
Cost of contract revenues		1,879			1,487
Depreciation expense		260			199

Total cost of revenues		3,211			2,519

Gross profit		341			330

Research and development expense		43			74
Selling, general and administrative expense		5,385			5,645

Loss from operations		(5,087	)		(5,389	)

Other income (expense)
Interest expense		(7	)		(41	)
Interest income		28			358
Equity in loss of affiliate		—			(40	)
Impairment charge - investment in affiliate		(910	)		—
Other income		—			2

Total other income (expense)		(889	)		279

Loss before taxes		(5,976	)		(5,110	)
Income tax benefit		—			—

Loss before noncontrolling interest		(5,976	)		(5,110	)
Less: net income attributable to noncontrolling interest		(46	)		(74	)

Net loss	$	(6,022	)	$	(5,184	)

Net loss per share:
Basic	$	(0.27	)	$	(0.24	)
Diluted	$	(0.27	)	$	(0.24	)
Weighted average common shares outstanding:
Basic		21,920			21,737
Diluted		21,920			21,737

See accompanying notes to unaudited condensed consolidated financial statements.

BASIN WATER, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENT OF CHANGES IN EQUITY

(In thousands)

(Unaudited)


	Basin Water, Inc. Stockholders’ Equity
	Common Stock			Additional Paid-in Capital		Treasury Stock			Accumulated Deficiency			Noncontrolling Interest		Total Equity
	Shares	Amount		Additional Paid-in Capital		Treasury Stock			Accumulated Deficiency			Noncontrolling Interest		Total Equity
Balance - December 31, 2008	22,206	$	22	$	112,698	$	(552	)	$	(68,371	)	$	432	$	44,229
Stock-based compensation expense	—		—		552		—			—			—		552
Deferred stock compensation	17		—		—		—			—			—		—
Net loss	—		—		—		—			(6,022	)		46		(5,976	)

Balance - March 31, 2009	22,223	$	22	$	113,250	$	(552	)	$	(74,393	)	$	478	$	38,805

See accompanying notes to unaudited condensed consolidated financial statements.

BASIN WATER, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOW

(In thousands)


	Three Months Ended March 31,
	2009			2008
Cash flows from operating activities
Net loss	$	(6,022	)	$	(5,184	)
Adjustments to reconcile net loss to net cash provided by operating activities:
Depreciation and amortization		544			464
Stock-based compensation expense		552			607
Amortization of deferred compensation		—			39
Equity in loss of affiliate		—			40
Net income attributable to noncontrolling interest		46			74
Impairment of investment in affiliate		910			—
Impairment of capitalized costs due to contract terminations		685			—
Changes in operating assets and liabilities:
Accounts receivable		2,076			1,078
Unbilled receivables		(170	)		(936	)
Inventory		(148	)		(475	)
Prepaid expenses and other		113			63
Accounts payable		(165	)		(1,227	)
Deferred revenues		362			9
Accrued expenses and other		(173	)		(41	)
Contract loss reserve		(642	)		(367	)
Other assets and other liabilities		(249	)		(1,604	)

Net cash used in operating activities		(2,281	)		(7,460	)

Cash flows from investing activities
Purchase of property, plant and equipment		(632	)		(587	)
Patent costs		—			(10	)

Net cash used in investing activities		(632	)		(597	)

Cash flows from financing activities
Repayments of notes payable and capital lease obligations		(209	)		(89	)

Net cash used in financing activities		(209	)		(89	)

Net decrease in cash and cash equivalents		(3,122	)		(8,146	)
Cash and cash equivalents, beginning of period		11,954			36,038

Cash and cash equivalents, end of period	$	8,832		$	27,892

Supplemental disclosures of cash flow information:
Cash paid during the period for:
Interest	$	5		$	41

Income taxes	$	—		$	—

See accompanying notes to unaudited condensed consolidated financial statements.

BASIN WATER, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

(In thousands, except share and per share data)

Note 1—Business Activity and Basis of Presentation

Basin Water, Inc. and its subsidiaries (the Company) design, build and implement systems for the treatment of contaminated groundwater, municipal and industrial wastewater, industrial process water, and air streams from municipal and industrial sources. Customers can choose between purchasing the Company’s systems and entering into long-term contracting arrangements for the Company’s systems.

The Company markets its treatment systems and services primarily to utilities, cities, municipalities, special districts, industry and other organizations for use in treating groundwater that does not comply with federal or state drinking water regulations due to the presence of chemical contaminants, treating wastewater, and treating air streams from municipalities and industry for the removal of odor-causing and other contaminants. The Company markets its treatment systems and services through its direct sales force, independent contractors and strategic relationships.

Capital Resources

The accompanying consolidated financial statements have been prepared by the Company on a going concern basis, which contemplates the realization of amounts and satisfaction of obligations in the normal course of business. As of March 31, 2009 and December 31, 2008, the Company had approximately $8,400 and $11,500 in cash and cash equivalents, respectively (excluding cash balances resulting from the consolidation of VL Capital, which funds of VL Capital are not available to support the Company’s liquidity needs). The Company has experienced significant negative cash flows from operating and investing activities since 2006, including during the first quarter of 2009, and expects to require additional cash for such activities for the foreseeable future. The Company had a net loss of approximately $6,000 for the three months ended March 31, 2009 and incurred net losses during the fiscal years ended December 31, 2008 and 2007 of approximately $32,500 and $18,300, respectively. Unless and until the Company is able to generate sufficient revenues from its system sales and contract services, it expects such losses to continue in the future. Therefore, the Company’s ability to continue to operate as a going concern is highly dependent on the amount of cash and cash equivalents on hand combined with its ability to raise capital to support future operations. Additional capital, whether obtained through financial markets or collaborative or other arrangements with water providers, corporate partners or from other sources, may not be available at all, when needed, or on terms acceptable to the Company. This raises substantial doubt as to the Company’s ability to continue as a going concern.

The Company’s independent auditors’ report for the year ended December 31, 2008 included an explanatory paragraph stating that these recurring losses from operations and negative cash flows raise substantial doubt about the Company’s ability to continue as a going concern. If the Company is unable to continue as a going concern, it may elect or be required to seek protection from creditors by filing a voluntary petition in bankruptcy or may be subject to an involuntary petition in bankruptcy. In such a case, the Company may have to liquidate its assets and may receive less than the value at which those assets are carried on its financial statements, and it is likely that investors will lose all or a part of their investment.

Note 2—Summary of Significant Accounting Policies

Interim Consolidated Financial Statements

The interim consolidated financial statements for the three-month periods ended March 31, 2009 and 2008 have been prepared in accordance with Regulation S-X Rule 10-01 of the Securities Exchange Act of 1934 (the Exchange Act) as prescribed by the Securities and Exchange Commission (SEC). As such, certain disclosures which would substantially duplicate the disclosures contained in the Company’s latest audited consolidated financial statements have been omitted. This Quarterly Report on Form 10-Q for the quarter ended March 31, 2009 (the March Report) should be read in concert with the Company’s Annual Report on Form 10-K for the year ended December 31, 2008 (the 2008 Annual Report), as amended on April 30, 2009, which contains the Company’s audited consolidated financial statements for the year ended December 31, 2008.

BASIN WATER, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

(In thousands, except share and per share data)

Note 2—Summary of Significant Accounting Policies (continued)

The interim financial information for the three-month periods ended March 31, 2009 and 2008 is unaudited and has been prepared on the same basis as the audited financial statements. However, the financial statements contained in the March Report do not include all of the information and disclosures required by accounting principles generally accepted in the United States of America (US GAAP) for audited financial statements. In the opinion of management, such unaudited information includes all adjustments (consisting of normal recurring adjustments) necessary for fair presentation of the interim financial information.

Basis of Presentation and Use of Estimates

The preparation of financial statements in conformity with US GAAP requires management to make estimates and assumptions that affect certain reported amounts of assets, liabilities, revenues and expense, and related disclosures. Accordingly, actual results could differ from those estimates.

Certain reclassifications have been made to the prior year financial statement presentation to conform to the current year presentation.

Inventory

Inventory consists primarily of raw materials and supplies used in the fabrication of the Company’s ground water treatment systems, as well as the reprocessing and conditioning of resins. Inventory items are stated at the lower of cost on a first-in, first-out (FIFO) basis or market. Inventory that is no longer usable as a system component is considered obsolete. A reserve for slow-moving inventory is maintained as appropriate.

Revenue Recognition and Fluctuation

As described in the Company’s 2008 Annual Report, the Company recognizes revenues either from the sale of a system or as recurring revenues from the lease of a system. In addition, the Company also recognizes recurring revenues from long-term contracts for the treatment of the water produced from installed treatment systems or by providing other services for the processing of water and other water treatment-related services. These revenues are also referred to as service revenues.

The Company’s revenues vary from period to period, because customers may choose between purchasing groundwater treatment systems and entering into long-term contract arrangements for groundwater treatment systems. If a customer chooses to purchase a system, revenues are recognized over a much shorter period of time, generally within two or three quarters, than for the same system if the customer chooses a long-term contract arrangement. Revenues tend to be higher in periods in which sales rather than long-term lease and services contracts occur. In addition, service revenues tend to be higher in warmer, dryer weather when treated water is at a high demand. The results of operations for the first three months of 2009 are not necessarily predictive of the remaining nine months of the year. The timing and amount of revenues from system sales in a given period can be unpredictable and relatively inconsistent, and are dependent on such factors as the duration of the sales cycle (which varies from customer to customer), size and number of water treatment systems included in the sale, and whether the equipment is sold or leased .

Recently Issued Accounting Pronouncements

In May 2008, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) No. 162, The Hierarchy of Generally Accepted Accounting Principles , which identifies the sources of accounting principles and the framework for selecting the principles to be used in the preparation of financial statements of nongovernmental entities that are presented in conformity with US GAAP. SFAS No. 162 becomes effective in the third quarter of 2009 and is not expected to have a material impact on the Company’s consolidated financial statements.

Other than the above, there have been no recent accounting pronouncements issued which would impact the Company’s consolidated financial statements following the filing of the Company’s 2008 Annual Report.

Impact of Recently Adopted Accounting Pronouncements

In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements . This statement establishes a single authoritative definition of fair value, sets out a framework for establishing fair value, and requires additional disclosures about fair value measurements. This statement applies only to fair value measurements that are already required or permitted by other accounting standards and is expected to increase the consistency of those measurements. The Company was required to adopt SFAS No. 157 for its fiscal year beginning on January 1, 2008, prospectively applied, except for the provisions of SFAS No. 157 relating to nonfinancial instruments, which were required to be adopted by the Company for its fiscal year beginning January 1, 2009. The adoption of SFAS No. 157 did not have a material impact on the Company’s consolidated financial statements.

BASIN WATER, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

(In thousands, except share and per share data)

Note 2—Summary of Significant Accounting Policies (continued)

In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities—Including an amendment of FASB Statement No. 115 . This statement permits companies to choose to measure many financial instruments and other specified items at fair value. The Company was required to adopt SFAS No. 159 for its fiscal year beginning on January 1, 2008, prospectively applied. The adoption of SFAS No. 159 did not have a material impact on the Company’s consolidated financial statements.

In December 2007, the FASB issued SFAS No. 141(R), Business Combinations (SFAS 141(R)). This statement replaces SFAS 141 in its entirety and retains the fundamental requirements in SFAS 141, including that the purchase method be used for all business combinations and for an acquirer to be identified for each business combination. This standard defines the acquirer as the entity that obtains control of one or more businesses in the business combination and establishes the acquisition date as the date that the acquirer achieves control instead of the date that the consideration is transferred. SFAS 141(R) requires an acquirer in a business combination, including business combinations achieved in steps (step acquisition), to recognize the assets acquired, liabilities assumed, and any non-controlling interest in the acquiree at the acquisition date, measured at their fair values of that date, with limited exceptions. It also requires the recognition of assets acquired and liabilities assumed arising from certain contractual contingencies as of the acquisition date, measured at their acquisition-date fair values. SFAS 141(R) applies prospectively to business combinations for which the acquisition date is on or after the beginning of the first reporting period beginning on or after December 15, 2008, and could not be applied before that date. The adoption of SFAS 141(R) did not have a material impact on the Company’s consolidated financial statements.

In December 2007, the FASB issued SFAS No. 160, Noncontrolling Interests in Consolidated Financial Statements—an amendment of ARB No. 51 (SFAS 160) which establishes accounting and reporting standards for the noncontrolling interest in a subsidiary and for the deconsolidation of a subsidiary. This statement became effective for the fiscal year beginning January 1, 2009 to be applied prospectively. The adoption of SFAS 160 did not have a material impact on the Company’s consolidated financial statements.

In March 2008, the FASB issued SFAS No. 161, Disclosures about Derivative Instruments and Hedging Activities, an amendment of SFAS No. 133 , which requires enhanced disclosures for derivative and hedging activities. SFAS No. 161 became effective in the first quarter of 2009 and did not have a material impact on the Company’s consolidated financial statements.

Note 3—Acquisition of Envirogen

On September 18, 2008, the Company acquired the bioreactor and biofilter business (Envirogen) of Shaw Environmental & Infrastructure, Inc. (Shaw) through an asset purchase agreement.

The Company previously sold to Shaw water treatment systems for a total purchase price of approximately $4,800, including installation, of which the Company recognized revenues of approximately $3,000 and approximately $1,600 during the years ended December 31, 2006 and 2005, respectively. Under the terms of the sale, Shaw made a down payment of $227 and was to pay an additional $2,048 of the total amount due not later than December 31, 2007 and the remaining balance of approximately $2,300 not later than December 31, 2008.

The aggregate purchase price for Envirogen was approximately $4,100, consisting of cash consideration of approximately $2,000 (including adjustments and transaction costs) of cash and the satisfaction of approximately $4,700 of accounts receivable and accrued interest owed to the Company by Shaw (as described in the previous paragraph), less approximately $2,600 representing the fair value of the water treatment systems returned by Shaw to the Company. The fair value of the water treatment systems was determined by management through an evaluation of the current replacement cost of equivalent systems, less the expected costs to sell such systems.

BASIN WATER, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

(In thousands, except share and per share data)

Note 3—Acquisition of Envirogen (continued)

The following table presents the estimated fair values of the assets acquired and liabilities assumed at the date of acquisition:


Current assets	$	890
Property, plant and equipment		1,132
Goodwill		1,140
Intangible assets		1,524

Total assets acquired		4,686

Current liabilities		(584	)
Other liabilities		—

Total liabilities assumed		(584	)

Net assets acquired	$	4,102

The purchase price was allocated to net tangible and intangible assets acquired based on their estimated fair values, with approximately $1,100 allocated to intangible assets with a weighted-average useful life of approximately nine years and approximately $400 allocated to intangible assets with indefinite useful lives.

Acquired intangible assets consist of contract backlog in the amount of $83 (one year useful life), distribution network in the amount of $112 (six year useful life), patents in the amount of $966 (10 year useful life) and trade name in the amount of $363 (indefinite useful life). The excess of the net purchase price over the estimated fair value of assets acquired was approximately $1,100 which was recorded as tax deductible goodwill.

The results of Envirogen’s operations have been included in the consolidated financial statements since it was acquired on September 18, 2008.

Note 4—Earnings Per Share

In accordance with the provisions of SFAS No. 128, Earnings Per Share , the Company reports earnings per share (EPS) by computing both basic and diluted EPS. Basic EPS measures the Company’s performance for a reporting period by dividing net income available to common stockholders by the weighted average number of shares of common stock outstanding during the period. Diluted EPS measures the Company’s performance for a reporting period by dividing net income available to common stockholders by the weighted average number of shares of common stock plus common stock equivalents outstanding during the period. Common stock equivalents consist of all potentially dilutive common shares, such as stock options and warrants, which are convertible into shares of common stock.

The Company incurred net losses for both of the quarters ended March 31, 2009 and 2008. As a result, approximately 0 and 247,000 shares issuable upon exercise of outstanding stock options and approximately 0 and 416,000 warrants have been excluded from the computation of diluted EPS for the three months ended March 31, 2009 and 2008, respectively, due to the antidilutive effect of such common stock equivalents. Also, approximately 2,061,000 and 784,000 stock options and approximately 419,000 and 48,000 warrants have been excluded from the computation of diluted EPS for the three months ended March 31, 2009 and 2008, respectively, as the exercise prices of such options and warrants were higher than the weighted average price of the Company’s common stock during those periods.

BASIN WATER, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

(In thousands, except share and per share data)

Note 4—Earnings Per Share (continued)

The following tables contain a reconciliation of the numerators (net loss) and denominators (weighted average shares) used in both basic and diluted EPS calculations:


	Three Months Ended March 31,
	2009			2008
	(Unaudited)
Net loss per share

Numerator:
Net loss applicable to common shares	$	(6,022	)	$	(5,184	)


Denominator:
Weighted average common shares outstanding		21,920			21,737


Net loss per common share	$	(0.27	)	$	(0.24	)

Net loss per share - assuming dilution

Numerator:
Net loss applicable to common shares	$	(6,022	)	$	(5,184	)


Denominator:
Weighted average common shares outstanding		21,920			21,737

Net loss per common share - diluted	$	(0.27	)	$	(0.24	)

Note 5—Stock-Based Incentive Compensation Plans

2006 Equity Incentive Award Plan

In May 2006, the Company adopted the Basin Water 2006 Equity Incentive Award Plan, or 2006 Equity Plan. The 2006 Equity Plan became effective immediately prior to the completion of the initial public offering in May 2006. Under the 2006 Equity Plan, 2,500,000 shares of the Company’s common stock were initially reserved for issuance. In addition, the 2006 Plan contains an evergreen provision that allows for an annual increase in the number of shares available for issuance under the plan on January 1 of each year during the ten-year term of the 2006 Plan, beginning on January 1, 2007. Under this evergreen provision, the annual increase in the number of shares shall be equal to the least of:

•

5.0% of the Company’s outstanding common stock on the first day of the relevant fiscal year;

•

1,000,000 shares; and

•

an amount determined by the Company’s board of directors.

In no event shall the number of shares of the Company’s common stock that may be issued or transferred pursuant to awards under the 2006 Plan exceed an aggregate of 12,500,000 shares. The number of total shares of common stock that may be issued under the 2006 Plan automatically increased to 5,495,383 and 4,495,383 shares as of January 1, 2009 and 2008, respectively.

Options under the plan are issued with an exercise price equal to the closing price of the Company’s stock on the date of the grant. Option grants generally vest over three years, with one-third of the shares subject to the option vesting on each of the first, second and third anniversaries of the grant date and expire 10 years from the date of grant. Options granted to directors generally vest on the first anniversary of the grant date.

Cheap Stock Amortization

Prior to becoming a publicly traded company in May 2006, the Company granted stock options with exercise prices equal to the estimated fair value of its common stock. However, to the extent that the deemed fair value of the common stock exceeded the exercise price of stock options on the grant date the Company recorded deferred stock-based compensation expense and amortizes the expense over the vesting period of the options. The fair value of the Company’s common stock was determined by the Board. In the

BASIN WATER, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

(In thousands, except share and per share data)

Note 5—Stock-Based Incentive Compensation Plans (continued)

absence of a public trading market for the Company’s common stock, the Board considered both objective and subjective factors in determining the fair value of the Company’s common stock and related stock options, consistent with the guidance provided by the American Institute of Certified Public Accountants in its Technical Practice Aid (TPA) entitled The Valuation of Privately Held Company Equity Securities Issued as Compensation .

In connection with the Company’s initial public offering, the Company re-evaluated the historical fair value of its common stock. As a result of this re-evaluation, the Company recorded deferred stock-based compensation which represents the difference between the exercise price of stock options granted in the first quarter of 2006 and in the fourth quarter of 2005 and the revised fair value of the common stock underlying such options on the date of grant.

Pursuant to FASB Interpretation (FIN) No. 28, the Company has amortized these deferred compensation amounts using both the graded attribution method and the straight-line attribution method over the vesting period of the options, which is generally three years. As a result of the amortization of these deferred compensation amounts, the Company recorded $0 and $39 of non-cash stock-based compensation expense for the three-month periods ended March 31, 2009 and 2008, respectively, all of which was included in selling, general and administrative expense.

Method of Accounting for Stock-Based Compensation

The Company accounts for stock-based compensation in accordance with the provisions set forth in SFAS No. 123(R), Share-Based Payment (SFAS 123(R)). Under the provisions of SFAS 123(R), stock-based compensation cost is measured at the date of grant, based on the calculated fair value of the stock-based award, and is recognized as expense over the employee’s requisite service period (generally the vesting period of the award).

The Company estimates the fair value of stock options granted using the Black-Scholes method. Key assumptions used to estimate the fair value of stock options include the exercise price of the award, the fair value of the Company’s common stock on the date of grant, the expected option term, the risk free interest rate at the date of grant, the expected volatility of the Company’s common stock over the expected option term, and the expected annual dividend yield on the Company’s common stock.

No options were granted during the three-month periods ended March 31, 2009 and 2008.

The expected option term in years is calculated using an average of the vesting period and the option term, in accordance with the “simplified method” for “plain vanilla” stock options allowed under Staff Accounting Bulletin (SAB) 110.

The risk free interest rate is the rate on a zero-coupon U.S. Treasury bond with a remaining term equal to the expected option term. The expected volatility is derived from an industry-based index, in accordance with the calculated value method allowed under SFAS 123(R).

SFAS 123(R) requires entities to estimate the number of forfeitures expected to occur and record expense based upon the number of awards expected to vest.

BASIN WATER, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

(In thousands, except share and per share data)

Note 5—Stock-Based Incentive Compensation Plans (continued)

Stock Option Activity

A summary of stock option activity for the three months ended March 31, 2009 is as follows:


(In thousands, except exercise prices)	Number of Shares		Weighted Average Exercise Price
Options outstanding at December 31, 2008	2,167		$	5.66
Granted	—			—
Exercised	—			—
Forfeited	(16	)		5.19

Options outstanding at March 31, 2009	2,151		$	5.66

The following table summarizes information about stock options outstanding and exercisable as of March 31, 2009:


(In thousands, except exercise prices and years)	Outstanding		Exercisable
Number of shares		2,151		1,121
Weighted average remaining contractual life in years		7.1		5.8
Weighted average exercise price per share	$	5.66	$	4.67
Aggregate intrinsic value (at March 31, 2009 closing price of $0.88 per share)	$	5	$	5

The aggregate intrinsic value in the preceding table represents the total pretax intrinsic value (the difference between the Company’s closing stock price as of March 31, 2009 and the weighted average exercise price multiplied by the number of shares) that would have been received by the option holders had all option holders exercised their options on March 31, 2009. This intrinsic value will vary as the Company’s stock price fluctuates.

Compensation expense arising from stock option grants was $218 and $306 for the three months ended March 31, 2009 and 2008, respectively, all of which expense was included in selling, general and administrative expense for each period. No related income tax benefit was recorded as the Company has significant net operating loss carryforwards.

As of March 31, 2009, approximately $1,000 of unrecognized compensation expense related to stock options is expected to be recognized over a weighted average period of 1.0 years. The total fair value of options vested during the three months ended March 31, 2009 and 2008 was $55 and $74, respectively.

Stock options outstanding and exercisable at March 31, 2009, and the related exercise price and remaining contractual life are as follows:


	Options Outstanding				Options Exercisable
Exercise Price	Number of Options Outstanding	Weighted Average Exercise Price		Weighted Average Remaining Contractual Life of Options Outstanding	Number of Options Exercisable	Weighted Average Exercise Price
$0.83 - $1.33	217	$	1.03	2.4 yrs	217	$	1.03
$4.00 - $4.29	450	$	4.04	6.5 yrs	303	$	4.00
$5.00	665	$	5.00	7.8 yrs	340	$	5.00
$6.79 - $9.00	714	$	7.88	8.0 yrs	227	$	7.56
$9.87 - $12.29	105	$	11.33	8.4 yrs	34	$	11.34

	2,151	$	5.66		1,121	$	4.67

BASIN WATER, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

(In thousands, except share and per share data)

Note 5—Stock-Based Incentive Compensation Plans (continued)

The total intrinsic value of stock options exercised during the three months ended March 31, 2009 and 2008 was $0 and $38, respectively.

Non-vested Stock

Under the 2006 Equity Plan, the Company has granted non-vested common stock to management, officers and directors, which is subject only to a service condition. In general, such non-vested stock vests over three years for management and one year for directors. The total cumulative number of shares of non-vested stock granted under the 2006 Equity Plan through March 31, 2009 is 528,035, of which 232,856 shares had vested as of March 31, 2009.

The fair value of non-vested stock is measured at the date of grant based upon the closing price of the Company’s common stock on that date, and such fair value is recognized as stock-based compensation expense over the requisite vesting period. Compensation expense arising from grants of non-vested stock during the three months ended March 31, 2009 and 2008 was $334 and $301, respectively, all of which expense was included in selling, general and administrative expense for each year. As of March 31, 2009, approximately $900 of unrecognized compensation expense related to non-vested stock grants is expected to be recognized over a weighted average period of 0.6 years.

Note 6—Customer Contract Terminations

During the first quarter of 2009, five of the Company’s existing customer contracts were cancelled either pursuant to their contract terms or by mutual consent and the leased water treatment systems were returned to the Company. As a result of these contract terminations, the Company expensed certain previously capitalized costs in the amount of approximately $700 associated with these systems consisting primarily of spent resin and deployment costs. In addition, the Company accrued approximately $200 of decommissioning and resin disposal expenses in connection with the return of these systems. The total charge to income related to the termination of these contracts was approximately $900 in the first quarter of 2009 before approximately $400 in contract loss reserve reversals associated with the terminated contracts.

Note 7—Goodwill and Intangible Assets

Goodwill

Goodwill represents the excess of the cost of an acquired entity over the net fair value of identifiable assets acquired and liabilities assumed. The carrying amount of goodwill as of March 31, 2009 and December 31, 2008 was $2,490.

Intangible Assets

Net intangible assets are as shown in the following table as of the dates indicated:


	March 31, 2009			December 31, 2008
Service agreements and contracts	$	1,438		$	1,438
Customer relationships		681			681
Covenant not to compete		322			322
Trade name		543			543
Accumulated amortization		(742	)		(602	)

Intangible assets, net	$	2,242		$	2,382

The amortization periods of intangible assets are as follows: customer relationships—15 years; covenant not to compete—three years; trade name—two years; and service agreements and contracts—six years.

Patent Costs

The Company capitalizes costs of patent applications. When patents are issued, the Company amortizes the patent cost over the life of the patent, usually 17 years. If a patent is denied, capitalized patent costs are written off in the period in which the patent application is denied.

BASIN WATER, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

(In thousands, except share and per share data)

Note 8—Investment in Empire Water Corporation (Empire)

In April and May 2007, the Company entered into a letter of intent and then an agreement to acquire certain water rights and related assets from various parties at a total cost of $1,500, of which a deposit of $100 was made by the Company at the time of execution of the letter of intent. In December 2007, the Company sold to Empire its rights to purchase certain collective assets from unrelated parties including (a) a canal located in San Bernardino and Riverside counties in Southern California that is approximately eighteen miles in length, (b) rights to pump water from the San Bernardino Basin, and (c) other equipment and tangible and intangible personal property of the sellers. As consideration for the sale of the rights to purchase these assets, the Company received 6,000,000 shares of Empire common stock, which represented an ownership interest of approximately 32% in Empire as of December 31, 2007 and 2008. In connection with the settlement of a lawsuit in February 2009, the Company transferred 150,000 shares of Empire common stock to Opus Trust, Inc. (see Note 11). After this transfer, the Company owned 5,850,000 shares of Empire common stock, which represents an ownership interest of approximately 31% in Empire as of March 31, 2009.

The Company recorded the December 2007 transaction under the equity method; therefore, under EITF 01-2 the Company recorded a partial gain of approximately $3,100 on the transaction. The Company determined the gain by (a) estimating the fair value of such stock based upon concurrent sales of Empire common stock to third parties, less a discount for risk and illiquidity and including a reimbursement of certain due diligence costs pursuant to the terms of the agreement with Empire, which amounted to an estimated fair value of approximately $4,904; (b) subtracting the Company’s basis in the assets sold, amounting to approximately $354, and (c) reducing the resulting gain of $4,550 by the Company’s 32% ownership interest in Empire, for a reduction of $1,456 .

During the quarter ended September 30, 2008, the Company assessed its investment in Empire. Based upon current market conditions, Empire’s financial condition, and the Company’s understanding of Empire’s business prospects, the Company determined that the carrying value of its investment in Empire should be reduced by approximately $1,900 at September 30, 2008. As part of this assessment, the Company determined that a portion of the impairment was attributable to the deferred revenue recorded at the date that the Company sold assets to Empire, as the Company has evaluated the underlying assets associated with the deferred revenue and concluded that such assets are impaired to the extent of the Company’s 32% ownership interest in Empire. Accordingly, the Company reduced deferred revenue-affiliate by $659 at September 30, 2008.

In March 2009, Empire announced that it would no longer operate as a public company and it subsequently deregistered its common stock with the Securities and Exchange Commission. Following its announcement, the quoted market price for Empire’s common stock declined precipitously. These developments, along with Empire’s continued uncertain status as a development stage company, and inability to obtain additional funding to sustain its operations, raise substantial doubt about its ability to continue as a going concern. Accordingly, the Company determined that its investment in Empire was substantially impaired as of March 31, 2009 and wrote down its remaining investment by approximately $1,700. After reducing deferred revenue-affiliate by approximately $800, this resulted in a charge to other expense of approximately $900 in the quarter ended March 31, 2009.

Note 9—Notes Payable

The following table summarizes notes payable as of March 31, 2009 and December 31, 2008:


	March 31, 2009			December 31, 2008
Note payable to a financing company, non-interest bearing, imputed interest rate of 68.9% per annum, payable in 80 monthly installments beginning on August 1, 2008 and ending on March 1, 2014	$	155		$	155
Contract payable to a financing company in nine monthly installments including interest at 4.6% per annum		155			362

Total notes payable		310			517
Less: current portion of notes payable		(202	)		(408	)

Notes payable, net of current portion	$	108		$	109

Notes Payable to Finance Companies

In June 2007, the Company sold 10 of its water treatment systems to a special purpose entity, VL Capital (VLC). The total sales price was $3,853, consisting of $500 in cash to be paid to the Company plus notes issued by VLC to the Company payable in 72 monthly installments of $56 beginning April 2008, with a net present value of $3,353, calculated using an imputed interest rate of 5.0% per annum. VLC, in turn, received a loan of $500 from a finance company to fund the cash payment to the Company. This non-interest bearing loan is due in nine monthly installments of $63 plus 71 monthly installments of $7 beginning August 2008.

The Company has determined that, in accordance with the provisions of FIN 46(R), Consolidation of Variable Interest Entities (revised December 2003)—an interpretation of ARB No. 51 , the financial statements of VLC should be included in the consolidated financial statements of the Company. Accordingly, both the sale of equipment to VLC and the note receivable from VLC have been eliminated in consolidation, and the Company has included in its consolidated financial statements the note payable by VLC to the finance company. As of March 31, 2009, there was $155 outstanding under this note payable.

BASIN WATER, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

(In thousands, except share and per share data)

Note 9—Notes Payable (continued)

The Company also has a contract payable to a financing company for a portion of its insurance premiums, payable in nine monthly installments of $51 beginning in November 2008 and ending in July 2009.

Note 10—Contract Loss Reserve

The reserve for contract losses included in the consolidated balance sheet, both short- and long-term, as of March 31, 2009 and 2008 were approximately $7,300 and $8,700, respectively. The changes in the reserve for contract losses are as follows:


	Three Months Ended March 31,
	2009			2008
Beginning balance	$	7,970		$	9,112
Additions to contract loss reserve		—			—
Reductions in contract loss reserves due to contract terminations		(448	)		—
Actual contract losses charged against reserve		(194	)		(367	)

Ending balance		7,328			8,745
Less: current portion		(1,640	)		(2,153	)

Long-term portion	$	5,688		$	6,592

Included in the total contract loss reserve at March 31, 2009 is approximately $1,200 related to service contracts for water treatment systems which have not yet become operational but are anticipated to go online in the future.

The Company is in ongoing discussions with several customers in an effort to reduce the current and expected operating losses associated with certain water services agreements. While the ultimate outcome of such discussions cannot be predicted with certainty, it is reasonably possible that such negotiations may result in amendments to existing contracts or new contracts which will result in reduced future operating losses and a reduction in the amount of the required reserve for contract losses. However, at this time, such contract amendments or new contracts have not yet been finalized.

BASIN WATER, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

(In thousands, except share and per share data)

Note 11—Litigation

On December 27, 2007 and January 2, 2008, two purported securities class action complaints were filed in the United States District Court for the Central District of California against the Company, Peter L. Jensen, Michael M. Stark and Thomas C. Tekulve (collectively referred to as the Basin defendants) for violations of the Exchange Act. These lawsuits, which contain similar allegations, are captioned Poulos v. Basin Water, et al ., Case No. CV 07-8359 GW (FFMx) and Nofer v. Basin Water, et al ., Case No. CV 08-0002 SGL (JCRx). The lawsuits were subsequently consolidated, and on October 3, 2008 a Consolidated Amended Complaint (CAC) was filed which alleges that the Company deliberately understated the reserves it took for certain unprofitable contracts, and committed various intentional violations of GAAP during a putative class period between November 14, 2006 and August 8, 2008 (the Federal Lawsuit). The suit did not state a specific amount of damages. On February 19, 2009, the Company and its insurance carriers reached an agreement in principle to settle the class action with representatives of the class. The settlement is still subject to preparation of a final settlement agreement, following which the Company would intend to seek preliminary approval from the Court so that class members can receive notice of the settlement, providing them with the opportunity to accept its terms or to opt out and choose whether to pursue their own individual claims. Following a fair period of notice to the class, it would be the Company’s intention to seek final Court approval of the settlement and the dismissal of all claims against us. The Company denies all of the allegations in the lawsuit and believes that its disclosures were appropriate under the law. Nevertheless, management has agreed to settle the litigation in order to avoid costly and time-consuming litigation. Management does not expect a cash effect of the settlement on the Company as the entire settlement amount is expected to be paid by the Company’s liability insurers.

On January 31, 2008, Loren Charif, a purported stockholder of the Company, filed a shareholder derivative lawsuit in the Superior Court of the State of California, County of San Bernardino, against certain of the Company’s executive officers and its current directors. The complaint assumes the truth of the aforementioned allegations in the federal securities class action lawsuits and in connection with those allegations alleges, among other things, breaches of fiduciary duties, waste of corporate assets, unjust enrichment and violations of California Corporations Code pertaining to allegations of improper selling. The suit does not state a specific amount of damages. On November 12, 2008, the Company obtained an order staying this action until a final determination occurs in the Federal Lawsuit.

On March 10, 2009, Demetrice Ledbetter, III, a purported shareholder of the Company, filed a shareholder derivative lawsuit in the United States District Court for the Central District of California against certain current and former executive officers and directors of the Company. The complaint assumes the truth of the federal securities class action lawsuits described in the Company’s Annual Report on Form 10-K/A for the year ended December 31, 2007 and in connection with those allegations alleges, among other things, breaches of fiduciary duty, waste of corporate assets, abuse of control, gross mismanagement, unjust enrichment, and claims for contribution and indemnification. The suit does not state a specific amount of damages.

In May 2009, the Company learned that the Division of Enforcement of the Securities and Exchange Commission has opened a formal investigation in relation to the events and allegations set forth in the class actions and derivative actions noted above.

On February 5, 2009, the Company, BionBasin, Inc. (Bion), Opus Trust, Inc. (Opus Trust) and Martin Benowitz, individually and as Trustee of the Martin A. Benowitz Qualified Profit Sharing Plan (Benowitz), entered into a Settlement Agreement and Mutual Release Agreement (the Settlement Agreement) to settle, among other things, certain claims related to (a) ion exchange units previously sold to Opus Trust by Bion, including a unit that was damaged by an uninsured motorist, (b) Benowitz’ acquisition and sale of the Company’s common stock and (c) Opus Trust’s acquisition of Bion common stock (collectively, the Dispute). Pursuant to the terms of the Settlement Agreement, (a) the Company paid $125 to Opus Trust and transferred to Opus Trust 150,000 shares of Empire Water Corporation common stock (all of which was expensed in the year ended December 31, 2008), (b) Opus Trust transferred to the Company all shares of Bion common stock (500,000 shares) held by Opus Trust and title to the ion exchange units previously sold to Opus Trust, (c) Opus Trust and Benowitz released the Company and Bion from any and all claims and actions arising from the Dispute, (d) the Company and Bion released Opus Trust and Benowitz from any and all claims and actions arising from the Dispute and (e) the parties agreed not to make negative references to the character or business reputation of the parties to the Settlement Agreement.

FORWARD-LOOKING STATEMENTS

This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act (the Exchange Act) of 1934, as amended, which are subject to the “Safe Harbor” created by those sections. Any such forward-looking statements would be contained principally in “Risk Factors” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations.” Forward-looking statements include information concerning our possible or assumed future results of operations, business strategies, financing plans, competitive position, industry environment, potential growth opportunities and the effects of regulation. Forward-looking statements include all statements that are not historical facts and can be identified by terms such as “anticipates,” “believes,” “could,” “estimates,” “expects,” “intends,” “may,” “plans,” “potential,” “predicts,” “projects,” “should,” “will,” “would” or similar expressions.

Forward-looking statements involve known and unknown risks, uncertainties and other factors which may cause our actual results, performance or achievements to be materially different from any future results, performance or achievements expressed or implied by the forward-looking statements. We discuss many of these risks in greater detail in Part I, Item 1A of our Annual Report on Form 10-K for the year ended December 31, 2008 and our other filings with the SEC. Given these uncertainties, you should not place undue reliance on these forward-looking statements. Also, forward-looking statements represent our management’s beliefs and assumptions only as of the date of this Quarterly Report on Form 10-Q. You should read this Quarterly Report on Form 10-Q along with our Annual Report on Form 10-K for the year ended December 31, 2008 completely and with the understanding that our actual future results may be materially different from what we expect.

We assume no obligation to update these forward-looking statements publicly, or to update the reasons actual results could differ materially from those anticipated in these forward-looking statements, even if new information becomes available in the future.

The following discussion and analysis should be read in conjunction with the unaudited financial statements and notes thereto included in Part I, Item 1 of this Quarterly Report on Form 10-Q.

Item 2.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Overview

Basin Water, Inc. and its subsidiaries (the Company) design, build and implement systems for the treatment of contaminated groundwater, municipal and industrial wastewater, industrial process water and air streams from municipal and industrial sources. Customers can choose between purchasing the Company’s systems and entering into long-term contracting arrangements for the Company’s systems. The Company also offers long-term contracts for the treatment of water produced from installed treatment systems as well as other water treatment-related services.

In 2007 and 2008, we derived most of our revenues from designing, assembling and servicing our proprietary ion-exchange systems for the treatment of contaminated groundwater for use as drinking water. Also, in 2007 and 2008, we launched major initiatives, both external and internal, to facilitate our transformation into a water services company focused on development of our technology+services business model. Using this model, we seek opportunities to combine proprietary or specialized technologies with long-term relationships built through performance-based service agreements to meet groundwater treatment, industrial water and wastewater treatment and resource recovery needs. By expanding the array of technologies we offer through our technology+services model beyond our proprietary ion-exchange technology, we believe we can expand the potential pool of customers, markets and geographic areas for our services.

While we commenced a number of new initiatives in 2007 and 2008, we continue to derive a significant part of our revenues from selling and servicing our proprietary, ion-exchange, onsite regenerable treatment system. That system reduces groundwater contaminant levels in what we believe is an efficient, flexible and cost-effective manner. Our system produces what we believe are very low waste rates, can meet a wide range of volume requirements and is capable of removing multiple chemical contaminants at a single site. These systems regenerate the resin by using a salt brine solution to remove the contaminants from the resin so that it can be used again in the ion-exchange process. We market these systems to utilities, cities, municipalities, special districts, real estate developers, investor-owned utilities and other organizations for use in treating groundwater that does not comply with federal or state drinking water regulations due to the presence of chemical contaminants.

We are taking steps to become a next generation water services company that succeeds by combining the strengths of our existing businesses and employees with the offering of cutting edge technology and site-tailored solutions. Subject to the availability of capital resources, we plan to employ this model across a broad range of treatment scenarios in municipal and industrial water markets.

We make available free of charge through our internet website our press releases, our Annual Report on Form 10-K, Quarterly Reports on Form 10-Q (including this Quarterly Report on Form 10-Q), Current Reports on Form 8-K and all other required filings with the Securities and Exchange Commission (SEC) and amendments thereto as soon as reasonably practical after they are electronically filed with, or furnished to, the SEC. Our principal executive offices are located at 9302 Pittsburgh Avenue, Suite 210, Rancho Cucamonga, California 91730, and our telephone number is (888) 481-6811. Our website address is www.basinwater.com . The information on our website is neither part of nor incorporated by reference into this Quarterly Report on Form 10-Q.

Results of Operations

The following table sets forth key components of our results of operations for the periods indicated, both in thousands of dollars and as a percentage of revenues:


	Three Months Ended March 31,
	2009			% of Revenues		2008			% of Revenues
	(dollars in thousands)
Revenues
System sales	$	1,422		40	%	$	1,064		37	%
Contract revenues		2,130		60	%		1,785		63	%

Total revenues		3,552		100	%		2,849		100	%

Cost of revenues
Cost of system sales		1,072		30	%		833		29	%
Cost of contract revenues		1,879		53	%		1,487		52	%
Depreciation expense		260		7	%		199		7	%

Total cost of revenues		3,211		90	%		2,519		88	%

Gross profit		341		10	%		330		12	%
Research and development expense		43		1	%		74		3	%
Selling, general and administrative expense		5,385		152	%		5,645		198	%

Loss from operations		(5,087	)	-144	%		(5,389	)	-189	%
Other income (expense)		(889	)	-25	%		279		10	%

Loss before taxes		(5,976	)	-169	%		(5,110	)	-179	%
Income tax benefit		—					—

Loss before noncontrolling interest		(5,976	)	-169	%		(5,110	)	-179	%
Less: net income attributable to noncontrolling interest		(46	)	-1	%		(74	)	-3	%

Net loss	$	(6,022	)	-170	%	$	(5,184	)	-182	%

Three Months Ended March 31, 2009 and 2008

The following table summarizes the significant components of revenues, cost of revenues and gross profit or loss for the three months ended March 31, 2009 compared to the same period in the prior year:


	2009			2008			Increase (Decrease)
	(In thousands)
Revenues:
System sales		1,422			1,064			358
Contract operations		2,130			1,785			345

Total Revenues		3,552			2,849			703

Cost of Revenues:
System sales		1,072			833			239
Contract operations		1,650			1,854			(204	)
Net change in contract loss reserve		(642	)		(367	)		(275	)
Contract termination costs		871			—			871
Depreciation expense		260			199			61

Total Cost of Revenues		3,211			2,519			692

Gross Profit:
System sales		350			231			119
Contract operations		(651	)		(268	)		(383	)
Reserve for future contract operations		642			367			275

Total Gross Profit	$	341		$	330		$	11

Revenues

Revenues increased by $0.7 million, or 24%, to $3.6 million in the first quarter of 2009 from $2.9 million during the first quarter of 2008. Revenues from system sales increased by $0.4 million, or 36%, to $1.4 million in the first quarter of 2009 from $1.1 million in the first quarter of 2008. In September 2008, we acquired Envirogen, which contributed $1.0 million of system sales during the first quarter of 2009. At the same time, our system sales revenue other than from Envirogen decreased by $0.7 million, or 64%, to $0.4 million in the first three months of 2009 compared to $1.1 million in the same period in 2008. Contract operations revenues increased from $1.8 million during the first quarter of 2008 to $2.1 million during the same period of 2009, an increase of $0.3 million, or 17%. The acquisition of Envirogen had no impact on contract revenues in the first quarter of 2009.

Cost of Revenues

Cost of revenues increased by $0.7 million, or 28%, to $3.2 million during the first quarter of 2009 compared to $2.5 million during the same period in 2008. Cost of system sales increased to $1.1 million in the first quarter of 2009 compared to $0.8 million in the first quarter of 2008. The September 2008 acquisition of Envirogen resulted in approximately $0.5 million in cost of revenues in the first quarter of 2009, compared to the $1.0 million of revenue contributed by Envirogen in the same period. Gross profit on Envirogen system sales during the quarter ended March 31, 2009 was favorably impacted by the close out of two projects at higher than expected gross margins.

In addition, the increase in cost of revenues was due to approximately $0.9 million of contract termination costs which were incurred in the first quarter of 2009. During the first quarter of 2009, five of our existing customer contracts were cancelled either pursuant to their contract terms or by mutual consent and the leased water treatment systems returned to us. As a result of these contract terminations, we expensed certain previously capitalized costs of approximately $0.7 million associated with these systems consisting primarily of spent resin and deployment costs. In addition, we accrued approximately $0.2 million of decommissioning and resin disposal expenses in connection with the return of these systems. The total charge to income related to the termination of these contracts was approximately $0.9 million in the first quarter of 2009 before approximately $0.4 million in contract loss reserve reversals associated with the terminated contracts.

The aforementioned increase in the cost of system sales was accompanied by a decrease of $0.2 million in the cost of contract revenues from $1.9 million in the first quarter of 2008 to $1.7 million in the first quarter of 2009. Operating costs include salt, waste disposal and field service labor and related expenses. In the first quarter of 2009, we had decreases in labor, waste disposal and supply expenses. The decrease in labor is reflective of our reduced workforce in the first quarter of 2009 when compared to the same period in 2008. In addition, we implemented measures to improve our efficiency in field service, resulting in the decreased waste and supply expenses. Operating costs for the first quarter of 2009 and 2008 were partially offset by $0.2 million and $0.4 million, respectively, of charges against the related reserves for operating losses. The acquisition of Envirogen had no impact on cost of contract revenues in the first quarter of 2009.

Gross Profit

We recorded gross profit of $0.3 million during each of the first quarters of 2009 and 2008, respectively. In 2009, gross profit was negatively impacted by the aforementioned net contract termination costs of approximately $0.5 million recorded in the first quarter of 2009. These contract termination costs were offset in part by higher gross profit on system sales in the first quarter of 2009, primarily attributable to Envirogen.

Research and Development Expense

Research and development expense was less than $0.1 million in each of the three-month periods ended March 31, 2009 and 2008.

Selling, General and Administrative Expense

The following table summarizes the significant components of selling, general and administrative (SG&A) expense for the three months ended March 31, 2009 compared to the same period in the prior year.


	2009		2008		Increase (Decrease)
	(In thousands)
Compensation and benefits	$	2,108	$	2,003	$	105
Severance, consulting and stock-based compensation - former Chairman and CEO		—		983		(983	)
Professional fees		611		832		(221	)
Restatement expenses		486		—		486
Travel and entertainment		264		310		(46	)
Stock-based compensation expense		218		261		(43	)
Restricted stock expense		334		250		84
Amortization - intangibles		179		143		36
Depreciation		118		67		51
Directors’ fees and public company costs		365		162		203
Bad debt expense		100		153		(53	)
Outside selling, marketing & promotion		86		83		3
Insurance		127		80		47
Communications		46		43		3
Facility expense		251		190		61
Other SG&A expense		92		85		7

Total SG&A Expense	$	5,385	$	5,645	$	(260	)

SG&A expense decreased by $0.3 million, or 5%, to $5.4 million during the first quarter of 2009 from $5.7 million during the same period of 2008. The decrease was due in part to approximately $1.0 million in severance and other compensation expenses related to our former Chairman and CEO during the first quarter of 2008. No significant severance payments were made in the first quarter of 2009. Our professional fees were approximately $0.2 million less in the first quarter of 2009 when compared to the same period in 2008, as legal fees were reduced as settlements and insurance deductible levels were reached in the last half of 2008 and early 2009 for certain outstanding litigation matters. These reductions in SG&A expense were partially offset by approximately $0.5 million of expenses incurred in connection with the restatement of our 2007 and 2006 financial statements. In addition, Envirogen accounted for approximately $0.7 million of our SG&A expense in the first quarter of 2009, consisting primarily of compensation and benefits, offsetting otherwise lower staffing costs due to a reduced headcount.

Other Income (Expense)

The following table summarizes the significant components of other income and expense for the quarter ended March 31, 2009 compared to the same period in the prior year.


	2009			2008			Expense (Increase) Decrease
	(In thousands)
Interest income	$	28		$	358		$	(330	)
Interest expense - notes & loans		(7	)		(41	)		34
Equity in loss of affiliate		—			(40	)		40
Impairment charge - investment in affiliate		(910	)		—			(910	)
Other		—			2			(2	)

Total Other Income (Expense)	$	(889	)	$	279		$	(1,168	)

Other expense was approximately $0.9 million during the quarter ended March 31, 2009 compared to other income of approximately $0.3 million in the first quarter of 2008. The principal factor affecting other expense in the 2009 quarter is the charge to earnings of approximately $0.9 million to write off the carrying value of our investment in Empire, of which we hold an approximate 31% interest. As discussed in Note 8 to the unaudited condensed consolidated financial statements, we determined that the carrying value of our investment in Empire should be reduced by approximately $1.7 million, offset by a reduction of approximately $0.8 million in deferred revenue – affiliate.

We earn interest income on our invested cash balances. Interest income decreased due to both lower cash balances as we used cash for our operations and lower interest rates on money market funds during the first quarter of 2009 compared to the same period in 2008.

Liquidity and Capital Resources

At March 31, 2009 we had approximately $8.8 million in cash and cash equivalents, including $0.4 million resulting from the consolidation of VL Capital, which funds of VL Capital are not available to us to support our liquidity needs. We have invested substantially all of our available cash balances in money market funds placed with reputable institutions for which credit loss is not anticipated. The following table summarizes our primary sources and uses of cash in the periods presented.


	Three Months Ended March 31,
	2009			2008
	(in thousands)
Net cash used in:
Operating activities	$	(2,281	)	$	(7,460	)
Investing activities		(632	)		(597	)
Financing activities		(209	)		(89	)

Net decrease in cash and cash equivalents	$	(3,122	)	$	(8,146	)

Operating Activities

Net cash used in operating activities was approximately $2.3 million for the first three months of 2009 compared to net cash used of $7.5 million for the comparable period in 2008. We recorded a net loss of $6.0 million in the first quarter of 2009 which was offset by a $1.9 million decrease in receivables, a $0.4 million increase in deferred revenues, a $0.9 million write down of our investment in Empire and the $0.7 million expense of previously capitalized costs associated with the termination of certain contracts.

In 2008, in addition to our net loss of $5.2 million, cash used in operating activities was primarily due to an increase in other assets and liabilities of $1.4 million including approximately $0.9 million of bid deposits, a net decrease in accounts payable of $0.7 million, a $0.4 million increase in inventory, and a $0.4 million decrease in contract loss reserve.

Investing Activities

Net cash used in investing activities was $0.6 million in the first three months of 2009 which was consistent with the first three months of 2008.

Financing Activities

Net cash used in financing activities was approximately $0.2 million for the first three months of 2009 compared to net cash used in financing activities of approximately $0.1 million in the same period of 2008.

Liquidity and Capital Resources

Our future capital requirements will depend on many factors, including our level of revenues, the expansion and success of our sales and marketing activities, the success of our strategic relationships in the marketing of our treatment systems, our ability to sell existing systems or place them under long-term contracts and provide service under our long-term contracts and the continued market acceptance of our systems and services.

At March 31, 2009 we had approximately $8.4 million and as of May 15, 2009 we had approximately $7.3 million in cash and cash equivalents (excluding cash balances resulting from the consolidation of VL Capital which are not available to us to support our liquidity needs). We have invested substantially all of our available cash funds in money market funds placed with reputable institutions for which credit loss is not anticipated.

We have experienced significant negative cash flows from operating and investing activities since 2006, including during the first quarter of 2009, and we expect to consume additional cash for such activities for the foreseeable future. We had a net loss of approximately $6.0 million for the three months ended March 31, 2009 and incurred net losses during the past two fiscal years ended December 31, 2008 and 2007 of approximately $32.5 million and $18.3 million, respectively. Unless and until we are able to generate sufficient revenues from our system sales and contract services, we expect such losses to continue in the future. Therefore our ability to continue to operate our business over the next 12 months is highly dependent on the amount of cash and cash equivalents on hand combined with our ability to raise capital to support our future operations.

Additional capital, whether obtained through financial markets (in the form of public or private debt or equity) or collaborative or other arrangements with water providers, corporate partners or from other sources, may not be available at all, when needed, or on terms acceptable to us. If additional funds are raised through the issuance of additional common stock, other equity securities or indebtedness, the percentage ownership of our then-current stockholders may be diluted substantially and the equity or debt securities issued to new investors may have rights, preferences or privileges senior to those of the holders of our then-existing capital stock.

The U.S. credit markets have recently experienced significant dislocations and liquidity disruptions which have caused spreads on prospective debt financings to widen considerably. These circumstances have materially impacted liquidity in the debt markets, making financing terms for borrowers less attractive, and in certain cases have resulted in the unavailability of certain types of debt financing. These events in the credit markets as well as deteriorating market conditions have also had an adverse effect on other financial markets in the United States, including the equity markets, which we expect will make it very difficult and costly for us to raise capital through the issuance of debt, common stock or other equity securities. To date, our efforts to secure additional capital from debt or equity financing have been unsuccessful. If adequate funds are not available or are not available on acceptable terms, we may not be able to continue operations, resulting in significant harm to our financial condition and prospects and a decline in our stock price. This raises substantial doubt as to our ability to continue as a going concern.

Our independent auditors’ report for the year ended December 31, 2008 includes an explanatory paragraph stating that our recurring losses from operations and negative cash flows raise substantial doubt about our ability to continue as a going concern. If we are unable to obtain additional financing on commercially reasonable terms, our business, financial condition and results of operations will be materially and adversely affected and we may be unable to continue as a going concern. The question about our ability to continue as a going concern may also limit our ability to obtain financing on acceptable terms or at all, and may limit our ability to obtain new business due to potential customers’ concern about our ability to provide water treatment and other services. If we are unable to continue as a going concern, we may elect or be required to seek protection from creditors by filing a voluntary petition in bankruptcy or may be subject to an involuntary petition in bankruptcy. In such a case, we may have to liquidate our assets and may receive less than the value at which those assets are carried on our financial statements, and it is likely that investors will lose all or a part of their investment.

As previously announced, our Board of Directors has engaged Canaccord Adams to conduct a review of the Company’s strategic alternatives. These alternatives include the sale of some or all of our assets or stock, a merger or other business combination involving the Company, third party investment and other strategic alternatives. The Company and Canaccord Adams have engaged in confidential discussions with a number of potential counterparties regarding a strategic transaction, most of which have involved a sale of substantially all of our assets under Section 363 of the Bankruptcy Code intended to result in continuation of the Company’s current business. However, there can be no assurance that these efforts will result in any specific transaction or that any transaction that is consummated will be favorable to our stockholders.

Outstanding Indebtedness

At March 31, 2009, we had no outstanding indebtedness except for approximately $0.2 million of notes payable to a finance company in connection with the consolidation of VLC and approximately $0.1 million of notes payable to another finance company for insurance premiums. See Note 9 to our unaudited condensed consolidated financial statements for further discussion.

Contractual Obligations

The following table summarizes our known contractual obligations to make future cash payments as of March 31, 2009 as well as an estimate of the periods during which these payments are expected to be made.


Payments Due by Period	Less than 1 Year (2009-2010)		1 to 3 Years (2010-2012)		3 to 5 Years (2012-2014)		More than 5 Years (After 2014)		Total
	(In thousands)
Long-term debt obligations	$	202	$	22	$	86	$	—	$	310
Capital lease obligations		13		—		—		—		13
Operating lease obligations		800		1,045		127		—		1,972
Capital commitments (1)		4,008		—		—		—		4,008
Purchase commitments (2)		—		—		—		—		—

Totals	$	5,023	$	1,067	$	213	$	—	$	6,303

(1)- Represents estimated costs to complete groundwater treatment systems under current contracts with customers

(2)- There are no minimum purchase arrangements with vendors

Capital Expenditures

Our capital expenditures in the first three months of 2009 and 2008 were approximately $0.6 million, respectively. Our capital expenditures are primarily for groundwater treatment systems that we build and then contract to customers under long-term contracts. Our future capital expenditures will fluctuate depending on the number of our systems we place with customers under long-term contracts and the availability of cash resources to fund such expenditures.

Item 3.

Quantitative and Qualitative Disclosures About Market Risk

Market risk represents the risk of loss arising from adverse changes in market rates and foreign exchange rates. At March 31, 2009, other than the non-interest bearing notes payable by VL Capital to a financing company and short-term notes payable to finance insurance premiums (see Note 9 to the condensed consolidated financial statements), we had no outstanding indebtedness. The amount of our outstanding debt at any time may fluctuate and we may from time to time be subject to refinancing risk. A hypothetical 100 basis point increase in interest rates would not have a material effect on our annual interest expense, our results of operations or financial condition. We derive substantially all of our revenues from sales within the United States. Since transactions in foreign currencies are immaterial to us as a whole, we do not consider it necessary to hedge against currency risk.

As noted above, the U.S. credit markets have recently experienced significant dislocations and liquidity disruptions which have caused spreads on prospective debt financings to widen considerably. These circumstances have materially impacted liquidity in the debt markets, making financing terms for borrowers less attractive, and in certain cases have resulted in the unavailability of certain types of debt financing. These events in the credit markets, as well as deteriorating market conditions, have also had an adverse effect on other financial markets in the United States, including the equity markets, which may make it more difficult or costly for us to raise capital through the issuance of common stock or other equity securities.

Item 4.

Controls and Procedures

(a) Evaluation of Disclosure Controls and Procedures

We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in our Exchange Act reports is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by us in the reports that we file or submit under the Exchange Act is accumulated and communicated to our management, including our chief executive officer (CEO) and chief financial officer (CFO), as appropriate to allow for timely decisions regarding required disclosure. In designing and evaluating our disclosure controls and procedures, we recognize that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and management is required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures.

Management, with participation by our CEO and CFO, has designed the Company’s disclosure controls and procedures to provide reasonable assurance of achieving the desired objectives. As required by SEC Rule 13a-15(b), in connection with filing this Quarterly Report on Form 10-Q, management conducted an evaluation, with the participation of our CEO and CFO, of the

effectiveness of the design and operation of our disclosure controls and procedures, as such term is defined under Rule 13a-15(e) promulgated under the Exchange Act, as of March 31, 2009, the end of the period covered by this report.

Based upon the evaluation conducted by management in connection with the audit of the Company’s financial statements for the year ended December 31, 2008, and in connection with the restatement of our financial statements for the years ended December 31, 2007 and 2006, we identified material weaknesses in our internal control over financial reporting that existed as of December 31, 2008 and that we believe still existed as of March 31, 2009. A material weakness is a deficiency, or a combination of deficiencies, in internal control over financial reporting such that there is a reasonable possibility that a material misstatement of our annual or interim financial statements will not be prevented or detected on a timely basis.

As a result of these material weaknesses, our CEO and CFO concluded that our disclosure controls and procedures were not effective at the reasonable assurance level as of March 31, 2009.

(b) Management’s Evaluation of Internal Control over Financial Reporting

Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Rule 13a-15(f) of the Exchange Act. Internal control over financial reporting refers to a process designed by, or under the supervision of, our CEO and CFO, and effected by our 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 (GAAP) and includes those policies and procedures that: (1) pertain to the maintenance of records that in reasonable detail accurately and fairly reflect our transactions and disposition of our assets; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with GAAP, and that our receipts and expenditures are being made only in accordance with authorizations of our management and directors; and (3) 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.

Our management performed an assessment of the effectiveness of our internal control over financial reporting as of December 31, 2008 based upon the Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on that evaluation, management concluded that our internal control over financial reporting was not effective as of December 31, 2008 as a result of the material weaknesses described below. We believe these material weaknesses still existed as of March 31, 2009.

The ineffectiveness of internal control over financial reporting as of December 31, 2008 stemmed from several significant factors. The organization structure was changing as we hired additional management, and we were establishing new accounting processes and procedures. Additionally, the integration of recently-acquired businesses, namely MPT in late 2007 and Envirogen in late 2008, caused additional changes to our organization structure and accounting systems. This placed additional stress on the organization and our internal controls as these new structures were being instituted within the Company. These changes in our management, reporting structure and our accounting systems and processes resulted in a material weakness in our internal control over financial reporting.

In connection with the restatement of our consolidated financial statements, we have identified the following material weaknesses in our internal control over financial reporting that continued to exist as of March 31, 2009:

•

A lack of sufficient personnel with appropriate knowledge, experience and training in applying GAAP to transactions and the correct application of revenue recognition principles required under GAAP;

•

A failure to maintain adequately organized business records and complete documentation for sales contracts, many of which lacked execution dates, signatures by Company or counterparty representatives; the use of draft or non-standard arrangements; and the lack of adequate written agreements to memorialize significant transactions;

•

Insufficient information systems and processes to accumulate information to timely identify and address business and accounting issues;

•

A lack of sufficiently detailed written accounting policies and procedures with respect to the timing and recognition of sales transactions and an insufficient process at the time of the transactions to monitor compliance with such policies and procedures; and

•

A failure to maintain an effective internal audit function.

In light of these material weaknesses, we performed additional analyses and procedures in order to conclude that our unaudited consolidated financial statements for the three-month period ended March 31, 2009 included in this Quarterly Report on Form 10-Q were fairly presented in accordance with GAAP. Accordingly, management believes that despite our material weaknesses, our unaudited consolidated financial statements for the three-month period ended March 31, 2009 are fairly presented in accordance with GAAP.

Based on our remediation efforts described below, we expect to enhance our internal control over financial reporting with the goal of remediating the foregoing material weaknesses by December 31, 2009. The effectiveness of the measures we implement in this regard will be subject to ongoing management review supported by confirmation and testing by management and by our internal auditors, as well as audit committee oversight. As a result, we expect that additional changes could be made to our internal control over financial reporting and our disclosure controls and procedures. In addition, we may in the future identify additional material weaknesses in our internal control over financial reporting that we have not identified as of the date of this report.

(c) Plan for Remediation of Material Weaknesses

We have implemented a number of changes designed to improve our internal control over financial reporting such as:

•

We hired a new CFO in June 2008;

•

We retained an experienced consultant to assist us in our efforts to comply with Section 404 of the Sarbanes-Oxley Act of 2002;

•

We have developed and are implementing our accounting policies and procedures with enhanced controls surrounding expenditures, cutoff dates and payroll processing and procedures;

•

With respect to revenue recognition, we now require the CFO and either the General Counsel or the CEO to provide formal written or electronic approval of all sales contracts;

•

We have developed procedures and internal documentation to reduce the risks associated with non-routine transaction documents;

•

We have developed policies and procedures designed to ensure that the appropriate authorized officers receive on a timely basis information regarding proposed transactions prior to execution and approval of such transactions;

•

With respect to non-routine transactions, we have adopted additional procedures designed to ensure the correct accounting treatment of such transactions including, where appropriate, retention of outside accounting specialists where additional expertise is determined to be advisable based upon the nature of the transaction; and

•

We have implemented new financial systems designed to enhance our financial reporting process.

Subject to the availability of resources in light of our liquidity situation, we intend to take the following additional remediation efforts:

•

increase our accounting and finance resources and/or the accounting qualifications of current personnel;

•

conduct additional employee training relating to existing and newly implemented policies and procedures;

•

realign our internal audit review and internal reporting function in a manner designed to ensure compliance with written accounting and revenue recognition procedures;

•

adopt additional procedures with respect to monitoring and internal communication within the organization; and

•

implement new policies and procedures designed to improve cutoff, reporting and processing functions.

We believe these remediation efforts will continue to improve our internal control over financial reporting.

We have incurred, and expect to continue to incur, substantial expenses relating to the remediation of the material weaknesses in our internal control over financial reporting. The effectiveness of our internal control over financial reporting may in the future be limited by:

•

failure of the effectiveness of our policies, procedures and information systems and processes;

•

delays in upgrading financial software systems; and

•

the possibility that enhancements to our disclosure controls and procedures or internal control over financial reporting may not adequately assure timely and accurate financial information.

(d) Changes in Internal Control over Financial Reporting

Other than as described above, there were no changes in our internal control over financial reporting during the quarter ended March 31, 2009 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

Part II Other Information

Item 1.

Legal Proceedings

On December 27, 2007 and January 2, 2008, two purported securities class action complaints were filed in the United States District Court for the Central District of California against our Company, Peter L. Jensen, Michael M. Stark and Thomas C. Tekulve (collectively referred to as the Basin defendants) for violations of the Exchange Act. These lawsuits, which contain similar allegations, are captioned Poulos v. Basin Water, et al ., Case No. CV 07-8359 GW (FFMx) and Nofer v. Basin Water, et al ., Case No. CV 08-0002 SGL (JCRx). The lawsuits were subsequently consolidated, and on October 3, 2008 a Consolidated Amended Complaint (CAC) was filed which alleges that the Company deliberately understated the reserves it took for certain unprofitable contracts, and committed various intentional violations of GAAP during a putative class period between November 14, 2006 and August 8, 2008 (the Federal Lawsuit). The suit did not state a specific amount of damages. On February 19, 2009, we and our insurance carriers reached an agreement in principle to settle the class action with representatives of the class. The settlement is still subject to preparation of a final settlement agreement, following which we would intend to seek preliminary approval from the Court so that class members can receive notice of the settlement, providing them with the opportunity to accept its terms or to opt out and choose whether to pursue their own individual claims. Following a fair period of notice to the class, it would be our intention to seek final Court approval of the settlement and the dismissal of all claims against us. We deny all of the allegations in the lawsuit and believe that our disclosures were appropriate under the law. Nevertheless, we have agreed to settle the litigation in order to avoid costly and time-consuming litigation. We do not expect a cash effect of this settlement on our Company as the entire settlement amount is expected to be paid by our liability insurers.

On January 31, 2008, Loren Charif, a purported stockholder of our Company, filed a shareholder derivative lawsuit in the Superior Court of the State of California, County of San Bernardino, against certain of our current and former executive officers and our current directors. The complaint assumes the truth of the aforementioned allegations in the federal securities class action lawsuits and in connection with those allegations alleges, among other things, breaches of fiduciary duties, waste of corporate assets, unjust enrichment and violations of California Corporations Code pertaining to allegations of improper selling. The suit does not state a specific amount of damages. On November 12, 2008, we obtained an order staying this action until a final determination occurs in the Federal Lawsuit.

On March 10, 2009, Demetrice Ledbetter, III, a purported shareholder of our Company, filed a shareholder derivative lawsuit in the United States District Court for the Central District of California against certain current and former executive officers and directors. The complaint assumes the truth of the aforementioned federal securities class action lawsuits and in connection with those allegations alleges, among other things, breaches of fiduciary duty, waste of corporate assets, abuse of control, gross mismanagement, unjust enrichment, and claims for contribution and indemnification. The suit does not state a specific amount of damages.

From time to time, we are involved in legal and administrative disputes and proceedings arising in the ordinary course of business, which we believe are not material to the conduct of our business. With respect to these ordinary matters, management believes that we have adequate accruals for related costs, and we may also have effective legal defenses.

Item 1A.

Risk Factors

A description of the risk factors associated with our business is contained in Part I, Item 1A, “Risk Factors,” of our recently filed Annual Report on Form 10-K for the year ended December 31, 2008. These cautionary statements are to be used as a reference in connection with any forward-looking statements. The factors, risks and uncertainties identified in these cautionary statements are in addition to those contained in any other cautionary statements, written or oral, which may be made or otherwise addressed in connection with a forward-looking statement or contained in any of our subsequent filings with the Securities and Exchange Commission. There have been no material changes in our risk factors from those disclosed in our Annual Report on Form 10-K for the year ended December 31, 2008. You should carefully consider the risk factors discussed in our Annual Report on Form 10-K, as well as the other information in this report, before deciding whether to invest in shares of our common stock. The occurrence of any of the risks discussed in our Annual Report on Form 10-K could harm our business, financial condition, results of operations or growth prospects.

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

There have been no repurchases of our common stock during the three months ended March 31, 2009 under the stock repurchase program authorized by our Board of Directors in May 2007 that allowed us to repurchase up to $10 million of our common stock. The shares could be repurchased at times and prices as determined by management, and may be completed through open market or privately negotiated transactions. The repurchase program provides that repurchases must be made in accordance with the terms and subject to the restrictions of Rule 10b-18 under the Exchange Act, as amended.

Item 3.

Defaults Upon Senior Securities

None.

Item 4.

Submission of Matters to a Vote of Security Holders

None.

Item 5.

Other Information

None.

Item 6.

Exhibits


31.1		Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002, filed herewith.

31.2		Certification of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002, filed herewith.

32.1*		Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

32.2*		Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

These certifications are being furnished solely to accompany this quarterly report pursuant to 18 U.S.C. Section 1350, and are not being filed for purposes of Section 18 of the Exchange Act and are not to be incorporated by reference into any filing of Basin Water, Inc., whether made before or after the date hereof, regardless of any general incorporation language in such filing.

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereto duly authorized.