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CONVERTED ORGANICS INC.
NOTES TO CONSOLIDATED INTERIM FINANCIAL STATEMENTS — CONTINUED
(UNAUDITED)

NOTE 12 — SUBSEQUENT EVENTS (Continued)

TERRASPHERE SYSTEMS LLC ACQUISITION

     On November 12, 2010, the Company acquired 95% of the membership interest TerraSphere Systems LLC. The acquisition will enable the Company to license TerraSphere’s patented Growth System, which is a system of modules and processes for growing plants in a controlled environment. The system uses and controls precise combinations of light, water, nutrition, gravity, centrifugal forces, and gasses to produce growing conditions that can be controlled and manipulated to result in desired plant growth and maximum crop production.

The membership interest purchase agreement (“Agreement”) entered on July 6, 2010 allows for an election by TerraSphere members to accept 1) 27,777,778 shares of Company common stock upon closing of the transaction (with a 6 month holding period) (“Option One”) or 2) 15,873,016 shares of Company common stock upon closing of the transaction with an option to earn an additional 21,164,021 shares of Company common stock in contingent consideration based upon TerraSphere achieving certain milestones and agreeing to an 18 month holding period on stock distributed to them (“Option Two”). Based on 26% of TerraSphere members’ electing Option One and 69% electing Option Two, the maximum total shares that could be issued is 32,777,778 in the Company’s common stock. Per the Agreement, TerraSphere members who elected Option One received 7,222,222 shares of Company common stock upon closing and members electing Option Two received 10,952,381 shares of Company common stock upon closing and up to an additional 14,603,175 shares of Company common stock based on achieving the defined milestones (contingent consideration).

     Milestone One Payment: 4,563,492 shares of Company common stock, if, and only if, between the date of the Agreement and the 90th day following the closing date or the 180th day following the date of the Agreement, the following occurs (such shares to be payable within ten (10) business days of achievement of the following or the closing date, whichever is later): For a period of five (5) consecutive trading days, the Company’s market capitalization exceeds the sum of: (1) the Company’s initial market capitalization on the date of execution of the Agreement, plus (2) the closing price per share, multiplied by the number of shares of Company common stock to be issued at closing pursuant to the Agreement, and, if such calculation is being made prior to the closing date, including this Milestone One. If between the date of the Agreement and the 90th day following the closing date or the 180th day following the date of the Agreement, the Company completes an equity financing, the cash received from the equity financing during such period shall be added to the market capitalization. If between the closing date and December 31, 2011, the Buyer sells equity of either the Company or any of the Company’s subsidiaries, any cash received from such equity sales during such period shall be added to the market capitalization;

     Milestone Two Payment: 1,825,397 shares of Company common stock, if, and only if, $2,000,000 of TerraSphere’s accounts receivable as of the date of the Agreement are received prior to February 28, 2011;

     Milestone Three Payment: 4,563,492 shares of Company common stock, if, and only if, the Company generates gross margin of $6,000,000 (gross margin target) from its operations during the period commencing as of the date of the Agreement and ending on December 31, 2011; provided that, if the Company generates gross margin of at least $4,200,000 (gross margin threshold) from its operations during such period, the Sellers shall be entitled to a pro rata portion of the Company common stock; and

     Milestone Four Payment: 3,650,794 shares of Company common stock, if, and only if, the Company generates gross margin of $4,000,000 from its operations during any nine-month period commencing on the Agreement date and ending on December 31, 2012; provided that, if the Company achieves the Milestone Three gross margin threshold, but does not achieve the Milestone Three gross margin target, 83.3% of the difference between the Milestone Three gross margin target and the actual gross margins achieved pursuant to the Agreement (the “Milestone Three Deficiency”) may be added by the Sellers to the Milestone Four Payment and the Milestone Four gross margin target. Notwithstanding anything to the contrary herein, the total amounts payable pursuant to the Milestone Three Payment and Milestone Four Payment shall be no more than 8,214,286 shares of Company common stock.

On November 12, 2010, the Company acquired 95% of TerraSphere issuing 18,174,603 shares of Company common stock at the closing and additional shares will be issued if TerraSphere achieves the above milestones.

CONVERTED ORGANICS INC.
NOTES TO CONSOLIDATED INTERIM FINANCIAL STATEMENTS — CONTINUED
(UNAUDITED)

NOTE 12 — SUBSEQUENT EVENTS (Continued)

TERRASPHERE SYSTEMS LLC ACQUISITION (Continued)

The unaudited pro forma consolidated financial information for the three and nine months ended September 30, 2010 and 2009 as though the acquisition had been completed at the beginning of the respective periods are as follows:

		For the three months ended								For the nine months ended
		September 30,								September 30,
		2010				2009				2010				2009
Revenue		$	817,765			$	703,306			$	7,268,190			$	1,828,595
Net loss		$	(22,304,569	)		$	(5,156,798	)		$	(29,330,290	)		$	(13,038,842	)
Net loss per share, basic and diluted			(0.36	)			(0.13	)			(0.50	)			(0.43	)

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

     The following discussion should be read in conjunction with the consolidated interim financial statements and related notes to the consolidated interim financial statements included elsewhere in this report. This discussion contains forward-looking statements that relate to future events or our future financial performance. These statements involve known and unknown risks, uncertainties and other factors that may cause our actual results, levels of activity, performance or achievements to be materially different from any future results, levels of activity, performance or achievements expressed or implied by these forward-looking statements. These forward-looking statements are based largely on our current expectations and are subject to a number of uncertainties and risks including the Risk Factors identified in our Annual Report on Form 10-K for the year ended December 31, 2009. Actual results could differ materially from these forward-looking statements. Converted Organics Inc. is sometimes referred to herein as “we”, “us”, “our” and the “Company”.

Introduction

     Our operating structure is composed of our parent company, Converted Organics Inc., three wholly-owned operating subsidiaries, a newly formed wholly-owned subsidiary, TerraSphere Inc. and a 92.5% owned non-operating subsidiary. The first operating subsidiary is Converted Organics of California, LLC, which includes the operation of our Gonzales, California facility. The second operating subsidiary is Converted Organics of Woodbridge, LLC, which includes the discontinued operation of our Woodbridge, New Jersey facility. The third operating subsidiary is Converted Organics of Mississippi, LLC (“Converted Organics of Mississippi), a Mississippi limited liability company, established for the purpose of adding a poultry litter-based fertilizer product to the Company’s existing product lines. On May 20, 2010, we formed TerraSphere Inc. (“TerraSphere Inc”), a Delaware corporation, to acquire 100% of the membership interests of TerraSphere Systems LLC, a transaction which was approved by our shareholders at a special meeting held on September 16, 2010 and acquired 95% of the membership interest of TerraSphere on November 12, 2010. The 92.5% owned subsidiary is Converted Organics of Rhode Island, LLC (“Converted Organics of RI”), which currently has no operating activity. On February 25, 2010, we signed a letter of intent with the non-controlling member in Converted Organics of RI to sell substantially all of the assets and a limited select amount of liabilities of Converted Organics of RI. We operate a processing facility that uses food and agricultural waste as raw materials to manufacture all-natural fertilizer and soil amendment products combining nutritional and disease suppression characteristics. In addition, we have sales from a poultry litter based fertilizer product. We have current sales in the agribusiness, retail and turf management markets. We also hope to achieve additional revenue by licensing the use of our technology to others, developing our Industrial Waterwaste Resources division and expanding our newly acquired division TerraSphere Inc.

     In addition to our fertilizer manufacturing and sales operations, we have also begun to operate an Industrial Wastewater Resources division of the Company (IWWR). Converted Organics is the exclusive licensee of LM-HT Concentrator technology for the treatment of Industrial Wastewater. Due to its unique, energy efficient design, the LM-HT Concentrator provides a highly cost-effective alternative to traditional IWW treatment technology. Since IWWR’s inception in March of 2010, we have entered into multiple strategic relationships to build waste water treatment facilities on landfills and other waste processing facilities across the nation. Once the LM-HT Concentrators are installed at facilities, Converted Organics plans to apply for carbon credits and government grants, based on the technology’s ability to reduce carbon emissions and energy consumption through its use of waste heat and renewable energy as thermal fuel.

          Converted Organics of California, LLC — Gonzales Facility

     The Gonzales facility is a state-of-the-art production facility that services a strong West Coast agribusiness customer base through established distribution channels. This facility uses our proprietary technology and process known as the High Temperature Liquid Composting, or HTLC, system, which processes various biodegradable waste products into liquid and solid food waste-based fertilizer and feed products.

     The Gonzales facility began to generate positive cash flow in June 2009 which has continued through September 2010. For the nine month period ended September 30, 2010, the Gonzales facility generated revenues of $2,511,000 and a positive gross margin of $628,000, or 25% (based on no allocation of corporate overhead). We plan to continue to improve this operating margin by maximizing the production capacity at the facility, by generating tip fees from receiving additional quantities of food processing waste and by reducing the amount of raw material and freight costs currently associated with the production process. We estimate that the plant in its current configuration, and based on current market prices, has the capacity to generate monthly sales in the range of $350,000 to $400,000. In addition, we have plans to add capacity to the Gonzales plant, whereby the plant will be able to produce approximately three times its current production and will be capable of producing both liquid and solid products. We have completed

certain aspects of the planned upgrades which allow us to receive solid food waste for processing but have delayed the upgrades which would allow us to produce dry product. The remaining upgrades have been delayed due to a lack of market demand for a dry product within the area the Gonzales facility serves. Because we will have to obtain the proper building permits for continued expansion, further development of the Gonzales facility will be delayed until further market research is completed and those permits are obtained.

          Converted Organics of Woodbridge, LLC — Woodbridge Facility

     On July 30, 2010, we temporarily halted production at our Woodbridge facility in order to undertake steps to lower our cost structure at the Woodbridge facility. Specifically we attempted to negotiate more favorable terms under our operating lease and to lower certain utility costs. We were unable to lower such costs and therefore, management determined the Company could not sustain the negative cash flow from the Woodbridge facility and discontinued the operations at the Woodbridge plant. As a result, we impaired the Woodbridge facility’s assets thereby reducing the carrying value to approximately $1.5 million which is the value expected to be received from the sale of those assets. The consolidated statements of operations reflect the impairment charge of approximately $15.4 million for the three and nine month periods ended September 30, 2010 in loss from discontinued operations. On October 18, 2010, we entered into a Termination and Surrender Agreement with the Woodbridge facility’s landlord (“Lessor”) transferring all equipment, tools and fixtures owned by us to the Lessor in lieu of our obligations to the Lessor. The completion of our restructuring coupled with the expense reduction measures we implemented in July 2010 are expected to yield total cash savings of approximately $6.0 million per year, providing us with the operational and financial flexibility necessary to drive Converted Organics to its next phase of corporate development

          Converted Organics of Mississippi, LLC

          On January 26, 2010, we formed Converted Organics of Mississippi, LLC, a Mississippi limited liability company and a wholly owned subsidiary of the Company, for the purpose of adding a poultry litter-based fertilizer product to our existing product lines. We have outsourced production of this new product line. From the date of inception through September 30, 2010, Converted Organics of Mississippi, LLC recorded product sales revenue of approximately $255,000.

          TerraSphere Inc.

          On May 20, 2010, we formed TerraSphere Inc., a Delaware corporation and a wholly owned subsidiary of the Company, for the purpose of acquiring 100% of the membership interests of TerraSphere Systems LLC (“TerraSphere”). On July 6, 2010, a membership interest purchase agreement was entered into by the Company, TerraSphere Inc., TerraSphere and the members of TerraSphere, pursuant to which we agreed to acquire 100% of the membership interest of TerraSphere. The maximum total shares that could be issued for TerraSphere is estimated to be 34,166,667 shares of Company Common Stock, which includes earn-out share payments of up to 14,603,175 shares of Company common stock. Pursuant to the purchase agreement, the acquisition was approved by our shareholders on September 16, 2010. The Company acquired 95% of the membership interest of TerraSphere on November 12, 2010. We will issue up to 32,777,778 shares of our common stock to the members of TerraSphere in exchange for 95% of the units of TerraSphere, subject to certain anti-dilution adjustments. Of these shares, 18,174,603 shares were issued on November 12, 2010, the closing of the acquisition, and the remainder of the shares will be issued if TerraSphere achieves certain milestones. TerraSphere designs, builds and operates highly efficient and scalable systems, featuring a patented, proprietary technology that utilizes vertically-stacked modules to house rows of plants, which are then placed perpendicular to an interior light source to grow pesticide and chemical-free, organic fruits and vegetables. Due to a controlled, indoor environment, the system generates fresh produce year-round in any location or climate world-wide. We believe the acquisition of TerraSphere will expand our portfolio of sustainable, environmentally-friendly businesses, and will provide us with an immediate revenue stream.

          Industrial Wastewater Resources Division

          On March 23, 2010, we entered into a loan and license agreement with Heartland Technology Partners, LLC (“HTP”). The loan agreement requires us to advance $500,000 to HTP in three monthly installments that commenced upon signing of the loan. The outstanding principal balance of the loan is due if either a change of control of HTP or the completion by HTP of a financing in excess of $10 million occurs on or before June 30, 2012. In consideration for entering into the loan agreement, we were granted an exclusive, irrevocable license to utilize HTP’s patented LM-HT(TM) Concentrator technology in the U.S. industrial wastewater (IWW) market. The IWW market involves the treatment of waters that have been contaminated by anthropogenic industrial or commercial activities, prior to their reuse or release into the environment. A breakthrough wastewater treatment process, the LM-HT(TM) Concentrator reduces carbon emissions compared to traditional technologies by using waste heat and renewable energy as thermal fuel. In addition,

we have hired a senior executive in the waste water processing industry and have begun to develop plans to operate our Industrial Wastewater Resources division. On July 30, 2010, we signed a letter of intent with Spirit Services, Inc. to jointly develop an energy and IWW treatment facility using our exclusively licensed technology to evaporate IWW at a facility in South Boston, Virginia. We have subsequently signed additional agreements to establish relationships to jointly develop IWW treatment facilities at certain established waste treatment facilities in the United States. Such relationships are in the development stage and we expect to build upon them, as well as secure new partnerships, throughout the remainder of this year and in 2011.

Recent Financing Activities

     On April 20, 2010, we entered into an agreement with a single institutional investor, pursuant to which we issued to the investor: (a) 2,400,000 shares of common stock and (b) five-year warrants to purchase 1,163,362 shares of common stock at an exercise price of $1.06 per share. The warrants may be exercised at any time on or following a date one year after the date of issuance and expire five years from the date of issuance. The transaction closed on April 22, 2010 and provided us with net proceeds of approximately $2.4 million.

Future Development

     Our long-term strategic plan calls for growth of our organic fertilizer business as well as expansion of our portfolio of sustainable, environmentally-friendly businesses. To grow our existing fertilizer business, we plan to develop and license additional organic fertilizer manufacturing facilities and utilize the remaining capacity of our Gonzales facility which currently operates at approximately 60% capacity. In connection with our plan to expand the capacity of our Gonzales facility, we plan to increase production to approximately three times the facility’s current production and, based on market demand, we may expand the capability of the plant to have the ability to produce both liquid and solid products. In connection with the plan for additional facilities, we have completed preliminary work aimed at establishing facilities in Massachusetts, where we have performed initial development work in connection with construction of three manufacturing facilities to serve the eastern Massachusetts market. Two of our proposals to develop facilities are currently under review by the property owners. The third proposal has evolved into the MassOrganics I transaction described below. The Massachusetts Strategic Envirotechnology Partnership Program has completed a review of our technology.

     We also plan to strengthen our green technology portfolio with the TerraSphere acquisition and grow our Industrial Wastewater Resources Division. Through the TerraSphere acquisition, we will expand our business into the market of building highly efficient systems for growing pesticide and chemical-free, organic fruits and vegetables in controlled indoor environments. TerraSphere will provide us with an immediate revenue stream and its clean technology helps to promote the sustainable consumption of natural resources by accelerating plant production and maximizing crop yields, while improving environmental footprints through the reduction of carbon emissions and fuel use associated with traditional crop production and distribution. Also, we will continue to grow our Industrial Wastewater Resources Division by working to form industry and/or project-based partnerships that utilize our exclusively licensed, irrevocable technology to treat industrial wastewaters.

     We have developed smaller capacity operating units, namely the Scalable Modular AeRobic Technology (SMART) units that are suitable for processing 5 to 50 tons of waste per day. The semi-portable units are capable of operating indoors or outdoors and may be as sophisticated or as basic in design and function as the owner/user requires. The SMART units will be delivered to jobsites in pre-assembled, pre-tested components, and will include a license to use the HTLC technology. Our target market is users who seek to address waste problems on a smaller scale than would be addressed by a large processing facility. Our plan contemplates that purchasers of the SMART units would receive tip fees for accepting waste and would sell fertilizer and soil amendment products in the markets where their units operate. We plan to market and sell the SMART units in both the United States and abroad.

     We have also begun the development of a licensing program, under which we will license to third parties, the right to use our proprietary technology. The licensing program consists of a know-how license, which could be complemented with SMART unit sales so that any individual or entity buying a SMART unit would also receive a license agreement to use our technology. We are working to patent our process and technology and anticipate that we will expand upon the licensing program when the necessary patent registrations are achieved. We are currently in negotiations with MassOrganics I, LLC (“MassOrganics I”) regarding the use of Converted Organics’ proprietary technology for the manufacture of organic fertilizer products. On January 25, 2010, we signed a memorandum of understanding under which MassOrganics I would install and operate the system at a new manufacturing facility to be constructed at The Sutton Commerce Park in Sutton, Massachusetts. MassOrganics I has agreed to enter into a licensing agreement under which MassOrganics I will pay a licensing fee to Converted Organics.

Trends and Uncertainties Affecting our Operations

     We are subject to a number of factors that may affect our operations and financial performance. These factors include, but are not limited to, the available supply and price of organic food waste, the market for liquid and solid organic fertilizer, increasing energy costs, the unpredictable cost of compliance with environmental and other government regulation, and the time and cost of obtaining USDA, state or other product labeling designations. Demand for organic fertilizer and the resulting prices customers are willing to pay also may not be as high as our market studies suggest. In addition, supply of organic fertilizer products from the use of other technologies or other competitors may adversely affect our selling prices and consequently our overall profitability. Furthermore our plan calls for raising additional debt and/or equity financing to construct additional operating facilities. Currently there has been a slowdown in lending in both the equity and bond markets which may hinder our ability to raise the required funds.

Liquidity and Capital Resources

     At September 30, 2010, we had total current assets of approximately $4.3 million consisting primarily of cash, accounts receivable, assets of discontinued operations, and had current liabilities of approximately $8.1 million, consisting primarily of accounts payable, accrued expenses and liabilities of discontinued operations, leaving us with a negative working capital of approximately $3.8 million. Non-current assets totaled approximately $4.9 million and consisted primarily of property and equipment, intangible assets and non-current assets of discontinued operations. Non-current liabilities of approximately $19.0 million consisted primarily of non-current liabilities of discontinued operations of $17.5 million and a $1.4 million derivative liability. We had an accumulated deficit at September 30, 2010 of approximately $81.5 million. Shareholders’ deficit at September 30, 2010 was approximately $17.8 million. We have completed a series of transactions in October 2010 which will provide approximately $15.4 million in positive Shareholders’ equity in the fourth quarter of 2010. We also acquired 95% of the membership interest of TerraSphere on November 12, 2010 which provided approximately $7.5 million in positive Shareholders’ equity in the fourth quarter of 2010 with an additional $6.0 million in positive Shareholders’ equity if certain future milestones are met. The effects of these transactions on the balance sheet at September 30, 2010 are as follows:

						Woodbridge Transactions
		September 30, 2010				and TerraSphere Acquisition				Total
Assets		$	9,200,000			$	6,100,000			$	15,300,000
Liabilities			27,000,000				(16,800,000	)			10,200,000
Shareholders equity (deficit)			(17,800,000	)			22,900,000				5,100,000

     During the nine month period ended September 30, 2010, we used approximately $10.2 million in cash on hand. The significant cash expenditures during the first nine months of 2010 were as follows:

$1,561,000		to fund future revenue generating activities, including the purchase of chicken litter-based fertilizer product ($615,000), a deposit for a license to treat Industrial Wastewater ($500,000) and to fund capital equipment purchases ($446,000).
$1,100,000		related to funding acquisition activities.
$1,540,000		to repay debt principal and interest on term notes related to discontinued operations of the Woodbridge facility.
$4,460,000		to fund operations related to the discontinued operations of the Woodbridge facility.
$1,500,000		to fund ongoing operations during the first nine months of 2010, including $600,000 of marketing costs to implement a formal marketing program.

     On July 30, 2010 we announced that we reduced our work force by 50% which included employees at the corporate level and the Woodbridge facility. We expect those salary reductions to save approximately $2.1 million over the next twelve months. Also, on July 30, 2010, we temporarily halted production at our Woodbridge facility in order to undertake steps to lower our cost structure at the Woodbridge facility. Specifically we attempted to negotiate more favorable terms under our operating lease and to lower certain utility costs. We were not successful in lowering such costs and therefore, management determined the Company could not sustain the

negative cash flow from the Woodbridge facility and discontinued the operations at the Woodbridge plant. We expect the closing of the Woodbridge facility and debt restructuring of its related debt will save us approximately $6.0 million per year. On October 18, 2010, we entered into an Exchange Agreement with the sole bond holder of $17.5 million bonds whereby we exchanged the Bonds for 17,500 shares of our newly authorized 1% Series A Convertible Preferred Stock, which is convertible into an aggregate of 32,228,361 shares of our common stock. In addition, the Bond Holder agreed to waive all interest accrued and unpaid from February 1, 2010 until the date of the Exchange Agreement on the Bonds totaling approximately $933,000, and agreed to transfer to the us approximately $600,000 that we had previously deposited into certain reserve accounts in connection with the Bonds.

     We and the Woodbridge Facility’s landlord (“ Lessor “) entered into a Termination and Surrender Agreement on October 18, 2010 whereby we agreed to transfer all equipment, tools and fixtures owned by us and presently located at the premises and 892,857 shares our common stock valued at $500,000 to the Lessor in satisfaction of claims of approximately $1.5 million. In addition, we have deposits totaling $415,000 with the Lessor which will not be returned to us. On October 18, 2010, a court order was entered whereby we agreed to issue to a third party a total of 20,726,980 shares of our common stock in full settlement of approximately $1.7 million of promissory notes issued by us to four contractors that had provided services to the Woodbridge Facility. After the above transactions, Woodbridge will have approximately $1.3 million in current payables remaining.

     We have additional manufacturing capabilities at our Gonzales facility currently operating at approximately 60% of its production capacity. The Gonzales facility is cash flow positive and the additional production capacity would produce approximately $175,000 a month in positive cash flow. We are focusing our current sales efforts on taking advantage of the additional production capacity. Previously, we estimated our negative cash flow requirements on a monthly basis were approximately $400,000 at the corporate level. We estimate that the current cost reduction efforts will lower the monthly cash flow requirements at the corporate level to $150,000, excluding current payable obligations of approximately $1.6 million. If we are unable to increase sales levels at Gonzales to offset the corporate level cash flow requirement, we will need to seek additional financing.

     On July 6, 2010 we reached an agreement to acquire 100% of the membership interests of TerraSphere Systems LLC. The transaction was approved by our shareholders at a special meeting on September 16, 2010. The closing of the transaction was executed on November 12, 2010. Any cash acquired by us would reduce amounts that otherwise need to be raised through a financing.

     On April 22, 2010, we raised net proceeds of $2.4 million through the issuance of (a) 2,400,000 shares of common stock and (b) a five-year warrants to purchase 1,163,362 shares of common stock at an exercise price of $1.06 per share. We previously disclosed that we believed the funds received through our secondary public offering of 17,250,000 units which raised $16.4 million after expenses and the April 2010 financing would be sufficient to operate our current business until we were cash flow positive assuming we achieved our desired production capacity and sales levels and assuming we did not encounter additional costs or expenses, either unforeseen or resulting from any proposed mergers and/or acquisitions. To date, we have not achieved the desired sales levels needed to meet our cash flow requirements. Therefore, we may require additional financing prior to achieving cash flow from operations for which we have no commitments. On July 2, 2010, we filed a registration statement on Form S-3 to register $75,000,000 of our common stock, which was declared effective on July 15, 2010. There is no assurance that capital in any form will be available to us, and if available, on terms and conditions that are acceptable.

Results of Continuing Operations

Sales

     Our sales increased $115,000 or 16%, and $964,000 or 54% for the three and nine month periods ended September 30, 2010, respectively, compared to the same periods ended September 30, 2009. We attribute our significant growth to our targeted marketing efforts, and to the increasing recognition nationwide regarding the importance of using organic fertilizer products for lawn care, professional turf, and agricultural applications.

     Sales at the Gonzales facility increased $96,000 or 24% and $737,000 or 42% for the three and nine month periods ended September 30, 2010 compared to the same periods ended September 30, 2009.

     Since its inception on January 26, 2010, Converted Organics of Mississippi has generated sales of $255,000.

Cost of Sales

     For the three and nine month periods ended September 30, 2010 cost of goods sold decreased approximately $25,000 and increased $247,000, respectively, compared to the same periods in 2009.

     Cost of goods sold at the Gonzales facility decreased $26,000 or 4% for the three month period ended September 30, 2010. Cost of goods sold increased $118,000 or 8% for the nine month period ended September 30, 2010 compared to the same period ended September 30, 2009 due to an increase in raw materials used to meet increased sales demand while the current level of fixed costs remained relatively unchanged. The Gonzales facility generated a 25% gross margin for the nine months ended September 30, 2010 compared to a 1% gross margin for the same period in 2009.

     Converted Organics of Mississippi generated a gross margin $117,000 or 46% on sales of $255,000 for the nine months ended September 30, 2010.

General and Administrative Expenses

     General and administrative expenses for the three month periods ended September 30, 2010 increased approximately $2.5 million compared to the same period in 2009 is primarily composed of $1.6 million related to compensation expense in connection with the issuance of common stock for M&A advisory services and an increase in legal and professional fees of approximately $300,000. The approximately $5.3 million increase in general and administrative expenses for the nine months ended September 30, 2010 compared to the same period in 2009 is composed of increases related to compensation expense in connection with the issuance of common stock for M&A advisory services of $1.6 million and issuance of stock options and restricted shares of $1.4 million, an increase in professional and legal fees of approximately $1,100,000 related to acquisition activities and an increase in marketing costs of approximately $600,000.

Interest Expense

     Interest expense decreased approximately $723,000 or 99% and $4.0 million or 99% for the three and nine month periods ended September 30, 2010, respectively, compared to the same periods ended September 30, 2009. The significant increase in 2009 was due to interest expense associated with the issuance of warrants and interest recognized in connection with borrowing transactions, primarily non-cash items.

Derivative gain (loss)

     We recognized derivative gains of approximately $662,000 and $1,161,000 in the three and nine month periods ended September 30, 2010, respectively. These gains are non-cash in nature and represent mark-to-market adjustments due to changes in fair value of warrants.

Results of Discontinued Operations

     On July 30, 2010, the Company temporarily halted production at its Woodbridge facility in order to undertake steps to lower its cost structure at the Woodbridge facility. Specifically the Company attempted to negotiate more favorable terms under its operating lease and to lower certain utility costs. The Company was unable to lower such costs and therefore, management determined that the Company could not sustain the negative cash flow from the Woodbridge facility and discontinued operations at the Woodbridge plant. On October 18, 2010, the Company entered into a Termination and Surrender Agreement with the Woodbridge facility’s landlord (“Lessor”) transferring all equipment, tools and fixtures owned by the Company to the Lessor in lieu of its obligations to the Lessor. As a result, the Company impaired the Woodbridge facility’s assets to reduce the carrying value to approximately $1.5 million, which is the value expected to be received from the sale of those assets. The consolidated statements of operations includes an impairment charge of approximately $15.4 million for the three and nine month periods ended September 30, 2010 in loss from discontinued operations.

     The following table provides the revenue and loss from the Woodbridge Facility discontinued operations:

		For the three months ended								For the nine months ended
		September 30,								September 30,
		2010				2009				2010				2009
Revenue from discontinued operations		$	105,714			$	53,123			$	834,089			$	430,403
Loss from discontinued operations		$	(18,685,007	)		$	(2,253,613	)		$	(22,711,406	)		$	(6,443,121	)

     The following table provides the assets and liabilities of the Woodbridge Facility, classified as discontinued operations, in the consolidated balance sheets dated September 30, 2010 and December 31, 2009:

		2010				2009
Accounts receivable		$	293,077			$	59,746
Inventory			—				272,396
Prepaid expenses			778,610				629,933
Property and equipment			1,526,543				17,935,216
Other assets			1,271,158				1,258,670
Assets of discontinued operations		$	3,869,388			$	20,155,961
Term notes payable		$	1,707,743			$	3,247,752
Accounts payable			1,964,459				1,237,275
Accrued expenses			2,375,129				950,782
Other liabilities			31,824				40,575
Bonds payable			17,500,000				17,500,000
Liabilities of discontinued operations		$	23,579,155			$	22,976,384

Critical Accounting Policies

Use of Estimates

     The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts and disclosures in the consolidated financial statements. Actual results could differ from those estimates.

Accounts Receivables

     Accounts receivable represents balances due from customers, net of applicable reserves for doubtful accounts. In determining the need for an allowance, objective evidence that a single receivable is uncollectible, as well as historical collection patterns for accounts receivable are considered at each balance sheet date.

Inventories

     Inventories are valued at the lower of cost or market, with cost determined by the first in, first out basis. Inventories consist primarily of raw materials and finished goods, which consist of soil amendment products. Inventory balances are presented net of applicable reserves.

Intangible Assets

     We account for our intangible assets in accordance with ASC section 350 which requires that intangible assets with finite lives, such as our license, be capitalized and amortized over their respective estimated lives and reviewed for impairment whenever events or other changes in circumstances indicate that the carrying amount may not be recoverable.

Derivative Instruments

     We account for derivative instruments in accordance with ASC 815, which establishes accounting and reporting standards for derivative instruments and hedging activities, including certain derivative instruments embedded in other financial instruments or contracts and requires recognition of all derivatives on the balance sheet at fair value.

Revenue Recognition

     Revenue is recognized when each of the following criteria is met: persuasive evidence of a sales arrangement exists; delivery of the product has occurred; the sales price is fixed or determinable, and collectability is reasonably assured. In those cases where all four criteria are not met, we defer recognition of revenue until the period these criteria are satisfied. Revenue is generally recognized upon shipment.

Share Based Compensation

     We account for share based compensation paid to employees in accordance with ASC 718. Under the provisions of the guidance, share-based compensation issued to employees is measured at the grant date, based on the fair value of the award, and is recognized as an expense over the requisite service period (generally the vesting period of the grant). We account for share based compensation issued to non-employees in accordance with ASC 505. Under the provisions of the guidance, such compensation is measured at the grant date, based on the fair value of the equity instruments issued and is recognized as an expense over the requisite service period.

Off-Balance Sheet Transactions

     We do not engage in material off-balance sheet transactions.

Item 3. Quantitative and Qualitative Disclosures about Market Risk

     Not applicable.

Item 4. Controls and Procedures

     Under the supervision, and with the participation of our management, including the Principal Executive Officer and Principal Financial Officer, we have evaluated the effectiveness of our disclosure controls and procedures pursuant to Exchange Act Rules 13a-15 and 15d-15 as of the end of the period covered by this report. Based on that evaluation, the Principal Executive Officer and Principal Financial Officer have concluded that these disclosure controls and procedures were effective such that the material information required to be filed in our SEC reports is recorded, processed, summarized and reported within the required time periods specified in the SEC rules and forms. This conclusion was based on the fact that the business operations to date have been limited and the Principal Executive Officer and Principal Financial Officer have had complete access to all records and financial information.

     There were no changes in our internal control over financial reporting during the three months ended September 30, 2010 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. Potential investors should be aware that the design of any system of controls and procedures is based in part upon certain assumptions about the likelihood of future events. There can be no assurance that any system of controls and procedures will succeed in achieving its stated goals under all potential future conditions, regardless of how remote.

PART II — OTHER INFORMATION

Item 1. Legal Proceedings

     On December 11, 2008, we received notice that a complaint had been filed in a putative class action lawsuit on behalf of 59 persons or entities that purchased units pursuant to a financing terms agreement, or FTA, dated April 11, 2006, captioned Gerald S. Leeseberg, et al. v. Converted Organics, Inc., filed in the U.S. District Court for the District of Delaware. The lawsuit alleges breach of contract, conversion, unjust enrichment, and breach of the implied covenant of good faith in connection with the alleged failure to register certain securities issued in the FTA, and the redemption of our Class A warrants in November 2008. The lawsuit seeks damages related to the failure to register certain securities, including alleged late fee payments, of approximately $5.25 million, and unspecified damages related to the redemption of the Class A warrants. In February 2009, we filed a Motion for Partial Dismissal of Complaint. On October 7, 2009, the Court concluded that Leeseberg has properly stated a claim for actual damages resulting from our alleged breach of contract, but that Leeseberg has failed to state claims for conversion, unjust enrichment and breach of the implied covenant of good faith, and the Court dismissed such claims. On November 6, 2009, we filed our answer to the Complaint with the Court. On March 4, 2010, the parties participated in a conference, and began discussing discovery issues. Plaintiff filed a Motion for Class Certification on June 22, 2010, which is pending before the District Court. A jury trial has been set for May 17, 2011.We plan to vigorously defend this matter and are unable to estimate any losses that may or may not be incurred as a result of this litigation and its eventual disposition. Accordingly, no loss has been recorded related to this matter.

     Related to the above matter, in December 2009, we filed a complaint in the Superior Court of Massachusetts for the County of Suffolk, captioned Converted Organics Inc. v. Holland & Knight LLP. We claim that in the event we are required to pay any monies to Mr. Leeseberg and his proposed class in the matter of Gerald S. Leeseberg, et al. v. Converted Organics, Inc., that Holland & Knight should make us whole, because its handling of the registration of the securities at issue in the Leeseberg lawsuit caused any

loss that Mr. Leeseberg and other putative class members claim to have suffered. Holland & Knight has not yet responded to the complaint. Holland and Knight has threatened to bring counterclaims against Converted Organics for legal fees allegedly owed, which we would contest vigorously. On May 12, 2010, the Superior Court stayed the proceedings, pending resolution of the Leeseberg litigation. At this early stage in the case, the Company is unable to predict the likelihood of an unfavorable outcome, or estimate any loss/gain.

     On May 19, 2009, we received notice that a complaint had been filed in the Middlesex County Superior Court of New Jersey, captioned Lefcourt Associates, Ltd. v. Converted Organics of Woodbridge, et al. The lawsuit alleged private and public nuisances, negligence, continuing trespasses and consumer common-law fraud in connection with the odors emanating from our Woodbridge facility and our alleged, intentional failure to disclose to adjacent property owners the possibility of our facility causing pollution and was later amended to allege adverse possession, acquiescence and easement. The lawsuit sought enjoinment of any and all operations which in any way cause or contribute to the alleged pollution, compensatory and punitive damages, counsel fees and costs of suit and any and all other relief the Court deems equitable and just. On April 12, 2010, the Middlesex County Superior Court of New Jersey issued an administrative order settlement dismissing without prejudice the matter of Lefcourt Associates, Ltd. v. Converted Organics of Woodbridge, et al. On June 8, 2010, Lefcourt Associates, Ltd re-filed their lawsuit but before a different court, the Chancery Division in Bergen County. We filed a motion to transfer the action back to the original court in Middlesex County, which was granted and we sought to have the lawsuit dismissed, which was granted in part on August 27, 2010. The Court limited the plaintiffs claims to the events in part that occurred after the dismissal of the prior action.

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

     In October 2010, we issued 165,000 unregistered shares of common stock to New Castle Consulting, LLC for consulting services with regard to investor relations. This transaction was exempt from the registration requirement of the Securities Act of 1933, as amended (the “1933 Act”), pursuant to Section 4(2) under the 1933 Act, as the recipient is an “accredited investor” as defined in the 1933 Act.

Item 3. Defaults upon Senior Securities

     None.

Item 4. [Removed and Reserved]

Item 5. Other Information.

     None.

Item 6. Exhibits

Exhibit No.		Description of Exhibit
31.1		Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
31.2		Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
32.1		Certification of Chief Executive Officer pursuant to Section 906
32.2		Certification of Chief Financial Officer pursuant to Section 906
99.1		Unaudited pro forma consolidated financial statements and consolidated financial statements of TerraSphere Systems LLC as of September 30, 2010 and December 31, 2009 and for the three and nine month periods ended September 30, 2010 and 2009.

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, thereunto duly authorized.